Complexity as a Means to Distract: Evidence from the Securitization of Commercial Mortgages

Abstract:     
In the years preceding the recent financial crisis, issuances of commercial mortgage backed securities (CMBS) varied noticeably in their complexity. In particular, deals differed dramatically in their size, the homogeneity of their underlying collateral, and the tranching of their securities. Analyzing a sample of approximately 40,000 commercial mortgage loans serving as the collateral for 334 CMBS deals issued between 2001 and 2007, I examine the relationship between deal complexity and loan performance. Controlling for observable loan characteristics, subsequent movements in commercial property prices, and the identities of key institutions involved in the deal, I find that loan performance is worse for loans packaged in more complex securitizations. Because the underwriter effectively determines a deal’s complexity, this finding suggests that underwriters constructed more complex deals to mask the presence of lower quality loans. Additional evidence on the composition of loan pools and the determinants of deal complexity is consistent with this interpretation.

Number of Pages in PDF File: 37

Keywords: complexity, securitization, CMBS

JEL Classification: G14, G21, G23

working papers series