Mortgage Securitization and Information Frictions in General Equilibrium

Abstract

We develop a model of the U.S. housing finance system that delivers an equilibrium connection between the securitization and mortgage credit markets. An endogenous securitization market efficiently reallocates illiquid assets, increases liquidity to fund mortgage lending, and lowers mortgage rates for households. However, its benefits are hindered by originators' private information about loan quality, which leads to adverse selection in securitization. Fluctuations in household credit risk induce mortgage credit expansion and contractions through the securitization liquidity channel. Information frictions and liquidity frictions on credit supply generate a multiplier effect of household shocks. Applying the model to the Great Financial Crisis, we quantify that information frictions amplified the observed mortgage credit contraction. Our assessment of the post-GFC securitization market indicates that pricing credit guarantees in a manner that accounts for the amplification factor of information frictions may enhance the financial stability of the system---reducing the volatility of prices and quantities and the probability of a market collapse.

Keywords: securitization, banking, DSGE, private information, liquidity frictions

JEL Classification: D5, D82, G21, G28