Securitization and Moral Hazard: Evidence from Credit Score Cutoff Rules

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Mortgage originators use credit score cutoff rules to determine how carefully to screen loan applicants. Recent research has hypothesized that these cutoff rules result from a securitization rule of thumb. Under this theory, an observed jump in defaults at the cutoff would imply that securitization led to lax screening. We argue instead that originators adopted credit score cutoff rules in response to underwriting guidelines from Fannie Mae and Freddie Mac and offer a simple model that rationalizes such an origination rule of thumb. Under this alternative theory, jumps in default are not evidence that securitization caused lax screening. We examine loan-level data and find that the evidence is inconsistent with the securitization rule-of-thumb theory but consistent with the origination rule-of-thumb theory. There are jumps in the number of loans and in their default rate at credit score cutoffs in the absence of corresponding jumps in the securitization rate. We conclude that credit score cutoff rules provide evidence that large securitizers were to some extent able to regulate originators' screening behavior. Terms of use: Documents in EconStor mayJEL Classifications: D82, G01, G18, G21, G24, G28.

Securitization and Mortgage Default

“…14 This definition is also used by Bubb and Kaufman (2014). In an earlier version of this paper, we considered a different definition of the investor type and obtained nearly identical estimation results.…”

“…For example, in the New Century securitization studied by Ashcraft and Schuermann (2008), 57 % of all loans have FICO scores below 620. Furthermore, work by Bubb and Kaufman (2014) shows that this B620-discontinuity^also plays a role in underwriting nonsecuritized loans, which, they suggest, makes it difficult to use to make inferences on the link between securitization and adverse selection.…”

Subprime mortgage design

“…The dominant explanation for the subprime crisis has been that securitization led to a severe weakening in underwriting standards over the past few years, eventually causing a downturn in this market (see Mayer et al, 2009, and references therein). However, evidence on lax underwriting for subprime mortgages due to the originate-to-distribute channel has been mixed (Bubb and Kaufman, 2011). This paper departs from this debate and proposes an alternative hypothesis for the boom and bust in the subprime mortgage market.…”

Household Debt: Facts, Puzzles, Theories, and Policies

“…), and empirical evidence on whether, how, and how much asymmetric information actually affects market outcomes is finally catching up to theory and practice. Examples include Adams et al (2009) and Dobbie & Skiba (2013) on subprime auto and payday loans, several papers on mortgage securitization (e.g., Keys et al 2010, Bubb & Kaufman 2014, and a growing literature on strategic default by mortgagors (e.g., Mayer et al 2014).…”