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Interbanking Conference in Almaty, Kazakhstan
Subprime Loans:
How to improve
Transparency
September 24 , 2008
Toshihiko Sasaki
Japan Securities Dealers Association
1
1.Matters in Question

Structure of Subprime Mortgage Loans
fees
H ousing loan lenders
housing loan finance com panies,com m ercialbanks,
（
etc.）
lending
H ousing loan brokers (interm ediaries)
H ousing loan borrow ers
・sales
・credit
evaluation
・required
docum entation
G SEs
transfer of
housing loans
（conform ing
loans）
Investors
（investing in
m ortgage-backed
securities w ith high
securities
credit rating）
（Fannie M ae,
Freddie M ac）
Short-term funding
through A B C P
rating
C redit R ating
A gencies
rating
rating
transfer of
housing loans
（non-confirm ing
loans＜subprim e
loans,etc.＞）
ＲＭＢＳ,ＣＤＯ
（w ith high credit
rating）
Investm ent B anks
（ＳＰＣ）
ＲＭＢＳ,ＣＤＯ
（w ith low credit
rating）
B anks provide
back-up lines
for A B C P
Investors
（investing in
securities w ith low
credit rating）
Short-term
funding through
repo transactions
2
Matters in Question

US Economy and Financial Market before
Subprime Crisis
・Continued booming economy
・Prolonged loose monetary policy
・Ample liquidity
・Rise in housing prices
・Reduction in credit and liquidity risk
premiums
3
Matters in Question

Investors
・ preferred high-risk-high-return investing under the aforementioned economic and financial circumstances
←invested in high-yield subprime products (particularly secondary securitized products) aggressively
taking interest-rate, liquidity and credit risks
・ meanwhile, lacked awareness and management of risks
(credit and liquidity risks)
←lacked firm-wide risk management, sometimes without top management’s involvement
←overlooked risks that should be recognized and managed, e.g. liquidity risk arising from off-balancesheet vehicles
←followed conventional risk management practices and lacked awareness of their limitations
←used risk models that did not properly perceive risks of underlying assets of securitized products
・ made investment relying excessively on credit rating
4
Matters in Question

Housing Loan Lenders
・ made loans under substantially relaxed lending criteria
← failed to conduct due examination of loans in the originate-to-distribute process
・ after securitization, provided insufficient disclosure on
performance of housing loans which were underlying assets
of securitized products

Government Authorities
・ kept regulations to protect the privacy of borrowers and may
have eventually hindered adequate information disclosure
←Loan-by-loan information has not been disclosed to all market participants
5
Matters in Question

Credit Rating Agencies
・ failed to duly investigate rating methods and accuracy of
information
・ did not exercise due diligence to credit capability of
housing loan borrowers
・ failed to make reviews periodically by independent groups
from those originally made ratings
・ had organizational structure apt to cause conflict of
interests (acquisition of customers vs. accuracy of ratings)

Originators
・ did “rating shopping” where they selected rating agencies
to get higher ratings they wanted
・ purchased housing loans without due diligence based on
the subsequent sales just after securitization
6
2. US and European Initiatives to Redress the Issues
 Enhanced risk management
・ CEO and top management should be wholly responsible for risk
management. In particular, CRO has a critical role.
・ When taking risks, all kinds of risks including off-balance-sheet
vehicles should be managed.
・ Risk management methods should be revised flexibly depending
on the amount of risks taken and on changes in external
economic environment.
・ Limitations of risk management models and logics like VAR
model should be recognized.
・ For securitized products, risk management models that directly
measure underlying assets’ risks and sensitivity to market should
be employed.
・ Methods for stress test should be improved by expanding its
coverage of risks including liquidity risks.
7
US and European Initiatives to Redress the Issues

Restoration of Confidence in CRAs
・ CRAs should constantly make internal reviewing
of their ratings done by an independent
monitoring department.
・ CRAs should build systems for external review of
the afore-mentioned internal monitoring.
・ CRAs should distinguish ratings of securitized
products from those of corporate bonds.
・ To prevent “rating shopping”, issuers should
provide enough disclosure so that third parties
can make alternative analysis.
8
US and European Initiatives to Redress the Issues
A. Improvement in Transparency
・ “Too much ” information means “too little” .Proper
transparency of information matching the needs of each
market player is imperative.
←For investors to easily understand schemes of securitized products, well-focused and
comprehensive summary of prospectus should be provided.
・ Key countries should take concerted approach for better
transparency and disclosure principles for securitized
products.
・ A common platform that provides database of securitized
products would improve transparency.
・ As well as private sector’s efforts, support from regulatory
and accounting fields (i.e. ensuring consistency between
both fields) is essential.
9
US and European Initiatives to Redress the Issues
B. Improvement in Transparency
・ Investors should expand and enhance disclosure on
securitized products that they hold.
・ Investors should provide sufficient disclosure both in
quality and in quantity as for valuation process for
securitized products.
・ Investors should provide proper disclosure on liquidity
risk management and potential obligations for funding
guarantee for off-balance-sheet vehicles.
10
３．Recent US Financial Market and Economy
 Stock Price
→ Witnessed a small pick up after the Treasury’s announcement of
rescue measures for GSEs on Sep. 7 but traced downward path with
Lehman’s bankruptcy
(US$)
14,500
(Dow Jones Industrial Average)
14,000
13,500
Lehman Brothers Holdings Inc. announced that it
intends to file a petition under Chapter 11 of the
U.S.Bankruptcy Code
( 15 Sep.)
13,000
12,500
GSEs Rescue Announcement
(7 Sep.)
12,000
11,500
11,000
10,500
08/
07/ 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3- 3Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep
11Aug
14Aug
17Aug
20Aug
23Aug
26Aug
29Aug
1Sep
4Sep
7Sep
10Sep
13Sep
16Sep
11
Recent US Financial Market and Economy
 Corporate Bonds’ Spread
→ Still continues to widen
(bp)
（Spread between corporate and government bonds）
360
BBB Rated
320
A Rated
280
AA Rated
240
AAA Rated
200
160
120
80
40
3-
06/Jan
3Mar
3May
(source) Morgan Stanley
3Jul
3Sep
33Nov 07/Jan
3Mar
3May
3Jul
3Sep
33Jan
Nov 08/
3Mar
3May
3Jul
3Sep
12
Recent US Financial Market and Economy
 Real GDP
→ During 2Q in 2008, recorded 3.3% annual growth compared with the previous period,
but its main driving force was external demands. Meanwhile, the trend of domestic
demands keeps weaker.
Annual rate compared to previous period (%)
CY
Private consumption
Inventory Investment
Residential Investment
Net export
Capital investment
Government
Expenditure
Real GDP
13
Recent US Financial Market and Economy
 Private Consumption
→ Already consumed tax reduction effect, private consumption could be
much weaker, due to sharp increase in energy prices and jobless rates
combined with negative-wealth effects triggered by sharp falls of real
estate prices and stock prices.
（Breakdown of Private Consumption）
（Saving Ratio of
Household sector）
Real change, annual rate compared to previous period, contributing rate (%)
CY
CY
Durable
goods
Nondurable
goods
Services
All goods
and services
/2Q
14
Recent US Financial Market and Economy
Employment
→ Continues to show decrease in number of employees and increase in
unemployment rate
US: Number of employees and unemployment rate
(10 thousand)
Number of employees ( right scale)
Unemployment rate (left scale)
CY
15
Recent US Finance Market and Economy
Residential Investment
→Facing sharp reduction and keeps falling
（Residential Investment）
（New Privately-owned Housing Units Started）
Real base, annual rate compared to previous period, contributing rate (%)
10 thousand units
Housing Units
Started (left scale)
Average fixed interest
rate of 30 year
mortgage
/2Q
CY
single
family
houses
collective
housing
others
residential
investment
CY
16
Recent US Financial Market and Economy

Future Prospects －key items
A. When would the private consumption hit the bottom?
B. When would the sharp construction of liquidity in the
financial markets get loose?
C. When would the stock prices hit the bottom?
⇒ Vicious circle between weaker real economy and dry-up
of liquidity in the U.S. should be avoided at any cost.
At the same time, a balance between “bail-out”
and ”moral hazard” should be perused.
17
4.Japan’s Situation

Subprime-related Losses in Japanese Financial Institutions
→Very limited compared with their business capacity and periodic income.
（
S ubprim e-related losses of Japanese deposit-taking institutions）
billion U S $
S ubprim e-related
realized
S ubprim e-related
T ier１C apital
O perating
valuation
profits/losses(-)
（
end-M arch,
P rofits（
endprofits/losses(-)
(totalfrom
2008）
M arch,2008）
（
end-June,2008）
A pr.2007 to
Jun.2008)
475
57
-1
-7
(source) FinancialS ervices A gency
→Japanese financial institutions have limited exposure to subprime-related products.
→Most securities firms’ subprime-related business is also a small portion.
（
Exposures of Japanese deposit-taking institutions to
subprim e-related products）
billion U S $
P roducts w hose
underlying assets w ere
originated abroad
B ook value
223
（
source）FinancialS ervice A gency
134
S ubprim e-related
products
9
18
Japan’s Situation
A. Responses in Japan



Japanese financial sector hold bonds issued by Fannie Mae and Freddie Mac
amounting 142 billion US dollars, second largest figures in Asia next to China.
In addition, losses triggered by the bankruptcy of Lehman Brothers should be handled.
Assuming all the negative elements are taken into account so far, our efforts have
focused on establishing preventive methods to avoid the same problem to occur in the
future.
Recent Issuance of Securitized Products
（\ trillion）
Japan
（Billion US$）
12
United States
1400
July-Dec.
Jan.-June
10
8
Aug.-Dec.
Jan.-July
1200
1000
800
6
600
4
▲３１．９％
400
2
200
0
0
2006
2007
2008
(source) Survey by Securitized Product Research Dept. of Deutsche Securities
▲７８．２％
2006
2007
2008
(source) Debt Capital Markets Review, Thompson Reuters
19
Japan’s Situation
B. Preventive measures in Japan
“Risk Management”
・ Japanese authorities are taking steps to strengthen risk management of investors.
・ Market-related bodies at the same time, started working to strengthen risk
management on their part.
“Avoidance of Moral Hazard”
・ In Japan, the lenders of housing loans, such as banks and others, rarely sell the
assets because the conditions are relatively good enough for most banks. As a result,
there are relatively few loans extended to later securitization.
・ Overall loan screening is carried out more prudently because of Japan’s experience
suffered by NPLs in the last decade. Inspections by authorities have also been
strengthened.
“Restoration of Confidence in CRAs”
・ Authorities and rating agencies are planning to take actions based on the discussions
in international bodies, such as the FSF and IOSCO.
・ Investors are also reinforcing their risk management and revising their excessive
dependence on ratings.
20
Japan’s Situation
“Accounting Valuation”←Enhancing Transparency
・ Actions will be taken based on the discussions in international bodies such as the
FSF and IOSCO
“Traceability of Underlying Assets”←Enhancing Transparency
・ Authorities made a revision of the supervision guidelines for Financial Instrument
Businesses Operators requiring distributors to establish procedures that ensure
traceability of underlying assets of securitized products for investors.
The JSDA set up a Working Group on Distributions of
Securitized Products to formulate self-regulatory rules.
21
Japan’s Situation

Initiative by JSDA
〇 In its interim report announced July 24 of this year, JSDA’s
Working Group on Distributions of Securitized Products indicated
the intention to formulate self-regulatory rules.
（ Towards formulation of self-regulatory rules）
A. A Unified Information Disclosure Format will be created to indicate
the detailed contents of information provision. → see Appendix 2
B. Distributors will have to properly provide information on the details
and risks of the underlying assets in securitized products to investors
taking fully into account the instructions described in the supervision
guidelines (The use of the Unified Information Disclosure Format will
be decided depending on individual transactions.).
〇 Following further detailed analysis in terms of practicality
based on the above, JSDA is planning to compete formulation
of the self-regulatory rules by February next year.
22
(Appendix 1)
US Government and Financial Authorities’ Responses
 Urgent measures (to avert negative impacts between
financial markets and the real economy)
A. Policy rate reduction and liquidity supply
→ From August 2007 to April 2008, FRB cut the Federal Funds (FF) Target Rate and official
discount rate several times (FF Target Rate: 5.25％→2.00％, official discount rate:6.25％
→2.25％)
→ In July 2007, FRB supplied huge amounts of funds and, in December, started the Term
Auction Facility (TAF) Program which allows to collateralize a wide range of assets
including RMBS.
→ In March 2008, FRB extended lending to Bear Stearns (BS) facing difficulty in its
management through JP Morgan Chase, who eventually acquired BS.
→ In December 2007, five central banks in the US and Europe announced measures to ease
pressure toward rising interest rates in short money markets. In March 2008, their second
collaborative approach was carried out.
→ Major Central Banks declared to provide ample liquidity to financial markets triggered by the
bankruptcy of Lehman Brothers (18,Sep).
B. Announcement of relief measures for GSEs
→ On September 7, the US Treasury Secretary Paulson announced that, in order to bail out
the two ailing GSEs (Fannie Mae and Freddie Mac), the government would put them under
its government control in the meantime and inject public money amounting to 2 bil. dollars
(approx. 220 bil. yen) .
C. Rescue of AIG by US Government (16,Sep)
23
US Government and Financial Authorities’ Responses

Protection of Housing Loan Borrowers
・Measures to avoid foreclosure
→ In August 2007, President Bush announced countermeasures to subprime
housing loan problem including review of the Federal Housing Loan Insurance,
budgetary support to avoid foreclosure, etc.).
→ The Bush administration expressed its support to “Hope Now” Plan, the
framework initiated by the American Securitization Forum (ASF) to bail out
subprime loan borrowers.
24
(Appendix 2)
Item s on the C om m on Inform ation Item List（
For ＲＭＢＳs）
Ⅰ．Inform ation on S pecialFeatures of P roduct and O utline of Issue
I-1
P roduct nam e
I-2
P roduct type
I-3
M ain applicable law s
I-4
Issuance total,ussance am ount of each tranche
I-5
A rrangers,underw riters and distributors
I-6
Issue date
I-7
Issue am ount
I-8
Interest rate and planned dividend rate
I-9
Interest paym ent date
I-10 R epaym ent m ethod
I-11 Finallegalrepaym ent date
I-12 P lanned repaym ent date or schedule
I-13 Forecast repaym ent schedule,etc.
I-14 R atings
Ⅱ．Inform ation on structure and parties involved
II-1 B asic schem e
II-2 O riginator
II-3 S ervicer
II-4 Issuer
II-5 O ther m ajor parties involved
II-6 S chem e-related risk
II-7 C redit and liquidity enhancem ents
II-8 Location of risk in structure
II-9 S tructure of trigger
II-10 W aterfall
Ⅲ．Inform ation on U nderlying A ssets
III-1 O utline of underlying assets
III-2 O utline of origin of underlying assets
III-3 Eligibility requirem ents
III-4 G rouping of underlying asset pools
III-5 C ash flow from underlying assets (planned)
III-6 W eighted average coupon (W A C )
III-7 W eighted average m aturity (W A M )
III-8 G roup distribution of debts or debtors for assets
Ⅳ．P erform ance of core pool,etc.,and asset pools used as com parative reference
IV -1 D elinquency rate
IV -2 D efault rate
IV -3 A dvance repaym ents
IV -4 C ollection or loss rate
IV -5 O thers
IV -6 G rouping of com parison pools
Ⅴ．S urveillance follow ing issue
V -1 Issue am ount
V -2 Interest rate (dividend rate)
V -3 R atings
V -4 C urrent credit and liquidity enhancem ent
V -5 Trigger indicators
V -6 O ccurrence or non-occurrence of events
V -7 A llocation of paym ents
V -8 B alance of subordinated portion
Ⅵ．P aym ents on U nderlying A ssets
V I-1 B alance of debt involved w ith underlying assets
V I-2 W A C
V I-3 W A M
V I-4 O ther poolgroupings
V I-5 G rouping allotm ent of debt or debtors behind underlying assets
V I-6 D elinquency am ount and rate
V I-7 A m ount of incurred default and rate
V I-8 C um ulative default or am ount of incurred loss and rate
V I-9 A dvanced repaym ent rate
V I-10 C ollection rate or loss rate
V I-11 B uyback rate
V I-12 O thers
25