مقررات مالی و اوراق بهادار : مدارک و شواهد از وامهای بدون پشتوانه

We examine the consequences of existing regulations on the quality of mortgage loans originations in the originate-to-distribute (OTD) market. The information asymmetries in the OTD market can lead to moral hazard problems on the part of lenders. We find, using a plausibly exogenous source of variation in the ease of securitization, that the quality of loan origination varies inversely with the amount of regulation: more regulated lenders originate loans of worse quality. We interpret this result as a possible evidence that the fragility of lightly regulated originators’ capital structure can mitigate moral hazard. In addition, we find that incentives which require mortgage brokers to have ‘skin in the game’ and stronger risk management departments inside the bank partially alleviate the moral hazard problem in this setting. Finally, having more lenders inside a mortgage pool is associated with higher quality loans, suggesting that sharper relative performance evaluation made possible by more competition among contributing lenders can also mitigate the moral hazard problem to some extent. Overall, our evidence suggests that market forces rather than regulation may have been more effective in mitigating moral hazard in the OTD market. The findings caution against policies that impose stricter lender regulations which fail to align lenders’ incentives with the investors of mortgage-backed securities.

The recent collapse of the financial system has fueled increased calls for tighter and stricter regulations in credit markets. While there exists a general consensus among scholars and policy makers that the current regulatory framework needs to be overhauled, it is not a priori clear what the optimal policy response should be. If anything, historical evidence suggests that the seeds of bad regulation are often sown in times of crises and thus cautions against knee-jerk reactions that accord the blame of the current subprime crisis on a lack of regulation of the banking sector.1 The objective of this paper is to investigate the role of regulation in the context of securitization. There is now substantial evidence which suggests that securitization, the act of converting illiquid loans into liquid securities, contributed to bad lending by reducing the incentives of lenders to carefully screen borrowers (Dell’Ariccia et al., 2008, Mian and Sufi, 2008, Purnanandam, 2008 and Keys et al., 2009). By creating distance between the originators of loans and the investors who bear the final risk of default, securitization weakened lenders’ incentives to screen borrowers, exacerbating the potential information asymmetries which lead to problems of moral hazard. The goal of this paper is to examine the effect of different regulations on the moral hazard problem that is associated with the ‘originate-to-distribute’ (OTD) model. Specifically, we exploit cross-sectional variation in different regulations affecting market participants in the OTD chain to examine how regulations interacted with the securitization process. Studying the subprime mortgage market provides a rare opportunity to evaluate the impact of financial regulation, as market participants who perform essentially the same tasks (origination and distribution) are differentially regulated. This unique feature of the market allows us to identify the impact of regulatory oversight. We begin our analysis by exploiting the cross-sectional differences in supervision faced by originators of subprime loans in the United States. Deposit-taking institutions (banks/thrifts and their subsidiaries, henceforth called banks) undergo rigorous examinations from their regulators: the Office of the Comptroller of the Currency (OCC), Office of Thrift Supervision (OTS), Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board. Non-deposit taking institutions (henceforth called independents), on the other hand, are supervised relatively lightly. We examine the performance of the same vintages of loans that are securitized by banks relative to those securitized by independents to assess the costs and benefits of allowing some market participants to operate beyond the scope of regulation. Theoretically, the differential impact of regulation on the two types of lenders is ambiguous as there are several economic forces at play. First, it can be argued that relative to independents, banks may suffer less from securitization-induced moral hazard since they face more supervision and are thus monitored better.2 On the contrary, one can argue that FDIC insurance for bank deposits could further aggravate the moral hazard problem as banks are less exposed to market discipline as compared to the independents who raise their money through the market as a line of credit or from a warehouse credit facility (Calomoris and Kahn, 1991 and Diamond and Dybvig, 1983). In addition, economic forces such as reputation and incentives complicate economic inferences. Our empirical tests examine these alternatives with a view to isolating the effects of regulation on the performance of banks (highly regulated) and independents (less regulated) in the OTD market. The challenge in making a claim about how regulation interacts with the performance of lenders in the OTD market lies with the endogeneity of the securitization decision by lenders. In any cross-section, securitized loans may differ on both observable and unobservable risk characteristics from loans which are kept on the balance sheet (not securitized). Moreover, documenting a positive correlation between securitization rates and defaults in time-series might be insufficient since macroeconomic trends and policy initiatives, independent of changes in lenders’ screening standards, may induce compositional differences in mortgage borrowers and their performance over time. We overcome these challenges by exploiting a rule of thumb in the lending market which induces exogenous variation in the ease of securitization of a loan compared to a loan with similar characteristics (Keys et al., 2009). In other words, the rule of thumb exogenously makes a loan more liquid as compared to another loan with similar risk characteristics. The empirical strategy then evaluates the performance of a lender's portfolio around the ad-hoc credit threshold as a measure of moral hazard in the OTD market and examines whether performance varies systematically across banks and independents. In addition, we examine how other attributes of regulation and incentives could influence the gap in performance induced by moral hazard around the securitization threshold. Using a large dataset of securitized subprime loans in the U.S., we empirically confirm that the number of loans securitized varies systematically around the ad-hoc credit cutoff using a sample of more than three million home purchase and refinance securitized loans in the subprime market during the period 2001–2006. In particular, when we examine the number of loans around the ad-hoc threshold, we find that both banks and independents securitize about twice as many loans above the ad-hoc credit cutoff as compared to below it. Interestingly, we find that loans originated by banks tend to default more relative to independents (for results with similar flavor, see Purnanandam, 2008; Loutskina and Strahan, 2008). This is in contrast to the populist view that has brought forth widespread calls for more regulation of independent mortgage institutions (Treasury Blueprint, 2008). In order to further our understanding of the behavior of banks, we examine banks’ financial ratios and find that larger banks, those with more deposits, and those with more liquid assets tend to originate higher quality loans around the threshold. We view this evidence as suggesting that banks with more reputation or bank quality (and hence with higher deposits) and conservative banks (and hence with more liquid assets) originated loans which were more carefully screened in the OTD market. While external regulation may not have provided the expected impact on the performance of loans, we investigate whether the internal incentives provided by firms could have mitigated moral hazard problems. Several researchers have conjectured that a misalignment of incentives may have played a role in distorting the quality of loans originated in the OTD market (e.g., Rajan, 2008). To examine the role of incentives, we examine two of its aspects: compensation of the top management of lenders and the structure of the mortgage pool to which the lender contributes. We find that the level of total compensation of top management per se does not have an effect on the performance of loans around the threshold. Interestingly, however, the relative power of the risk manager—as measured by the risk manager's share of pay given to the top five compensated executives in the company—has a negative effect on default rates. We interpret this result as suggesting that the moral hazard problem is less severe for lenders in which the risk management department has greater bargaining power.3 Examination of pool structure reveals several other interesting insights. First, we show that pools where loans are primarily originated by independent lenders tend to perform better around the threshold as compared to those where banks primarily originate loans. This corroborates our earlier results comparing loans originated by banks and independents. More importantly, we find a positive correlation between the number of lenders contributing to a pool and the performance of the pool, i.e., higher diversity reduces default rates. One plausible explanation for this result is that issuers of pools benchmark the quality of the loans offered by a given lender against the other lenders and relative performance mitigates the moral hazard problem to some extent (Gibbons and Murphy, 1990). In summary, we find some support for incentives mitigating moral hazard in the OTD market. We conclude our analysis by exploiting cross-sectional variation in state-level broker laws. We find that stringent broker regulation helps reduce bad loans of both banks and independent lenders around the threshold. We view these results as consistent with the importance of incentives in the OTD market. The reason is that broker compensation is based on commission received from both the lender and the borrower. Such a compensation structure encourages brokers to maximize the volume of the loans they originate rather than the quality of their originations. Stringent broker laws can help align the perverse incentives created by a fee-based structure since most of these involve surety bonds. This form of regulation, we argue, requires brokers to have ‘skin in the game,’ since there is a credible threat of upholding these bonds from mortgage lenders (banks and independent lenders). Overall, our results suggest that market forces rather than regulation have been more effective in mitigating moral hazard in the OTD market. We discuss this and other issues in conclusion.

The current financial crisis has prompted widespread calls for tougher regulation of financial markets and market participants. This paper contributes to the current debate on optimal regulation in the context of securitization. In doing so, we take a positive rather than a normative approach to regulation analysis as we examine the consequences of existing regulations on the quality of loans originated in the OTD market. The challenge in understanding how regulation interacts with the performance of lenders in the OTD market lies with the endogeneity of the securitization decision by lenders. We overcome these concerns by exploiting a rule of thumb in the lending market which induces exogenous variation in the ease of securitization of a loan compared to a loan with similar characteristics. The empirical strategy then evaluates the performance of a lender's portfolio around the ad-hoc credit threshold as a measure of moral hazard in the OTD market and examines how it is affected by different attributes of regulation and incentives. Comparing the performance of loans originated by highly regulated banks with less regulated independent mortgage institutions, we find that banks originated lower quality loans as compared to independents. This is contrary to the popular view that has put primary blame of low quality originations on the less regulated lenders. These results caution against any policy that imposes stricter regulation on the lenders purely for the sake of additional regulation, rather than aligning the lenders’ incentives with the investors of mortgage-backed securities. At the same time, it is well known that a majority of independent lenders exited the market as the crisis unfolded, primarily on account of not being able to absorb losses. However, the fragility of these lenders’ capital structure, as demonstrated by their inability to raise additional short-term funds to absorb losses, was perhaps also what kept moral hazard by these lenders in check. While external regulation may not have provided the expected impact on the performance of loans, we investigate whether the internal incentives provided by firms could have mitigated moral hazard problems. Examining the executive pay structure of banks, we do not find any relationship between the quality of loan originations and top management incentives. This seems quite reasonable given the high powered incentive component in the salaries of top executives across most of the lenders in the subprime market. For example, in March 2008, Jim Cayne, the CEO of Bear Stearns, sold his five million shares in the company for 10.84 USD after his personal wealth had fallen by 425 million dollars in one month. It is difficult for us to envisage that an even bigger stake in the firm could have produced the ‘correct’ incentives. Interestingly, however, our results suggest that power dynamics inside the firm might have a role to play in aligning incentives. In particular, we find that a proxy of relative power of the risk manager is associated with loans that have lower default rates. We interpret this result as suggesting that the moral hazard problem is less severe for lenders in which the risk management department has greater bargaining power within the firm. Our results also speak to calls for regulations to mandate competition among participants. There has been a widespread belief that competition over market share among mortgage lenders and brokers led to increased risk taking and reduced lending standards in a ‘race to the bottom.’ On the one hand, we find some evidence that supports this conjecture: stronger state level brokerage laws have been found to be associated with lower competition (see Kleiner and Todd, 2007), and we find better quality of OTD loans in these states. On the other hand, we also find that more lenders inside a pool are associated with better quality of loans originated. These results suggest that more competition among participants can help improve relative performance evaluation and mitigate the moral hazard problem to some extent. Finally, some of our results suggest that appropriate incentives for the originators (brokers) may help to attenuate the moral hazard problem. For instance, regulation that requires brokers to have ‘skin in the game’ does indeed help curb the moral hazard problem. Pushing this further, one can argue that policies which require originators to hold some risk have the potential to reduce the moral hazard problem. Implementing these policies would require making information on what loans the originator and the securitizer hold available to various market participants. This we feel is an important aspect that policy makers need to consider as they draft improved OTD-related disclosure policies. We refrain from making any welfare claims based on the results presented here. The starting point of our analysis is that securitization creates a moral hazard problem, which has been well documented in the literature. By evaluating different regulations in the context of this moral hazard problem, we are able to assess the impact of regulation as different market participants were differentially regulated. What do our findings have to say on how regulation should be changed in the OTD market? The objective of the new regulatory structure should be to make markets function better and provide appropriate incentives for market participants to reduce principal-agent problems. The answer, therefore, is not necessarily more government intervention but better government intervention. By providing evidence which suggests that market forces rather than regulation may have been more effective in mitigating moral hazard in the OTD market, our research marks a first step toward answering this question.