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Securitization and Moral Hazard: Evidence from Credit Score Cutoff Rules

73 Pages Posted: 25 Sep 2009 Last revised: 26 Aug 2013

Ryan Bubb

New York University School of Law

Alex Kaufman

Board of Governors of the Federal Reserve System (FRB)

Date Written: August 25, 2013

Abstract

A growing literature exploits credit score cutoff rules used by mortgage lenders as a natural experiment to estimate the moral hazard effect of securitization on underwriting. This research design is premised on the assumption that these cutoff rules are a response by lenders to securitization rules of thumb. We reexamine the evidence and find it is inconsistent with this interpretation. Credit score cutoff rules can be traced to underwriting guidelines for originators, not for securitizers, and we offer a simple model that rationalizes such origination rules of thumb. Because lenders independently employ cutoff rules in underwriting, one cannot use these same cutoff rules to learn about the effect of securitization on underwriting. Furthermore, loan-level data reveal robust evidence that lenders change their screening at credit score cutoffs in the absence of changes in the probability of securitization, corroborating the institutional evidence. Our analysis should move beliefs away from the conclusion that securitization was an important factor in the decline in underwriting standards in the run-up to the financial crisis.

Keywords: securitization, moral hazard, mortgages, subprime crisis, financial crisis

JEL Classification: D82, G01, G18, G21, G24, G28, N22

Suggested Citation

Bubb, Ryan and Kaufman, Alex, Securitization and Moral Hazard: Evidence from Credit Score Cutoff Rules (August 25, 2013). Available at SSRN: https://ssrn.com/abstract=1477891 or http://dx.doi.org/10.2139/ssrn.1477891

Ryan Bubb (Contact Author)

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States
(212)992-8871 (Phone)

HOME PAGE: http://https://its.law.nyu.edu/facultyprofiles/profile.cfm?personID=34148

Alex Kaufman

Board of Governors of the Federal Reserve System (FRB) ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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