Ronel Elul, a senior economist at the Federal Reserve Bank of Philadelphia, has penned a working paper that should be required reading for anyone interested in – or pontificating upon – the dynamics of securitisation and the mortgage market.
Elul’s paper examines the premise that securitisation contributed to the meltdown in the US mortgage market. From the abstract, emphasis FT Alphaville’s:
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.
That conclusion – that overall, securitized subprime loans did not perform any worse than non-securitised loans – might astonish the popular press and policymakers, for whom “structured finance” has become synonymous with “evil”.
Here’s some more detail from the paper:
We find evidence that for prime mortgages, private securitized loans indeed perform worse than portfolio loans; for instance, for loans originated in 2006, the two-year default rate is at least 15 percent higher, on average. Given the large number of prime loans that were originated over this period, this difference in default rates is economically significant. By contrast, securitized subprime loans do not appear to have defaulted at higher rates than similar non-securitized loans. As we discuss below, this relative difference in performance between prime and subprime loans may be driven by two factors. First, subprime loans are likelier to have been subject to greater scrutiny by investors, whereas prime loans would have been presumed to be of higher quality, thereby reducing the scope for adverse selection. In addition, as we discuss below, very few subprime loans were actually held in portfolio, further reducing the benefit to the lenders from cream-skimming and also increasing lenders’ risk from doing so.
A must-read, not least for arguments like this one:
while in earlier years reputational effects were sufficient to sustain underwriting standards, as loan volumes increased, and the future of the housing market became more and more tenuous, the current benefit from originating questionable loans outweighed the future costs, and this led to a deterioration in issuers’ incentives to properly underwrite loans. We should stress, however, that our results do not rule out the possibility that investors understood that such a deterioration in standards had taken place and that the prices or structures of the MBS reflected this.
There has been an outbreak of contrarian thinking on the links between ratings, securitisation and the mortgage market – see the links below for other examples.
Maybe Securitization Didn’t Cause the Crisis – The New Republic
How Much Do Investors Rely on Ratings? The Case of Mortgage Backed Securities – Manuel Adelino / SSRN