Chapter

Lender Incentives, Credit Risk, and Securitization: Evidence from the Subprime Mortgage Crisis

Amir Sufi

in A Debtor World

Published in print October 2012 | ISBN: 9780199873722
Published online January 2013 | e-ISBN: 9780199980000 | DOI: http://dx.doi.org/10.1093/acprof:oso/9780199873722.003.0004
Lender Incentives, Credit Risk, and Securitization: Evidence from the Subprime Mortgage Crisis

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This chapter focuses on the tension between the preservation of lender incentives and shedding credit risk. It addresses this issue in three steps. First, it discusses foundational theories of financial intermediation in which a bank's main purpose is to exert screening or the monitoring of loans to reduce borrower moral hazard and adverse selection. One of the primary features of these theories is that banks must retain at least part of the credit risk of the loans in order to preserve their incentives to monitor and screen borrowers. Second, it examines how contractual arrangements attempt to preserve bank incentives while transferring credit risk in a variety of markets, including credit default swaps, loan syndication, and securitization. It then examines the recent subprime mortgage crisis with a particular emphasis on how the conflict between lender incentives and shedding credit risk affected default patterns since 2005. Finally, the chapter explores potential reasons securitization failed to preserve lenders' incentives to screen and monitor borrowers.

Keywords: financial intermediation; loans; credit risk; bank incentives; subprime mortgage crisis; securitization; borrower screening

Chapter.  7283 words.  Illustrated.

Subjects: Company and Commercial Law

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