Mortgage Risk Premiums during the Housing Bubble

Abstract

How did pricing for mortgage credit risk change during the years prior to the 2008 financial crisis? Using a database from a major American bank that served as trustee for private-label mortgage-backed securitized (PLS) loans, this paper identifies a decline in credit spreads on mortgages conditioned on loan and borrower characteristics. We show that observable risk factors, FICO score and loan-to-value ratios, have less of an impact on mortgage pricing over time. As the volume of PLS mortgages expanded and lending terms eased, risk premiums failed to price the increase in risk.

Keywords: housing bubble, risk premium, securitization, private-label

JEL Classification: R31, G01, G12, G20, G21