Subprime Borrowers, Securitization and the Transmission of Business Cycles

Riksbank Research Paper Series No. 141

Sveriges Riksbank Working Paper Series No. 317

52 Pages Posted: 24 May 2016

Date Written: March 2016

Abstract

A growing literature (i.e. Jaffee, Lynch, Richardson, and Van Nieuwerburgh, 2009, Acharya and Schnabl, 2009) argues that securitization improves financial stability if the securitized assets are held by capital market participants, rather than financial intermediaries. I construct a quantitative macroeconomic model with a novel specification for mortgage-backed securities (MBS) to evaluate this claim for subprime securitization during the Great Recession. I find that output in the U.S. would have dropped by only about a third and house prices by only a half of what we actually observed, if subprime MBS had been purchased by non-financial agents, rather than held by banks. This is because banks are subject to capital requirements and if MBS remain within the banking system, the fall in their value puts a strain on banks’ balance sheets. The subsequent deleveraging amplifies business cycles. My findings suggest that the existence of the securitization market stabilizes the economy under the condition that financial intermediaries do not engage in the acquisition of securitized assets.

Keywords: Subprime Borrowers, Securitization, Financial Intermediation, Great Recession

JEL Classification: E32, E44, G01, G13, G21, R21

Suggested Citation

Grodecka-Messi, Anna, Subprime Borrowers, Securitization and the Transmission of Business Cycles (March 2016). Riksbank Research Paper Series No. 141, Sveriges Riksbank Working Paper Series No. 317, Available at SSRN: https://ssrn.com/abstract=2780414 or http://dx.doi.org/10.2139/ssrn.2780414

Anna Grodecka-Messi (Contact Author)

Sveriges Riksbank ( email )

Brunkebergstorg 11
SE-103 37 Stockholm
Sweden

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