The Impact of Collateral Value on Mortgage Originations

Abstract

Collateral, a debt contracting feature, affects risk of investments. I investigate how investment risk responds to stronger creditor rights, which increase collateral pledgeability. Exploiting the 2005 bankruptcy policy change – strengthening mortgage collateral creditor rights – shows stronger creditor rights shift new mortgages toward risky alternative structures. Minority-dominant, low-income-growth zip codes are more exposed to these alternative mortgages featuring low documentation and negative amortizing payments. These mortgages have correlated payment resets and higher defaults. The results highlight the importance of ensuring collateral maintains price stability before granting it super-senior bankruptcy status, which increases both collateral risk and salability – fueling fire sales. 

Keywords: collateral, mortgage backed securities, repo, race, repo safe harbor, contract types, bankruptcy code

JEL Classification: G01, G10, G20, G21, G23, G33, G50