Reputation vs. Adverse Selection
Author:
Ronel Elul, Federal Reserve Bank of Philadelphia
The academic literature, the popular press, and policymakers have all debated the securitization’s contribution to the poor performance of mortgages originated in the run-up to the current crisis. Theoretical arguments have been advanced on both sides, but the lack of suitable data has made it difficult to assess them empirically. We examine this issue by using a loan-level data set from LPS Analytics, covering approximately three-quarters of the mortgage market from 2003-2007 and including both securitized and non-securitized loans. We find evidence that privately securitized loans do indeed perform worse than similar, non-securitized loans. Moreover, this effect is concentrated in prime mortgage markets; for example, a typical prime ARM loan originated in 2006 becomes delinquent at a 20 percent higher rate if it is privately securitized, ceteris paribus. By contrast, subprime loan performance does not seem to be worse for most classes of securitized loans.
This paper was presented on September 16th, 2009 at the FDIC's Seidman Center for the FHFA and the FDIC cohosted symposium on “Improving Assessment of the Default Risk of Single-Family Mortgages”. The symposium included sessions on: Collateral and Appraisal Issues, Underwriting Standards, and Issues in Default Modeling. Attendance included housing and mortgage market experts from industry, academia, and government. The research paper was selected from submissions received in response to a Call for Papers issued in the spring.
The Call for Papers can be downloaded here.