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Federal Reserve Bank of Boston
Public Policy Discussion Paper
Securitization and moral hazard: evidence from credit score cutoff rules
Ryan Bubb
Alex Kaufman
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.


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Ryan Bubb & Alex Kaufman, Securitization and moral hazard: evidence from credit score cutoff rules, Federal Reserve Bank of Boston, Public Policy Discussion Paper 11-6, 2011.
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Keywords: Mortgage loans ; Credit scoring systems
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