Subprime Borrowers, Securitization and the Transmission of Business Cycles

Abstract

A growing literature (e.g., Jaffee et al. 2009, Acharya andSchnabl 2009) argues that securitization improves financial stability if the securitized assets are held by capital market participants, rather than financial intermediaries. I construct a quantitative macroeconomic model with a novel specification for mortgage-backed securities (MBS) to evaluate this claim. My findings suggest that the existence of the securitization market stabilizes the economy under the condition that financial intermediaries do not engage in the acquisition of securitized assets. In the presence of large negative housing preference shocks, the drop in output in the first year after the shock is halved if subprime MBS are purchased by non-financial agents rather than held by banks.

Subprime borrowers, securitization and the transmission of business cycles

“… Previous versions of the paper (Grodecka , Grodecka , chapter 1 in Grodecka ) included also the existence of prime borrowers who may borrow for long term and do not default on their loan obligations. The existence of prime borrowers has a quantitative impact on the results of the paper (it dampens the responses to the shocks shown in the paper), but does not change them qualitatively.…”

“… Capital and investment were part of the model in the earlier version of this paper, Grodecka (), and their inclusion does not change the results qualitatively, so for simplicity reason they were left out from this analysis. …”

“… A list of the log‐linearized equations for the extended version of the model (including capital and investment, as well as impatient prime borrowers) may be found in the previous working paper version of this model, Grodecka (). …”

“… An earlier working paper version presenting this model (Grodecka ) includes also a technology and an inflation shock. Monetary and preference shocks are the most important in explaining the main transmission mechanism, so I focus on only them.…”