Wednesday, February 20, 2008

It's Official, Securitization Sucks

It took them long enough to prove what we all knew in our heart, but four members of academia just published a paper on it. This excerpt is from the conclusion:

"The goal of this paper is to empirically investigate whether securitization had an adverse effect on the ex-ante screening activity of banks. We exploit a specific “rule of thumb” in the subprime lending market to generate an instrument for ease of securitization. Comparing characteristics of the loan market above and below the ad-hoc credit threshold, we show that securitization does indeed weaken the screening incentives of financial intermediaries."

"An 80% increase in securitization volume is on average associated with about a 20% increase in defaults. These defaults are being driven by characteristics of the loan or the borrower that are unobservable to both the researchers and the securities market. That we find any effect on default behavior in one portfolio compared to another with virtually identical risk profiles, demographic characteristics, and loan terms suggests that the ease of securitization may have a direct impact on incentives elsewhere in the subprime housing market, as well as in other securitized markets."

Full Paper

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