Financial Regulation and Securitization: Evidence from Subprime Loans

37 Pages Posted: 19 Feb 2009

See all articles by Benjamin J. Keys

Benjamin J. Keys

The Wharton School - University of Pennsylvania, Real Estate Department

Tanmoy K. Mukherjee

Sorin Capital Management, LLC

Amit Seru

Stanford University

Vikrant Vig

London Business School

Date Written: February 18, 2009

Abstract

We examine the consequences of existing regulations on the quality of mortgage loans originations in the originate to distribute (OTD) market. The information asymmetries in the OTD market can lead to moral hazard problems on the part of lenders. We find, using a plausibly exogenous source of variation in the ease of securitization, that the quality of loan originations varies inversely with the amount of regulation: more regulated lenders originate loans of worse quality. We interpret this result as possible evidence that the fragility of lightly regulated originators' capital structure can mitigate moral hazard. In addition, we find that incentives which require mortgage brokers to have 'skin in the game' and stronger risk management departments inside the bank partially alleviates the moral hazard problem in this setting. Finally, having more lenders inside a mortgage pool is associated with better quality of loans, suggesting that sharper relative performance evaluation made possible by more competition among contributing lenders can also mitigate the moral hazard problem to some extent. Overall, our evidence suggests that market forces rather than regulation may have been more effective in mitigating moral hazard in the OTD market. The findings caution against policies that impose stricter lender regulations which fail to align lenders' incentives with the investors of mortgage-backed securities.

Keywords: Securitization, screening, incentives, subprime, defaults, mortgages, disintermediation, subprime crisis, regulation

JEL Classification: G21

Suggested Citation

Keys, Benjamin J. and Mukherjee, Tanmoy K. and Seru, Amit and Vig, Vikrant, Financial Regulation and Securitization: Evidence from Subprime Loans (February 18, 2009). Available at SSRN: https://ssrn.com/abstract=1346131 or http://dx.doi.org/10.2139/ssrn.1346131

Benjamin J. Keys

The Wharton School - University of Pennsylvania, Real Estate Department ( email )

Philadelphia, PA 19104-6330
United States

Tanmoy K. Mukherjee

Sorin Capital Management, LLC ( email )

400 Atlantic St.
12th floor
Stamford, CT 06901
United States

Amit Seru (Contact Author)

Stanford University ( email )

Stanford, CA 94305
United States

Vikrant Vig

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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