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To securitize or to price credit risk?

Author

Listed:
  • Danny McGowan

    () (University of Birmingham)

  • Huyen Nguyen

    () (Halle Institute for Economic Research (IWH), and Friedrich Schiller University Jena)

Abstract

We evaluate if lenders price or securitize mortgages to mitigate credit risk. Exploiting exogenous variation in regional credit risk created by differences in foreclosure law along US state borders, we find that financial institutions respond to the law in heterogeneous ways. In the agency market where Government Sponsored Enterprises (GSEs) provide implicit loan guarantees, lenders transfer credit risk using securitization and do not price credit risk into mortgage contracts. In the non-agency market, where there is no such guarantee, lenders increase interest rates as they are unable to shift credit risk to loan purchasers. The results inform the debate about the design of loan guarantees, the common interest rate policy, and show that underpricing regional credit risk leads to an increase in the GSEs’ debt holdings by $79.5 billion per annum, exposing taxpayers to preventable losses in the housingmarket.

Suggested Citation

  • Danny McGowan & Huyen Nguyen, 2020. "To securitize or to price credit risk?," Jena Economic Research Papers 2020-013, Friedrich-Schiller-University Jena.
  • Handle: RePEc:jrp:jrpwrp:2020-013
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    File URL: http://www2.wiwi.uni-jena.de/Papers/jerp2020/wp_2020_013.pdf
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    Keywords

    loan pricing; securitization; credit risk; GSEs;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • K11 - Law and Economics - - Basic Areas of Law - - - Property Law

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