Originate-to-Distribute Model and the Subprime Mortgage Crisis

Abstract:     
An originate-to-distribute (OTD) model of lending, where the originator of a loan sells it to various third parties, was a popular method of mortgage lending before the onset of the subprime mortgage crisis. We show that banks with high involvement in the OTD market during the pre-crisis period originated excessively poor quality mortgages. This result is not explained away by differences in observable borrower quality, geographical location of the property or the cost of capital of high and low OTD banks. Instead, our evidence supports the view that the originating banks did not expend resources in screening their borrowers. The effect of OTD lending on poor mortgage quality is stronger for capital-constrained banks. Overall, we provide evidence that lack of screening incentives coupled with leverage induced risk-taking behavior significantly contributed to the current sub-prime mortgage crisis.

Number of Pages in PDF File: 53

Keywords: Sub-prime crisis, originate-to-distribute, screening, bank loans, risk-management, incentives

JEL Classification: G11, G12, G13, G14.

working papers series