Thursday, March 25, 2010

“Cream‐Skimming” in Subprime Mortgage Securitization

By Paul Calem, Christopher Henderson and Jonathan Liles:

Abstract: Depository institutions may use information advantages along dimensions not observed or considered by outside parties to “cream‐skim,” meaning to transfer risk to naïve, uninformed, or unconcerned investors through the sale or securitization process. This paper examines whether “creamskimming” behavior was common practice in the subprime mortgage securitization market prior to its collapse in 2007. Using Home Mortgage Disclosure Act data merged with data on subprime loan delinquency by ZIP code, we examine the bank decision to sell (securitize) subprime mortgages originated in 2005 and 2006. We find that the likelihood of sale increases with risk along dimensions observable to banks but not likely observed or considered by investors. Thus, in the context of the subprime lending boom, the evidence supports the cream‐skimming view.

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