Mortgage Prepayments as a Precursor to the Financial Crisis

Abstract

Mortgage-backed security prices have depended on interest rates, while idiosyncrasies of prepayments had obscured the effect of rates on portfolio value before the financial crisis. The principal components of balance sheet accounts identified managerial dimensions that could help clarify the portfolio sensitivity to interest rates. The real impact of prepayments and default on the value of equity had appeared negligible since the first two components were correlated, as was required by hedge-accounting rules at that time.