Demand for Safety, Risky Loans: A Model of Securitization

Abstract

We build a competitive equilibrium model of securitization in the presence of demand for safety by some investors. Securitization allows to create safe assets by pooling idiosyncratic risks from loan originators, leading to higher aggregate loan issuance. Yet, the distribution of loan risks out of their originators creates a moral hazard problem. An increase in the demand for safety leads to a securitization boom and riskier originated loans. When demand for safety is high, welfare is Pareto higher than in an economy with no securitization despite the origination of riskier loans. Aggregate lending expansions driven by demand for safety may, paradoxically, lead to riskier loan issuance than expansions driven by standard credit supply shocks.

Keywords: securitization, originate-to-distribute, safety demand, diversification, moral hazard

JEL Classification: G01, G20, G28