Securitization and Asset Price Cycle: Causality and Post-Crisis Policy Reform

Abstract

This study aims to explain causal relationships between the two dramatic cycles observed in the U.S. during the recent financial crisis - the mortgage credit cycle and the home price cycle. In the viewpoint of mortgage lending, the main demand-side driver for the observed credit concentration from the early 2000s was the extremely low, even negative, user cost of capital (UCC) for owning between 2002-2006. UCC was, in turn, influenced by three key factors - the record low mortgage interest rate, the practical removal of capital gains taxes for home sales, and high expected home price appreciation on the part of home owners. Easing borrowing constraints, gradually from the early 1980s and abruptly from the early 2000s, is also shown as a significant shift factor in the demand side. In the supply-side, the main drivers for the boom-bust of mortgage credit between early to mid 2000s are identified to be: the favorable interest rate environment, the low rates as well as the sizable yield spreads, which rapidly changed from 2005; the generous bond ratings at initial security issuance, followed by abrupt and deep post-issuance downgrading from 2007; and, the sudden rise of the private-label (PL) RMBS issuers from 2004, resulting in gradual deterioration of the mortgage underwriting criteria. Preliminary econometric analyses show that: the share of PL RMBS in the total issuance Granger-caused the home price growth, but not the other way around; and, the home price boom-bust in the 2000s was significantly influenced by UCC and the share of PL RMBS, but not by the total issuance volume of RMBS. Policy implications of the findings are discussed, in particular, regarding micro- and macro-prudence regulations governing the mortgage-MBS sector.