Chapter 2 — Exercises

Thirty problems. Items marked † have worked solutions in Appendix: Answers to Selected Exercises. No answers appear here.

A. Recall

2.1 Describe the typical American home loan of the 1920s in five attributes: term, amortization, what happens at maturity, typical loan-to-value, and renewal expectation.

2.2 † What is a balloon mortgage, and why was the balloon itself not considered a defect at the time?

2.3 What did the Home Owners' Loan Corporation do, and in what year was it created?

2.4 † The FHA was created in 1934. State precisely what it does — the verb matters — and what it does not do.

2.5 Name the four HOLC grades, their colors, and their labels.

2.6 In 1968 Fannie Mae was split. Name both resulting entities and say which one stayed inside the federal government.

2.7 † Match each entity to its year and function: Fannie Mae, Ginnie Mae, Freddie Mac, FHA, VA guaranty.

2.8 What is a pass-through security?

2.9 The savings and loan crisis is described in this chapter as a crisis of what kind of risk — and specifically not what kind?

2.10 Name the two 2008 statutes and the two 2010 institutions or rules this chapter says a loan officer works under daily.

B. Applied reasoning

2.11 † §2.1 argues the 1920s mortgage "did not have an obvious defect; it had an assumption." State that assumption in one sentence, then explain the mechanism by which a borrower who was employed and current could still lose a house in 1932.

2.12 The chapter claims the government created a mortgage market "by insuring and standardizing, not by lending." Give two pieces of evidence for that claim from §2.2, and name one modern institution that operates the same way.

2.13 † Explain, in terms a real estate agent would follow, why standardization of forms and guidelines was a prerequisite for a secondary market rather than a bureaucratic side effect.

2.14 §2.3 argues that the value of the 1930s inventions makes the exclusion more consequential rather than less. Reconstruct that argument in your own words in under 120 words.

2.15 † Restrictive covenants became judicially unenforceable in 1948, and the FHA's underwriting posture persisted afterward. Explain why the second fact matters more than the first for understanding modern disparate impact doctrine.

2.16 §2.4 says the amount of mortgage money available in the United States "is not limited by how much Americans have saved." Explain what it is limited by, and give one observable consequence a loan officer sees weekly.

2.17 † Explain the savings and loan crisis to someone who believes a bank fails only when its borrowers stop paying.

2.18 Choose three rows from the table in §2.6 and, for each, explain the specific harm to a borrower that the practice produced.

2.19 §2.6's ASCII diagram claims "nobody in the chain who could see the loan file bore the loss on it." Identify the one party in that diagram who bore all of it, and explain why they could not evaluate what they were buying.

2.20 † For each of the three eras in §2.9's "hidden assumption" argument, name the assumption. Then name one assumption you would expect to find embedded in mortgage lending as it is practiced today, and say how you would test it.

C. Run the numbers

2.21 † Using the §2.1 structure, compute the following for a \$10,000 house purchased in 1925 with 50% down on a five-year interest-only balloon at 6%: monthly payment, total interest paid over five years, principal reduction over five years, and amount owed at maturity.

2.22 The Linden Street borrowers build \$22,879.83 of equity from amortization in the first sixty payments. Express that as (a) a monthly average and (b) a percentage of the original loan amount.

2.23 † Using the §2.5 model: a thrift holds \$100,000,000 of mortgages at 7% and pays 12% on deposits. Compute the annual spread in dollars. Then compute what deposit rate would bring the institution back to breakeven, and comment on whether that is achievable.

2.24 A 2/28 hybrid ARM has a teaser rate of 3.5% for two years, then adjusts to a fully indexed rate of 8.25%. On a \$200,000 loan, compute the monthly principal-and-interest payment at each rate and the increase as both a dollar figure and a percentage. (You may use a payment calculator.) Then state which figure the Ability-to-Repay rule requires the borrower to be qualified at.

D. Judgment and writing

2.25 † Write the reply, in under 120 words, to the borrower in §2.8's On the Phone callout who asks why their parents bought a house with a handshake and they need two years of tax returns. Do not be defensive and do not apologize for the rules.

2.26 An experienced colleague tells you that fair lending law is "a compliance box, not a real issue in this market." Using only material from §2.3, write a three-sentence response you would actually say to a peer.

2.27 A borrower asks whether an adjustable-rate mortgage is "one of those loans that caused the crash." Write an accurate answer that neither defends the product uncritically nor confirms the premise.

2.28 Pick the single entry in §2.8's failure-to-rule map that you think a new loan officer is most likely to experience as pointless bureaucracy. Write the paragraph you would use to explain it to them.

E. The Loan File

2.29 † Complete the 1928-versus-2026 counterfactual table from the chapter's checkpoint for the Linden Street file, filling in every cell. Then answer: which single line in that table does the most work in making the purchase possible?

2.30 In your Appendix C workbook, write the plain-language paragraph the checkpoint asks for — explaining to these borrowers why \$38,000 buys a \$385,000 house — without using the words "leverage" or "amortization." Then mark every claim in it as historical fact, arithmetic, or assumption.