AGENCY CONFLICTS IN RESIDENTIAL MORTGAGE SECURITIZATION: WHAT DOES THE EMPIRICAL LITERATURE TELL US?

• Author: W. Scott Frame
• DOI: http://doi.org/10.1111/jfir.12145
• Published date: 01 June 2018
• Date: 01 June 2018

AGENCY CONFLICTS IN RESIDENTIAL MORTGAGE SECURITIZATION:

WHAT DOES THE EMPIRICAL LITERATURE TELL US?

W. Scott Frame

Federal Reserve Bank of Atlanta

Abstract

Agency conflicts inherent in securitization are viewed as having been a key contributor

to the recent financial crisis. A review of empirical research for the U.S. home mortgage

market suggests that the problem may not have been securitization itself, but rather the

origination and distribution of observably riskier loans. Low-documentation mortgages,

for which asymmetric information problems are acute, performed especially poorly

during the crisis. Low-documentation mortgages performed better when included in

deals where issuers were affiliated with lenders or had reputational capital at stake.

Investors priced low-documentation loan risk via higher required equity tranches and

security yields.

JEL Classification: G01, G21, G23, G28

I. Introduction

Since the global financial crisis, academics, policy makers, and the media have sought to

understand the causes and consequences of the rapid rise and fall of the U.S. subprime

mortgage market during the last decade. Broadly speaking, it seems that expectations

about future house price appreciation affected the behavior of both borrowers and

lenders. This is consistent with the fact that market participants became increasingly

comfortable with highly leveraged home financing for purchases of principal residences

and investment properties, as well as through equity extraction via cash-out refinancing.

Historically low interest rates and credit risk premiums would have reinforced these

perceptions. Some observers have also pointed to unregulated predatory lending

behavior that preys on unsuspecting lower income households or, alternatively,

government policies that encouraged risky lending in an effort to goose homeownership

rates in low- and moderate-income neighborhoods. Finally, others have pointed to

financial innovations, particularly securitization.

Securitization is a widely used form of financial intermediation that generally

involves: (1) pooling financial assets, (2) transferring the assets to a bankruptcy-remote

Some of this work was completed while the author was affiliated with the University of North Carolina at

Charlotte and the Federal Reserve Bank of Richmond. He thanks an anonymous referee, Brent Ambrose, James

Conklin, Edward DeMarco, Ronel Elul, Kristopher Gerardi, Joseph Tracy, Larry Wall, and Lawrence White for

helpful comments on an earlier draft, as well as seminar participants at the 2014 Financial Management Association

meetings in Nashville. The views expressed do not necessarily reflect those of the Federal Reserve Bank of Atlanta

or any other entities within the Federal Reserve System.

The Journal of Financial Research Vol. XLI, No. 2 Pages 237–251 Summer 2018

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© 2018 The Southern Finance Association and the Southwestern Finance Association