Residential Mortgage Securitization Research Articles

Securitization and risk appetite: empirical evidence from US banks

I investigate the impact of securitization on the risk-taking by bank holding companies (BHCs). For 2001 to 2017, I find a negative relationship between securitization and the risk appetite of BHCs. I find a negative relationship between securitization and the risk appetite of BHCs that is consistent with the recourse hypothesis of securitization. I also discover that the equilibrium in this relationship changes from the pre-crisis to the crisis period (crisis effect). This crisis effect hampers BHCs’ ability to engage in securitization that leads them to accumulate more risky assets on their books due to the deteriorated quality of their loan portfolios. This equilibrium then reverses after the crisis (post-crisis effect) due to policy makers’ response to the excessive risk-taking that manifested during the crisis. Moreover, I find that the securitization of residential mortgages not only boosts the recourse hypothesis but also triggers the crisis effect. My findings provide novel empirical insights into the different nexuses between the securitization and risk appetite of BHCs around the financial crisis.

Formulaic Transparency: The Hidden Enabler of Exceptional U.S. Securitization

Why does the securitization of residential mortgages, credit cards, auto loans, and other such consumer debt in the U.S. exceed the securitization of such debt in Europe by several trillion dollars? The author points out that lemon problems do not stop the sale of used cars but they do prevent the operation of a market in which buyers place sight‐unseen bids for used cars offered by unknown sellers. Buyers prefer to know who the seller is and test‐drive vehicles. Similarly until the 1980s, creditors were willing to forgo the information they could secure in private transactions to get tradability mainly in the case of bonds issued by governments or a few blue‐chip companies.U.S. government policy encouraged the securitization of trillions of dollars of loans made to millions of borrowers. U.S. rules—rather than new financial or information technologies—have strongly encouraged originators of mortgages and other consumer loans to rely on credit scores (commonly referred to as FICO scores) produced by credit bureaus. And reliance on scores that loan originators use but don’t produce helps overcome the information asymmetry problems that would otherwise constrain securitization.The argument turns the usual concern about securitization on its head: transferring risks to investors is normally expected to discourage careful screening of borrowers, but the author’s analysis suggests that formulaic, FICO‐based screening actually enables risk transfer by reducing information asymmetry problems. Moreover, while limiting screening reduces the upfront costs of lending, it also increases loans made to uncreditworthy borrowers.And because increasing loans made to bad borrowers raises the rates good borrowers have to pay (to compensate investors for higher defaults), U.S. rules that sacrifice information for more “complete” markets may be a bad bargain.

Qualified residential mortgages and default risk

Abstract The Dodd–Frank Act tasks regulators with defining a Qualified Residential Mortgage (QRM) as an exemption from risk retention for residential mortgage-backed securities. Congress instructs regulators to consider factors that result in lower levels of historic default in defining a QRM. We analyze non-agency loans and find credit scores and loan-to-value ratios are among the most significant predictors of default, even when controlling for risky loan products and loose underwriting standards. Importantly, credit scores and loan-to-value ratios better tradeoff the benefit of reduced default risk with the cost of limiting access to capital than most factors, yet are absent from the final QRM definition. Our results have important implications for current and future policy on residential mortgage securitization, risk retention, and disclosure.

Qualified Residential Mortgages and Default Risk

The Dodd-Frank Act tasks regulators with defining a Qualified Residential Mortgage (QRM) as an exemption from risk retention for residential mortgage-backed securities. Congress instructs regulators to consider factors that result in lower levels of historic default in defining a QRM. We analyze non-agency loans and find credit scores and loan-to-value ratios are among the most significant predictors of default, even when controlling for risky loan products and loose underwriting standards. Importantly, credit scores and loan-to-value ratios better tradeoff the benefit of reduced default risk with the cost of limiting access to capital than most factors, yet are absent from the final QRM definition. Our results have important implications for current and future policy on residential mortgage securitization, risk retention, and disclosure.

La titrisation aux États-Unis et au Canada

Depuis la recente crise economique, la titrisation des actifs financiers – et notamment des hypotheques residentielles – est menacee, tant aux Etats-Unis qu’au Canada. Aux Etats-Unis, les banques ont stoppe completement leurs activites de titrisation. Au Canada, le marche du papier commercial adosse a des actifs est moribond et les nouvelles normes comptables (IFRS) grevent l’avenir de la titrisation des hypotheques residentielles. Cependant, en depit de failles non negligeables, la titrisation contribue a diminuer la procyclicite de la croissance du credit. Des mesures doivent donc etre mises en œuvre par les autorites des marches financiers pour revigorer la titrisation.

Oversight and Due Diligence: Independent Credit Risk Managers and Trust Oversight in RMBS Transactions

In structured finance transactions, a trustee works collaboratively with the issuer and servicer to protect the financial interest of the investors. Large investors have been lobbying for residential mortgage-backed securities (RMBS) trustees to take on a more direct role to ensure that initial collateral conforms to the representations and warranties, put-back rights under the securitization’s reps and warranties are exercised properly, all loan documentation is properly executed and transferred, servicers are performing their duties, and adequate transparency is provided to the investors. RMBS trustees, however, are not currently equipped to handle any of these functions. Given the market and technical expertise required in the mortgage securitization arena, trustees could benefit from partnering with or retaining the services of an independent credit risk manager (CRM) steeped in a high degree of domain knowledge related to evaluation, modeling, stress testing, regulatory reporting, and complex asset credit underwriting. This article seeks to explain the role an independent CRM can provide in securitization of residential mortgages, with a specific focus on governance. <b>TOPICS:</b>MBS and residential mortgage loans, legal/regulatory/public policy, credit risk management

Finance’s outsiders?: networks, knowledge and power beyond the City

Contemporary research on the credit crunch has often been framed through global narratives. Although these studies recognize the spread of the US subprime crisis to different nation-states, research by geographers and social scientists which explicitly examine how the crisis unfolded at different spatial scales has been limited. This article seeks to provide new insight into how regional financial spaces became connected to global financial networks. Specifically, this article investigates the deepening of relations between ‘peripheral’ and global spaces, through the social production and securitization of residential mortgages. It argues that the formation of new powerful communities of practice and the development of project ecologies to securitize mortgages enabled the cultivation of temporal trans-local relationships, exposing British mortgage lenders to the credit crunch.

Stochastic control of credit default insurance for subprime residential mortgage-backed securities

Subprime residential mortgage securitization and its associated risks have been a major topic of discussion since the onset of the mortgage crisis in July 2007. In this paper, we provide a stochastic dynamic model for investing bank profit under mortgage securitization. In addition, aspects of this model are illustrated by means of a numerical example. In addition, we solve a stochastic optimal credit default insurance problem that has the cash outflow rate for satisfying depositor obligations, the investment in structured mortgage products and credit default insurance as controls. As far as the latter is concerned, we compute credit default swap and accrued premiums by considering the credit rating of structured mortgage products such as residential mortgage-backed securities and collateralized debt obligations. Copyright © 2011 John Wiley & Sons, Ltd.

Securitization and Mortgage Renegotiation: Evidence from the Great Depression

We use loan-level data from the New York City metropolitan area to examine the extent to which lenders attempted to prevent foreclosures with concessionary modifications during the Great Depression. We find no principal forgiveness in the sample and only a handful of concessionary mortgage modifications of other types. Far more mortgages terminated through foreclosure than received any sort of concessionary modification. The results indicate that there are significant impediments to renegotiation of residential mortgages beyond securitization. As such, less renegotiation seems unlikely to be a major cost of securitization of residential mortgages.

Investors Beware: Flaws in the Residential Mortgage Securitization Process

Investors Beware: Flaws in the Residential Mortgage Securitization Process

Investors Beware: Flaws in the Residential Mortgage Securitization Process

This article focuses on some of the less discussed flaws in the securitization process. In particular, the authors focus on: 1) the enforcement of representation and warranty violations, 2) defects in the deal closing process, and 3) defective transaction surveillance and reporting. The authors make the case that, even if you knew the prepayment rates, default transition rates and severities, you could not necessarily determine the cash flows and hence the yield on the security. Even if the deal modeling is correct (and, as the authors have shown, there can be issues) and the documents are internally consistent, there is a total lack of transparency in reporting on modifications and liquidations. More irritating, it is very difficult to tie out the cash coming into the deal with what is actually distributed to investors. <b>TOPICS:</b>MBS and residential mortgage loans, CMBS and commercial mortgage loans

Investors Beware:Flaws in the Residential Mortgage Securitization Process

Investors Beware:<i>Flaws in the Residential Mortgage Securitization Process</i>

Rethinking the Master Servicing Role in Light of Changing RMBS Needs

The focus of this article is on one small but very important component of the residential mortgage securitization process: the role of the master servicer. The primary duties of the master servicer are in three functional areas: cash management, investor reporting, and servicer oversight. This article addresses possible enhancements to the master servicer’s role in transactions that might add value to the investor. First, investors should play a more open and integrated role in structuring the transaction, not just from the cash flow side, but also from the master servicing and servicing side. Second, newly structured transactions should specifically and separately address the proper transaction accounting and cash flow distributions that are impacted by both the forbearance and forgiveness of principal and interest. Third, a securitization transaction’s governing documents should task one or more unconflicted parties with undertaking a periodic diligence or administrative review of loans and loan-level representations and warranties, whether on a sample or more substantial but still targeted basis. <b>TOPICS:</b>MBS and residential mortgage loans, CMBS and commercial mortgage loans

Subsidization as motor to residential mortgage securitization in the US

Residential mortgage securitization on the secondary mortgage market in the United States has grown enormously since 1970. This contribution describes the growth, especially the growth of the large special circuit housing finance system within the secondary mortgage market. Fannie Mae and Freddie Mac are at the heart of it. Different housing finance systems are introduced first in order to position the system of securitization. The technicalities of securitization are then briefly covered, before the focus shifts to the development of residential mortgage securitization in the United States. The reasons for expansion of the secondary mortgage market are traced, and especially of Fannie Mae and Freddie Mac and the benefits they offer to homeowners and the buyers of securities. The success of securitization by Fannie Mae and Freddie Mac does not seem to be based on a miracle of competition in the housing finance market, but largely on regulation and subsidization of these organizations. Nowadays, the question has become whether the undesired effects of this large part of the housing finance market outbalance the desired effects.

Over-Indebtedness, Predatory Lending, and the International Political Economy of Residential Home Mortgage Securitization: Comparing the United States' Subprime Home Mortgage Lending Crisis to Home Finance in the United Kingdom, Germany, and Japan

Following the United States, many countries around the world have increasingly turned to structured finance, also known as securitization, to fund loan portfolios. This trend has taken on troubling undertones in the wake of widespread default in the American sub-prime residential mortgage backed securities market. This essay provides a brief introduction to the business practices of, and law governing residential mortgage securitization in, the United States. Moreover, it surveys the use of securitization in three influential countries: the United Kingdom, Germany, and Japan. In comparison to these countries, relatively lax regulation, poor oversight of intermediary originators, and volume-oriented underwriting have all contributed to widespread foreclosures in the United States. Private structured finance of American sub-prime mortgages has created economic incentives that promote consumer over-indebtedness as well as predatory lending. Furthermore, by drawing politically powerful financiers into aggressive and ethically questionable lending, residential mortgage backed securitization tends to empower opponents of consumer protection law. Drawing on the U.S. example, caveats for other countries are offered.

Housing Finance and Mortgage-Backed Securities in Mexico

This paper reviews the Mexican experience with the securitization of residential mortgages. It highlights the key legislative and institutional reforms leading to the development of primary and secondary mortgage markets and reports the main features and valuation practices of the RMBS markets. The paper identifies areas warranting close attention to improve the outlook for the Mexican RMBS market and draws some lessons from the recent U.S. subprime mortgage market problems.

Housing Finance and Mortgage-Backed Securities in Mexico

This paper reviews the Mexican experience with the securitization of residential mortgages. It highlights the key legislative and institutional reforms leading to the development of primary and secondary mortgage markets and reports the main features and valuation practices of the RMBS markets. The paper identifies areas warranting close attention to improve the outlook for the Mexican RMBS market and draws some lessons from the recent U.S. subprime mortgage market problems.

Housing and the mortgage securities markets: Review, outlook, and policy recommendations

During the 1980s, strong demographic demand for housing created a bulging need for mortgage credit. The mortgage market has creatively accommodated this need through extensive securitization of residential mortgages. This process greatly facilitated the financing of housing demand. During this decade, however, the scheme of funding long-term mortgages with short-term deposits bankrupted savings institutions. A gigantic federal bailout for thrifts was finally required. In the 1990s, the weakening demographics and the resulting reduction in the demand for mortgage credit afford the federal government opportunities to reformulate its housing policies in terms of limiting federal insurance on consumer deposits, phasing out income tax deductibility of mortgage interest, and ensuring capital adequacy at federally sponsored credit agencies.