Theories of financial intermediation suggest that securitization, the act of converting illiquid loans into liquid securities, could reduce the incentives of financial intermediaries to screen borrowers. We empirically examine this question using a unique dataset on securitized subprime mortgage loan contracts in the United States. We exploit a specific rule of thumb in the lending market to generate an exogenous variation in ease of securitization and compare the composition and performance of lenders’ portfolios around the ad-hoc threshold. Conditional on being securitized, the portfolio that is more likely to be securitized defaults by around 20% more than a similar risk profile group with a lower probability of securitization. Crucially, these two portfolios have similar observable risk characteristics and loan terms.
Since our findings are conditional on securitization, we conduct additional analyses to address selection on the part of borrowers, lenders, or investors as explanations. Our results suggest that securitization does adversely affect the screening incentives of lenders.
Joint paper with Benjamin J. Keys (University of Michigan), Tanmoy Mukherjee (Sorin Capital Management) and Amit Seru (University of Chicago, GSB), April 2008