The Savings and Loan Industry: Current Problems and Possible Solutions

By Walter J. Woerheide | Go to book overview

had from their duration mismatch. The PLAMs and GEHLs will help the problem somewhat. The other AMIs simply do not contribute much to alleviating the interest rate risk exposure problem, are not particularly attractive to potential borrowers, or are actually counterproductive. This does not mean that these other forms of mortgages are without socially redeeming features. Indeed, some institutions such as pension funds and life insurance companies may actually have a need for financial securities with durations longer than those offered by the traditional SFPMs. For example, James McNulty has quoted Henry Kaufman as saying that "perhaps the greatest threat to the traditional bond investment" is the shared appreciation mortgage. 105

A cynic might point out that various forms of the adjustables have been around for several years, and the SLAs in 1982 were in their worst condition ever. The response to this is threefold. First, if the AMIs had not been introduced when they were, the SLA industry would be in even worse shape today.

The second response is that the SLAs are suffering from a stock versus flow problem created in part by the high interest rates. Because of the high interest rates rather than the form of mortgage offered, the volume of new mortgage lending is down and the pace of prepayments has slowed considerably. This means the SLAs have had to live longer with the old, low-rate SFPMs in their portfolio (the stock) and have not been able to add a sufficient number of new mortgages (the flow). It follows that once interest rates drop, and the SLAs can incorporate more of the adjustable mortgages into their portfolios, their interest rate risk exposure will be substantially reduced.

The third response to the cynic is that the financial problems of the industry accrue from their inability to forecast accurately the cost of liabilities. Regardless of what mortgage instrument is used, an SLA needs to price a mortgage so that its yield exceeds the average cost of the liabilities used to finance it over the life of the mortgage. Even with adjustable mortgages, SLAs must still make this forecast for the length of the adjustment period. This is not meant to imply that the rapid rise in the cost of liabilities in recent years was predictable. Rather, it was the inability to forecast this rise which created much of the problem and not the type of mortgage instrument used. 106 In fact, it is somewhat ironic that just as the SLAs have begun using these various AMIs which reduce their interest rate risk exposure, they have also received the authority to use financial futures in a way which enables them to transfer to others the task of forecasting changes in interest rates.


NOTES
1.
Henry J. Cassidy, "The Changing Home Mortgage Instrument in the United States," Federal Home Loan Bank Board Journal, December 1978, p. 11.
3.
Other restrictions include that any lender offering a VRM is required to offer the borrower an SFPM, and the lenders are restricted in that the majority of their mortgage portfolio cannot be in VRMs. The lender also has to disclose to the borrower what the

-97-

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The Savings and Loan Industry: Current Problems and Possible Solutions
Table of contents

Table of contents

  • Title Page iii
  • Contents vii
  • Tables ix
  • Acknowledgments xi
  • Introduction xiii
  • Note xv
  • Abbreviations xvii
  • 1 - History of the Federal Home Loan Bank System 3
  • Notes 23
  • 2 - The Determinants of Profitability for Savings and Loans 28
  • 3 - Measuring the Interest Rate Risk Exposure of Savings and Loans 49
  • Notes 67
  • 4 - Alternative Mortgage Instruments 70
  • Notes 97
  • 5 - Financial Futures and Forward Commitments 104
  • Notes 121
  • 6 - Consumer Lending 124
  • Notes 135
  • 7 - The Elimination of Interest Rate Ceilings 138
  • Notes 148
  • 8 - The Introduction of Now Accounts 152
  • Notes 160
  • 9 - Mergers and Conversions 163
  • SUMMARY AND CONCLUSIONS 184
  • 10 - The Future 189
  • Notes 195
  • Bibliography 197
  • Index 211
  • About the Author 217
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