Louisiana State University LSU Digital Commons LSU Historical Dissertations and Theses Graduate School 1990 Failed or Failing Lending Institutions Behavior and Implications for the Pricing of Mortgages. Quang Vinh Do Louisiana State University and Agricultural & Mechanical College Follow this and additional works at: https://digitalcommons.edu/gradschool_disstheses Recommended Citation Do, Quang Vinh, "Failed or Failing Lending Institutions Behavior and Implications for the Pricing of Mortgages. LSU Historical Dissertations and Theses.edu/gradschool_disstheses/4979 This Dissertation is brought to you for free and open access by the Graduate School at LSU Digital Commons. It has been accepted for inclusion in LSU Historical Dissertations and Theses by an authorized administrator of LSU Digital Commons.
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University Microfilms International A Bell & Howell Information C om pany 300 North Z ee b Road, Ann Arbor, Ml 48106-1346 USA 313/761-4700 800/521-0600 Order N um ber 0112336 Failed o r failing lending institutions behavior an d im plications for th e pricing of m ortgages Do, Quang Vinh, Ph. The Louisiana State University and Agricultural and Mechanical Col., 1900 C o p yright © 1091 by D o, Q uang V inh. All rlghtB reserved. Ann Aibor, MI 48106 Tailed or Tailing Lending Institutions Behavior and Implications for The Pricing of Mortgages A Dissertation Submitted to the Graduate Faculty of the Louisiana state University and Agricultural and Mechanical College in partial fulfillment of the requirements for the degree of Doctor of Philosophy in the Interdepartmental Program in Business Administration by Quang Vinh Do B., Chemistry, Emporia State University, 1976 B., Chemical Engineering, Kansas State University, 1977 M., Louisiana State University, 1983 M., Finance, Louisiana state University, 1985 August 1990 ACKNOWLEDGMENTS I would like to express my appreciation to my committee members: Dr.
John Howe, Dr. John Glascock and Dr. Loren Scott and Dr. X owe a special thank to Dr.
Jim Shilling, the chairman of my committee, for his patience, encouragement and advice. He has been a great help and inspiration as a teacher and advisor. I also would like to express my sincere appreciation to my major professor and committee member: Dr. His encouragements and guidance have been invaluable during my study at LSU.
I appreciate the active interest he has taken in my academic and professional development. I owe him a debt of intellectual growth. Special thanks are extended to Subbarao Jayanti, Rama Jayanti, John Hatem, Krisandra Guidry, David Batker, David Cornell, Greg Bushong, Joan Payne, Bessie Avera and many significant others for their continuing friendship and support. They have helped make my time at LSU genuinely enjoyable and rewarding.
This list of acknowledgements could never be complete without my special thanks and love to my mother. I shall always be greatful for the great influence she has had on my life. I owe her more than words can express. This is dedicated to her.
ii Contents chapter Paga Acknowledgements. 11 Liat of Tables. v List of Figures. Variations in Mortgage Pricing.
Institutional Disparities in Mortgage Pricing. Pricing Practices of Failed or Failing Institutions: The Case of Fixed-Rate Mortgages.1 Underpricing of Default Risk.2 Underpricing of Interest Rate Risk. Pricing Practices of Failed or Failing Institutions: The Case of Adjustable-Rate Mortgages. The Chow Test.
Goldfeld and Quandt Test. Tishler and Zang Test. Model Specifieiations andEmpirical Results: The Case of Fixed>RateMortgages. The Pricing of Fixed Rate Mortgages.
The Chow Test. The Goldfeld and Quandt Estimation Techniques. The Tishler and Zang Estimation Method. Empirical Results and Discussions.
Model Specifications and Empirical Results. The Case of Adjustable-Rate Mortgages. The Pricing of Adjustable-Rate Mortgages. The Chow Test for Adjustable-Rate Mortgages.
The Estimation of ARMs Using Goldfeld and Quandt Model. Estimations for ARMs Using Tishler and Zang Model. Empirical Results and Discussions. Summary and conclusion.
119 Appendix At Modeling the Behavior of railed or Failing Lending Institutions. The Model Framework. The Objective Expect Value Function.137 Appendix Ct The Institutional Picture of Mortgages. A Brief History of Mortgage Lending.
The Capital Markets. Mortgage Financing and Financial Intermediaries. Adjustable-Rate Mortgages. Graduated-Payment Mortgages.
Mortgage-Related Securities. Mortgage Pass-Throughs. Mortgage-Backed and Mortgage Pass- Through Bonds. Collateralized Mortgage Obligations (CMOs.
153 Appendix Dt Models of the Savings and Loan Institutions: A Review. 160 iv LIST OF TABLES Value of Mortgage with Default and Prepayment($). 37 Value of Mortgage without Default($). 38 Value of Default($).
39 Values of Default with Changes In Variances and Loan to Value Ratio (basis points). 40 Value of Fixed-Rate Mortgages for solvent and insolvent Institutions and the Interest Rate Risk Premium at Difference Mean Reversion Coefficient (b). 41 Value of Adjustable-Rate Mortgages for Solvent and insolvent Institutions and the Interest Rate Risk Premium on a $100,000 Loan. 42 Effective Rates on Fixed-rate Mortgages Made Between May and July 1987.
64 Sample Distribution of ARMs and FRMs by States for the Period Between May and July 1987. 65 Difference in Effective Rates Between Fixed-Rate Mortgages Originated by Solvent and Insolvent Thrift Institutions for all States for May-July 1987. 66 Difference in Effective Rates Between Fixed-Rate Mortgages Originated by Solvent and Insolvent Thrift Institutions for various States for May-July 1987. 67 Estimated Results for Fixed-rate Mortgages for the Month of May, June, July, 1987, Unrestricted Model (i=l).
68 Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July, 1987 Unrestricted model (i=2). Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July, 1987 restricted model. Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July, 1987. Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July,1987; Testing for pairs coefficients.
Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July, 1987 Testing for pairs coefficients [-1. Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July, 1987 Testing for pairs coefficients [—1. Estimated Results for Fixed-Rate Mortgages for the Month of May, June,July,1987 Unrestricted Model. Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July,1987 Restricted Model 79 5.
Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July, 1987. ML Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July, 1987 (Unrestricted Model) Using Goldfeld and Quandt. ML Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July, 1987 (Unrestricted Model) Using Tishler and Z a n g. ML Estimated Results for Fixed-Rate Mortgages for the Month of May, June, July, 1987 (Restricted Model) Using Goldfeld and Quandt and Tishler and Z a n g.
Effective Rates on Adjustable-Rate Mortgages Originated Between May and July 1987. Characteristics of ARMs Originated vi for the Months of May Through July 1987. Distribution of ARMs by Various States and Period of Adjustments For 1987. Number of ARMs for Various Ranges of Life-of-Loan Cap For the Year 1987.
Number of ARMs for Various Range of Periodic Cap Rate For the Year 1987 101 6. Differences in Effective Rates Between Adjustable-Rate Mortgages with Periodic Rate Cap £0,2%] Originated by Solvent and Insolvent Thrift Institutions in Various States for May-July 1987. Differences in Effective Rates Between Adjustable-Rate Mortgages with Periodic Rate Cap [0,2%] Originated by Solvent and Insolvent Thrift Institutions in The State of California for May-July 1987. Differences in Effective Rates Between Adjustable-Rate Mortgages with Periodic Rate Cap [0,2%] Originated by Solvent and Insolvent Thrift Institutions in The State of California at various Teaser Rate for May-July 1987.
Estimated Results for Adjustable-Rate Mortgages for the Month of May, June, July, 1987 (Unconstrained Model). Estimated Results for Adjustable-Rate Mortgages for the Month of May, June, July, 1987 (Constrained Model). Estimated Results for Adjustable-Rate Mortgages for the Month of May, June, July, 1987. Estimated Results for Adjustable-Rate Mortgages for the Month of May, June, July, 1987 (Testing for Pair Coefficients).
ML Estimated Results for Adjustable-Rate Mortgages for the Month of May, June, July, 1987 Using Goldfeld and Quandt (Unconstrained Model). ML Estimated Results for Adjustable-Rate vii Mortgages for the Month of May, June, July, 1987 Using Tishler and Zang (Unconstrained Model). ML Estimated Results for Adjustable-Rate Mortgages for the Month of May, June, July, 1987 Using Goldfeld and Quandt and Tishler and Zang (Constrained Model). Estimated Results for Adjustable-Rate Mortgages for the Month of May, June, July, 1987 (Testing for Pair Coefficients) [-3.
Estimated Results for Adjustable-Rate Mortgages for the Month of May, June, July, 1987 (Testing for Pair Coefficients) [-4. Estimated Results for Adjustable-Rate Mortgages for the Month of May, June, July, 1987 (Testing for Pair Coefficients) [-5.114 viii List of Figures Figure Page 3.1 Relationship Between Value of a Defaultable Fixed-Rate Mortgage and House Prices .1 The Approximation of D(r.) as Suggested by Goldfeld and Quandt.2 The Approximation of D(r,) as Suggested by Tishler and Z a n g. 51 ix Abstract As of 1989 more than one-fifth of the nation's federally insured saving and loans institutions have negative net worth. Very little is known, however, about their pricing behavior of financial assets.
Host of the existing literature has focused on whether insolvent institutions bid up their cost of funds. The asset pricing issue of insolvent institutions has not been examined in the mortgage literature. This dissertation extends the literature by examining whether failed or failing saving and loan institutions offer their conventional fixed- and adjustable-rate mortgages at a discount relative to solvent institutions. A theoretical argument for the underpricing proposition is presented based on the premises that insolvent lending institution use the conditional repayment probability and do not consider capital losses due to an adverse shift in interest rates in setting credit rates.
Therefore, insolvent lending institutions will tend to offer lower contractual interest rates on mortgages than well- capitalized institutions. Using a national data set three empirical tests are performed: a Chow test, a Goldfeld and Quandt test, and the Tishler and Zang maximum likelihood optimization technique. The results show that failed or failing saving and loans institutions do, indeed, offer their conventional fixed- and adjustable-rate mortgages at a discount relative to healthy lending institutions. x Failed or Failing Landing Institutions Behavior and Implications for the Pricing of Mortgages chapter I introduction Over the past few years the unsuccessful attempts to contain the escalating problems in the saving and loans industry have led to alarming headlines in the financial press about lending institutions failures, buyouts, and forced mergers.
Also, there are dismal predictions of the imminent collapse of the entire thrift industry. Many thrifts— approximately one-fifth of all federally insured thrift institutions— are negative-net-worth institutions that are being gradually closed.