While most industry participants have come to the conclusion that the U.S. housing market is unlikely to post rapid price declines on a nation-wide scale, Standard and Poor's last week released an updated simulation of how the RMBS market would perform in such a scenario - otherwise known as the ominous housing bubble burst.
Those deals backed by fixed-rate borrowers who have equity invested in their homes held up well because they did not experience payment shock. Meanwhile, fixed rate Alt-A transactions experienced defaults at the B' and BB' rating level. Excess spread absorbed losses in the initial years of the subprime transaction, but eventually the BBB-' bond defaulted and the BBB' bond was declared speculative grade.
S&P assumed a 20% national decline in home prices over the next two years and a 30% drop on the East and West coasts and 10% in the middle of the country. Analysts also added in the occurrence of a minor recession in 2007. For fear of inflation, the Federal Reserve in S&P's scenario did not lower short-term interest rates. The rating agency assumed that borrowers - those who have investment properties, and who rely more heavily on home price appreciation would feel more of a sting than others. S&P also assumed adjustable-rate borrowers would be hit harder than fixed-rate borrowers. The simulation was limited to 2006 issuance.
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