Mortgage Risk Premia During the Housing Bubble

Abstract

How did mortgage risk pricing for securitized loans change during the lead-up to the 2008 financial crisis? Using a database from a major American bank that serves as trustee for private-label securitized loans, this paper shows that the decline in underwriting standards was accompanied by a decline in credit spreads on mortgages, after adjusting for loan/borrower characteristics. Observable information, including FICO and LTV, became less influential on mortgage risk pricing over time during the housing bubble. As the volume of mortgages expanded and lending terms eased during the bubble, the increase in risk failed to be reflected in higher risk premiums. The result is consistent with a rightward shift of the mortgage credit supply curve during the housing bubble.

Keywords: mortgage, securitization, housing bubble, risk premium, credit spread

JEL Classification: R31