Understanding the Securitization of Subprime Mortgage Credit
[Editor's note: This subject is, strictly speaking, perhaps off-topic for Payments News. But the subject of the subprime mortgage situation is on everybody's mind these days - and, therefore, we're sharing this here.] Adam B. Ashcraft and Til Schuermann of the Federal Reserve Bank of New York have just published a new staff report titled "Understanding the Securitization of Subprime Mortgage Credit".
In this paper, we provide an overview of the subprime mortgage securitization process and the seven key informational frictions that arise. We discuss the ways that 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 rating agencies assign credit ratings to mortgage-backed securities, and outline how these agencies monitor the performance of mortgage pools over time. Throughout the paper, we draw upon the example of a mortgage pool securitized by New Century Financial during 2006.
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