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Securitization and moral hazard: evidence from credit score cutoff rules

Ryan Bubb and Alex Kaufman

No 11-6, Public Policy Discussion Paper from Federal Reserve Bank of Boston

Abstract: Mortgage originators use credit score cutoff rules to determine how carefully to screen loan applicants. Recent research has hypothesized that these cutoff rules result from a securitization rule of thumb. Under this theory, an observed jump in defaults at the cutoff would imply that securitization led to lax screening. We argue instead that originators adopted credit score cutoff rules in response to underwriting guidelines from Fannie Mae and Freddie Mac and offer a simple model that rationalizes such an origination rule of thumb. Under this alternative theory, jumps in default are not evidence that securitization caused lax screening. We examine loan-level data and find that the evidence is inconsistent with the securitization rule-of-thumb theory but consistent with the origination rule-of-thumb theory. There are jumps in the number of loans and in their default rate at credit score cutoffs in the absence of corresponding jumps in the securitization rate. We conclude that credit score cutoff rules provide evidence that large securitizers were to some extent able to regulate originators' screening behavior.

Keywords: Mortgage loans; Credit scoring systems (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-ban, nep-fmk and nep-ure
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Citations: View citations in EconPapers (3)

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