Authors: Benjamin J. Keys, Tanmoy Mukherjee, Amit Seru and Vikrant Vig
Abstract: 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 instrument for 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. We use variation across lenders (banks vs. independents), state foreclosure laws, and the timing of passage of anti-predatory laws to rule out alternative explanations. Our results suggest that securitization does adversely affect the screening incentives of lenders.