Foundations and Trends® in Finance > Vol 2 > Issue 3

Understanding the Securitization of Subprime Mortgage Credit

Adam B. Ashcraft, Research Officer, Financial Intermediation, Federal Reserve Bank of New York, adam.ashcraft@ny.frb.org Til Schuermann, Vice-President, Financial Intermediation, Federal Reserve Bank of New York and Wharton Financial Institutions Center, til.schuermann@ny.frb.org
 
Suggested Citation
Adam B. Ashcraft and Til Schuermann (2008), "Understanding the Securitization of Subprime Mortgage Credit", Foundations and TrendsĀ® in Finance: Vol. 2: No. 3, pp 191-309. http://dx.doi.org/10.1561/0500000024

Published: 05 Jun 2008
© 2008 A. B. Ashcraft and T. Schuermann
 
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Financial markets
 

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In this article:
1 Introduction
2 Overview of Subprime Mortgage Credit Securitization
3 An Overview of Subprime Mortgage Credit
4 Overview of Subprime MBS
5 An Overview of Subprime MBS Ratings
6 The Reliance of Investors on Credit Ratings: A Case Study
7 Concluding Remarks
Appendix A: Predatory Lending
Appendix B: Predatory Borrowing
Appendix C: Some Estimates of PD by Rating
Acknowledgments
References

Abstract

In this survey we provide an overview of the subprime mortgage securitization process and the seven key informational frictions which arise. We discuss how market participants work to minimize these frictions and speculate on how this process broke down. We continue with a complete picture of the subprime borrower and the subprime loan, discussing both predatory borrowing and predatory lending. We present the key structural features of a typical subprime securitization, document how the rating agencies assign credit ratings to mortgage-backed securities, and outline how the agencies monitor the performance of mortgage pools over time. Throughout the survey, we draw upon the example of a mortgage pool securitized by New Century during 2006.

DOI:10.1561/0500000024
ISBN: 978-1-60198-140-0
128 pp. $85.00
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ISBN: 978-1-60198-141-7
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Table of contents:
1 Introduction
2 Overview of subprime mortgage credit securitization
3 An overview of subprime mortgage credit
4 Overview of subprime MBS
5 An overview of subprime MBS ratings
6 The reliance of investors on credit ratings: A case study
7 Conclusions
References
Appendices

Understanding the Securitization of Subprime Mortgage Credit

How does one securitize a pool of mortgages, especially subprime mortgages? What is the process from origination of the loan or mortgage to the selling of debt instruments backed by a pool of those mortgages? What problems creep up in this process, and what are the mechanisms in place to mitigate those problems? Understanding the Securitization of Subprime Mortgage Credit seeks to answer all of these questions. It provides an overview of the market and some of the key players, and provides an extensive discussion of the important role played by the credit rating agencies. Understanding the Securitization of Subprime Mortgage Credit provides a broad description of the securitization process and pays special attention to seven key frictions that need to be resolved. Several of these frictions involve moral hazard, adverse selection and principal-agent problems. The authors provide an overview of subprime mortgage credit with a focus on the subprime borrower and the subprime loan and discuss how predatory lending and predatory borrowing fit into the picture. Next, the authors examine subprime mortgage-backed securities and discuss the key structural features of a typical securitization. The last section examines credit rating and rating monitoring process, and the extent to which investors rely upon on credit rating agencies views.

 
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