The Role of the Securitization Process in the Expansion of Subprime Credit

Taylor D. Nadauld*
Doctoral Candidate
Department of Finance
The Ohio State University
Nadauld_1fisher.osu.edu
Shane !. Sherlund*
Senior "conomist
#ousehold and $eal "state Finance
%oard of &overnors of the Federal $eserve System




First Draft' !ay ())*
This Draft' +pril ((, ())-
Abstract
.e analy/e the structure and attri0utes of su0prime mort1a1e20ac3ed securiti/ation deals
ori1inated 0et4een 1--5 and ())5. Our data set allo4s us to lin3 loan2level data for over 6.5
million su0prime loans to the securiti/ation deals into 4hich the loans 4ere sold. .e sho4 that
the securiti/ation process, includin1 the assi1nment of credit ratin1s, provided incentives for
securiti/in1 0an3s to purchase loans of poor credit 7uality in areas 4ith hi1h rates of house price
appreciation. 8ncreased demand from the secondary mort1a1e mar3et for these types of loans
appears to have facilitated easier credit in the primary mort1a1e mar3et. To test this hypothesis, 4e
identify an event 4hich represents an e9ternal shoc3 to the relative demand for su0prime
mort1a1es in the secondary mar3et. .e sho4 that follo4in1 the S"C:s adoption of rules reducin1
capital re7uirements on certain 0ro3er dealers in ());, five lar1e deal under4riters
disproportionately increased their purchasin1 activity relative to competin1 under4riters in <8=
codes 4ith the hi1hest reali/ed rates of house price appreciation 0ut lo4er avera1e credit 7uality.
.e sho4 that these loans su0se7uently defaulted at mar1inally hi1her rates. Finally, usin1 the
event as an instrument, 4e demonstrate a causal lin3 0et4een the demand for mort1a1es in the
secondary mort1a1e mar3et and the supply of su0prime credit in the primary mort1a1e mar3et.


Journal of Economic Literature classification num0ers' &(1, &(;.
>ey4ords' Securiti/ation, su0prime mort1a1es, financial intermediation.

* .e are 1rateful to ?iral +charya, +dam +shcraft, !i3e +ndersen, @osh Coval, >arl Diether, >aren
Dynan, !ichael &i0son, +ndre4 >arolyi, $ose Aiao, +nil !a3hiBa, !ichael =alum0o, +nthony Sanders,
=hil Strahan, $ene Stul/, @erome Taillard, !ichael .eis0ach, and Scott Con3er. .e 1enerously than3 Chris
!ayer and >aren =ence for sharin1 demo1raphic data. .e are also 1rateful to seminar participants at
%oston Colle1e, %ri1ham Coun1 University, The Federal $eserve %oard, UC Davis, Ne4 Cor3 University,
and The University of North Carolina2Chapel #ill for helpful comments and su11estions. The analysis and
conclusions contained in this paper are those of the authors and do not necessarily reflect the vie4s of the
%oard of &overnors of the Federal $eserve System, its mem0ers, or its staff.
8t is 4idely 0elieved that a misallocation of resources to the real estate sector, facilitated 0y the
practice of securiti/ation, is one of the causes of the current financial crisis DDiamond and $aBan
D())-EE. >ru1man D())5E summari/ed the issue, FG.in the later sta1es of the 1reat ()))2 ())H
housin1 0oom, 0an3s 4ere ma3in1 a lot of du0ious loans. Cet the 0an3s ma3in1 the loans 4eren:t
stupid' they passed the 0uc3 to other people. Su0prime mort1a1es and other ris3y loans 4ere
securiti/ed.I Nonetheless, despite the o0vious intuitive lin3, little empirical evidence e9ists on
the relationship 0et4een the securiti/ation process Di.e., ho4 deals are put to1ether and assi1ned
credit ratin1sE and the e9tension of su0prime credit.
This paper provides empirical evidence on the lin3a1e 0et4een the securiti/ation process and the
e9tension of su0prime credit. 8t relies on a sample of 1,(65 su0prime mort1a1e20ac3ed
securiti/ation deals ori1inated 0et4een 1--5 and ())5 as 4ell as data on the 6.5 million loans
4hich serve as collateral 4ithin these deals. The data set allo4s us to analy/e the attri0utes of
su0prime securiti/ation deals and deal ratin1s as a function of the deal collateral. Our sample
identifies the deal under4riter for each of the securiti/ed loans, allo4in1 for an investi1ation of the
loan purchasin1 decisions of investment 0an3s involved in securiti/ation as 4ell as the
performance of the loans purchased 0y each securiti/in1 0an3. Finally, our data set also allo4s us
to lin3 securiti/ation activity in the secondary mar3et to data on the e9tension of su0prime loans in
the primary mort1a1e mar3et.
Our empirical analysis e9amines a num0er of hypotheses motivated 0y theories of securiti/ation.
$atin1s ar0itra1e implies that 0an3s see3 to structure the cheapest portfolio of loans that 4ould
deliver favora0le credit ratin1s DCoval, @ure3, and Stafford D())5E, %rennan, #ein, and =oon
D())*EE . .e investi1ate empirically ho4 the structure and ratin1s of su0prime residential
mort1a1e20ac3ed securiti/ation deals affect the incentives drivin1 the loan purchase decisions of
investment 0an3s that under4rite securiti/ation deals. + second hypothesis su11ests that 0ecause
secondary mar3ets see3 to efficiently diversify ris3 across investor preferences and re1ions, a
healthy secondary mar3et should increase 0orro4ers: access to credit. .e e9amine ho4 the
process of sellin1 loans to the secondary mar3et impacts the e9tension of credit in the primary
mar3et.
Our analysis yields three 3ey results. First, all else e7ual, mort1a1e pools concentrated in areas
4ith hi1her than avera1e reali/ed rates of house price appreciation received +++ ratin1s on a
lar1er percenta1e of their deal:s principal. Our results imply that, on avera1e, a HJ increase in the
deal:s avera1e one2year la11ed rate of house price appreciation Done of our pro9ies for e9pected
appreciationE is associated 4ith a 1.)J to K.HJ increase in the percenta1e of a deal:s principal
receivin1 a +++ ratin1 Done standard deviation in the percent rated +++ is 6.;JE. This


(
is an economically meanin1ful result 0ecause deals 4ith a lar1er portion of the deal principal
rated +++ can fund the purchase of the underlyin1 loan collateral at a lo4er cost. The cost of
funds is lo4er 0ecause the structured investment vehicle DS8?E 4hich issues the 0onds can issue
0onds 4ith lo4er avera1e coupon payments Dhi1her pricesE.1 8f hi1her rates of house price
appreciation can lo4er the cost of fundin1 a deal 0y deliverin1 0etter credit ratin1s, the secondary
mort1a1e mar3et should demand loans in rapidly appreciatin1 housin1 mar3ets.
Our second 3ey result provides evidence consistent 4ith the hypothesis that investment 0an3s
4ould see3 to purchase the cheapest portfolio of loans that 4ould deliver mar3eta0le credit
ratin1s. To the e9tent that house price appreciation delivers favora0le credit ratin1s, deal
under4riters 4ould see3 to purchase mort1a1es of a lo4er credit 7uality Dand thus FcheapIE that
are concentrated in areas 4ith hi1h rates of house price appreciation. Usin1 an event to deal 4ith
the endo1eneity of mort1a1e demand from the primary mar3et, 4e sho4 that certain investment
0an3s increased their relative demand for su0prime loans disproportionately in <8= codes 4ith the
hi1hest rates of house price appreciation 0ut lo4er avera1e credit 7uality De.1., in the form of loans
4ith hi1h loan2to2value ratiosE. .e demonstrate that investment 0an3s purchased 6J more loans
than their competitors in <8= codes that e9perienced HJ hi1her reali/ed rates of house price
appreciation. .hile hi1her rates of house price appreciation deliver favora0le credit ratin1s, poor
credit 7uality loans 4ould presuma0ly 0e cheaper to purchase. Our results sho4 that investment
0an3s, on avera1e, purchased HJ more loans than their competitors in <8= codes 4ith HJ hi1her
loan2to2value ratios. .e 0elieve our evidence on the purchasin1 activity of investment 0an3s
provides some evidence consistent 4ith a theory of Fratin1s ar0itra1e.I .e also ac3no4led1e that
0ecause 4e do not have 4holesale prices of the underlyin1 mort1a1e loan collateral, 4e cannot
convincin1ly demonstrate that poor 7uality loans in areas 4ith hi1her house price appreciation are
indeed cheaper to purchase.( #o4ever, the loans purchased 0y investment 0an3s 4hich increased
their relative demand for su0prime loans defaulted at mar1inally hi1her rates. 8n theory, increased
demand from the secondary mort1a1e mar3et for loans should
facilitate easier credit in the primary mar3et. Secondary mar3ets, 4hen functionin1 properly,
efficiently allocate ris3 across 1eo1raphies and ris3 preferences and conse7uently lo4er the cost
of credit in the primary mar3et. #o4ever, little empirical evidence e9ists re1ardin1 the impact of


1 +n S8? is a separate, 0an3ruptcy2remote entity that is created 0y the under4ritin1 0an3 for the purpose
of sellin1 the 0onds created in the securiti/ation process.
( +lthou1h loans of a lesser credit 7uality are li3ely priced at a discount, the 4holesale loan mar3et
could conceiva0ly command a premium for loans concentrated in areas of hi1h e9pected house price
appreciation. .e address this criticism in section H of the paper. .e discuss unreported results sho4in1
that, at the <8=2code level, the spread of mort1a1e rates over a ris3 free reference rate seems to 0e
determined more 0y loan credit 7uality than house prices.

K
secondary mar3et activity on access to credit in the primary mort1a1e mar3et.K Usin1 our sample
of su0prime mort1a1es only, and an event 4hich identifies a relative shift in the demand for
su0prime loans from the secondary mort1a1e mar3et, 4e identify a causal relationship 0et4een
mort1a1e demand in the secondary mar3et and credit supply in the primary mort1a1e mar3et.
Our third 3ey result is that in ())H, on avera1e, a 1)J increase Dclose to one standard deviationE
in the percenta1e of ori1inated su0prime loans 0ein1 sold to the secondary mar3et results in the
ori1ination of an additional ; su0prime loans per 1)) housin1 units Dover one2half standard
deviationE. Thou1h the result is intuitive, 4e 0elieve a careful identification of the impact of
securiti/ation on the e9tension of mort1a1e credit is an important contri0ution 1iven the recent
0oom in securiti/ation activity.
To address concerns a0out the endo1eneity of mort1a1e demand 0et4een the primary and
secondary mort1a1e mar3ets, 4e identify an event 4hich represents an e9ternal shoc3 to the
relative demand for su0prime mort1a1es in the secondary mar3et.; 8n Octo0er ())K, the S"C
proposed amendin1 a series of rules 4hich reduced capital re7uirements on certain 0ro3er2
dealers.H The rule chan1e came in response to The "uropean Union:s D"UE Con1lomerates
Directive 4hich re7uired that affiliates of U.S. 0ro3er2dealers 0e su0Bect to consolidated
supervision 0y a U.S. re1ulatory authority. Formally adopted in +pril ());, the rule chan1e
esta0lished an alternative method of calculatin1 capital re7uirements for the lar1est independent
0ro3er2dealers that 4ere not already su0Bect to capital re1ulation from a re1ulatory authority.
%ro3er2dealers ta3in1 advanta1e of the alternative capital contri0ution 4ould 0e classified as a
FConsolidated Supervised "ntity DCS"EI and 4ould reali/e an estimated K)2;)J reduction in
capital deductions. 8n short, 4e ar1ue that in ()); the event endo4ed five of the lar1est 0ro3er2
dealers 4ith additional capital 4hich could 0e used to increase production of securiti/ation deals.6
%ecause 4e 3no4 4hich 0an3s o4ned 4hich loans servin1 as collateral in securiti/ation deals, 4e
e9amine 4hether the five CS" 0an3s did indeed increase their demand for su0prime mort1a1es
relative to competitor 0an3s that did not e9perience a chan1e in capital re7uirements. Further, 4e
can analy/e the attri0utes of the <8= codes 4here the five CS" 0an3s increased their purchasin1
activity follo4in1 the event, and ho4 those loans su0se7uently performed. Finally,

K One e9ception is &a0riel and $osenthal D())5E, 4ho sho4 that an active secondary mar3et increases
mort1a1e ori1ination rates in a sample of conventional mort1a1e loans, as 4ell as in a su02sample of areas
4here su0prime lenders 4ere active.
; 8ncreased activity in the secondary mort1a1e mar3et could simply reflect increased demand for
mort1a1e loans from 0orro4ers in the primary mar3et. The use of the event is desi1ned to identify shoc3s
to demand for loans from the secondary mar3et that are not correlated 4ith mort1a1e demand in the
primary mar3et.
H The chan1e involved the amendment of rules K)2K, 1Hc2K1, 15a2;, 15a2H, 15a211, 15h21T, and 15h2
(T under the Securities "9chan1e +ct of 1-K;.
6
.e address the role of capital in the production function of securiti/ation deals in Section ;0 of the paper.

;
0ecause 4e 3no4 4here the 0an3s increased their relative demand, 4e can investi1ate ho4 the
increase in demand from the secondary mar3et D4hich is, 0y the nature of the event, presumed to
0e e9o1enous to primary mort1a1e mar3et demandE impacted the supply of su0prime credit in the
primary mar3et.
+side from the considera0le interest su0prime loans have received from the media and investment
community, it is important to consider 4hy the su0prime e9perience should matter outside an
isolated episode. .e 0elieve the su0prime episode can 0e used as a la0oratory in 4hich 4e can
0etter understand the practice of asset securiti/ation. D+fter all, in a 4orld of perfect capital
mar3ets, 4hy should the repac3a1in1 of cash flo4s 0e a profita0le enterpriseLE =rior literature
attri0utes the profita0le practice of poolin1 and tranchin1 cash flo4s to the presence of asymmetric
information DDe!ar/o D())HEE, or incomplete mar3ets D&aur, Seshadri, and Su0rahmanyam
D())KEE. T4o recent studies, relyin1 on the assumption that investors purchase 0onds 0ased solely
on credit ratin1s, e9plain the proliferation of securiti/ation activity to the potential for deal
arran1ers to deliver the cheapest possi0le set of assets that can o0tain a hi1h 7uality credit ratin1.
Coval, @ure3, and Stafford D())5E conclude that Fthe 1ro4th of the credit tranche mar3et can
potentially 0e e9plained as an endo1enous, institutional response to an ar0itra1e opportunity in the
credit mar3ets.I 8n particular, the authors ar1ue that 0ecause credit ratin1s do not account for the
state in 4hich defaults occur, FnaMveI prices 0ased solely on ratin1s 4ill not account for
systematic, priced ris3 factors. %rennan, #ein, and =oon D())*E also attri0ute the e9istence of
poolin1 and tranchin1 to potential Fratin1s ar0itra1e.I
$ecent literature on the su0prime crisis addresses a num0er of 7uestions relevant to this paper.
&orton D())*E e9plains the importance of house price appreciation in the desi1n of su0prime
mort1a1e contracts 4hen he ar1ues, Fthe definin1 feature of the su0prime mort1a1e is the idea
that the 0orro4er and lender can 0enefit from house price appreciation over short hori/ons.I
Our study identifies the importance of house price appreciation in the secondary mar3et for
su0prime mort1a1e loans. !ian and Sufi D())*E ar1ue that a shift in the supply of
credit made to su0prime 0orro4ers caused an increase in house prices and su0se7uent default
rates. They attri0ute the increase in credit supply to the e9istence of securiti/ation. .hile an
increase in the supply of credit caused an increase in house prices, our results sho4 ho4 rates of
house price appreciation themselves could affect the supply of credit. Our results also 0uild upon
!ian and Sufi D())*E in that 4e identify ho4, and not Bust 4hether, the securiti/ation process
may have caused an une9pected increase in credit supply.
DellN+riccia, 81an, and Aaeven D())*E demonstrate that lendin1 standards declined in areas of
hi1h home price appreciation and attri0ute the decline in lendin1 standards to increased


H
competition amon1 lenders. >eys, !u3herBee, Seru, and ?i1 D())*E sho4 that securiti/ed loans
4ith a credit score sli1htly a0ove the traditional su0prime threshold DF8CO 6()E 4ere ()J more
li3ely to default than securiti/ed loans sli1htly 0elo4 the su0prime threshold. The result is
interpreted as evidence that the prospect of sellin1 loans to secondary mar3ets reduces lendersN
incentives to screen 0orro4ers carefully. Demyany3 and ?an #emert D())*E find that credit
7uality 4as ine9plica0ly lo4 durin1 ())62())5, even after controllin1 for house price
appreciation. +shcraft, &oldsmith2=in3ham, and ?ic3ery D())-E investi1ate 4hether potential
incentive conflicts of credit ratin1 a1encies led to ratin1s inflation. This paper, to the 0est of our
3no4led1e, is uni7ue in e9plorin1 empirically the su0prime securiti/ation process, the purchasin1
0ehavior of investment 0an3s under4ritin1 the securiti/ation deals, and the resultant impact on the
supply of su0prime credit.
Our paper is or1ani/ed as follo4s. Section ( descri0es our data. 8n section K 4e motivate and test
our hypotheses re1ardin1 the impact of home prices on the structure of securiti/ation deals.
Section ; e9amines the purchasin1 0ehavior of under4ritin1 0an3s. Section H evaluates the
impact of secondary mar3et demand on the e9tension of credit in the primary mar3et. Section 6
concludes. +ppendi9 1 contains a detailed description of the institutional features involved in the
securiti/ation of su0prime mort1a1e loans. +ppendi9 ( discusses data issues not discussed in the
0ody of the paper.


Section 2: Data and Summary Statistics
Section 2a: Data
The maBority of our empirical 4or3 analy/es the structure of securiti/ation deals, the loan
purchasin1 0ehavior of deal under4riters, and the performance of the purchased loans. 8n the
conte9t of this analysis, 4e rely on the intersection of t4o data sets provided 0y Aoan=erformance
and +%SNet. Our analysis of the lin3 0et4een activity in the secondary mar3et and the e9tension
of credit in the primary mort1a1e mar3et employs mort1a1e ori1ination data from the #ome
!ort1a1e Disclosure +ct D#!D+E data set, as 4ell as the secondary mar3et activity from
Aoan=erformance. .e ne9t provide a description of the three main data sets, as 4ell as a 0rief
description of some of the ancillary data used in our analysis.
Aoan=erformance, a su0sidiary of First +merican Trust, reports 0orro4er attri0utes and loan
information for a0out 5HJ of all su0prime securiti/ation deals over the past 1) years.5
8mportant loan2level attri0utes include 0orro4er F8CO scores, cumulative loan2to2value ratios,
5
The covera1e of Aoan=erformance varies 0y year, 0ut it is more complete in the later years of our sample.

6
de0t2to2income ratios, loan type, and the level of income documentation supportin1 the loan.
Aoan=erformance also trac3s the performance of su0prime mort1a1e loans, a feature 4e e9ploit
later in our analysis. +%SNet, a su0sidiary of Standard and =oor:s, contains summary information
on the structure and ratin1 of residential mort1a1e20ac3ed securiti/ation deals. The deal
summary from +%SNet contains data on the total si/e of the securiti/ation deal as 4ell as the si/e
and ori1inal credit ratin1 of each tranche included in the deal. .e measure rates of house price
appreciation at the <8=2code and state levels usin1 house price inde9es constructed 0y
Aoan=erformance.* .e o0tain state2level unemployment data made availa0le 0y the %ureau of
Aa0or Statistics D%ASE.
8n analy/in1 deal structure and credit ratin1s, our primary unit of analysis is at the deal level. .e
ta3e the follo4in1 steps to identify and a11re1ate residential su0prime loan data to the deal level.
First, 4e o0tain the deal summary for residential mort1a1e20ac3ed securiti/ation deals ori1inated
0et4een 1--5 and ())5 from +%SNet. The deal summary from +%SNet includes information on
the date of issuance and the total deal amount. 8t also includes the ori1inal credit ratin1, ori1inal
principal amount of each tranche, and tranche CUS8=s Deach tranche, or 0ond, has a uni7ue
CUS8=E. +%SNet does not classify the residential securiti/ation deals as 0ein1 su0prime. .e rely
on the classification of su0prime loans provided 0y Aoan=erformance. No uni7ue numerical
identifier e9ists 0et4een the deal summary data from +%SNet and the Aoan=erformance data0ase,
so 4e match these data 0y hand usin1 deal names. The total num0er of su0prime deals included in
our sample is dictated 0y the num0er of su0prime deals in the Aoan=erformance data0ase that can
0e matched to the universe of +%SNet deals 0y hand, 4hich totals 1,K1H su0prime deals.- .e
drop ;* deals from the sample 0ecause they do not have sufficient ratin1s information to properly
7uantify the structure of the deal. .e dou0le chec3 that our hand2matchin1 process correctly
matched the Aoan=erformance and +%SNet data 0y e9aminin1 a su02sample of deal names and
deal summaries from %loom0er1.
.e use the deal summary from +%SNet and complementary data from %loom0er1 4hich
classifies each tranche:s 0ond type to compute the amount of each deal rated +++ or investment
1rade. .hen possi0le, 4e use the SO= ratin1 to determine the ori1inal credit ratin1 of each
tranche. 8n the fe4 cases 4here SO= ratin1s do not e9ist, 4e use ratin1s provided 0y !oody:s.
The proportion of a deal rated +++ is calculated as the sum of the tranches 4ith +++ ratin1s
divided 0y the total deal 0alance. .e provide the details of a sample deal named &S+!= Trust
*
See the appendi9 for a more detailed description of Aoan=erformance house price inde9es.
-
8n addressin1 potential concerns a0out 4hether our final sample of deals is systematically 0iased in any
4ay, 4e conclude that our sample li3ely under2represents deal activity that occurred early in our sample
period on account of less complete covera1e of su0prime activity 0y Aoan=erformance.

5
())6 NC21 in Fi1ure 1. Fi1ure 1 reports the amount of principal contained in each tranche, the
ori1inal credit ratin1, the first coupon payment that 4as made to investors, and the coupon spread
over the relevant ris3 free reference rate D12month A8%O$ in the case of floatin1 rate tranchesE.
The median securiti/ation deal in our sample has H,(1- mort1a1e loans servin1 as
collateral. .e a11re1ate the loan data from Aoan=erformance to the deal level 0y ta3in1 the loan2
4ei1hted avera1e of each deal attri0ute. .e outline this process in the data appendi9. .e match
rates of house price appreciation to the data in three steps. First 4e match <8=2code house price
inde9es to loans accordin1 to the <8= code reported in the loan documentation from Aoan
=erformance. 8f a house price inde9 is not availa0le for the <8= code, 4e use state2level house
price inde9es.1) +fter matchin1 individual loans 4ith their respective rates of house price
appreciation 4e a11re1ate the house price appreciation rates to the deal level usin1 individual
loan si/es 4ithin each deal as 4ei1hts. Finally, 4e mer1e unemployment rates to the deal level
usin1 the state unemployment data. The final deal2level data set includes 1,(65 securiti/ation
deals, 6.5 million loans that serve as collateral in the deals, unemployment rates from H) states,
and house price appreciation data at the <8=2code and state levels. Some of the deals in our
sample do not have data on certain attri0utes of the collateral. The most fre7uent attri0ute
unavaila0le in the loan level data is the de0t2to2income ratio of the 0orro4er. Our final estimation
sample of 1,((H deals only employs deals for 4hich data on every attri0ute is availa0le.11
Our analysis of mort1a1e ori1inations re7uires the use of data made availa0le under the #ome
!ort1a1e Disclosure +ct, 4hich re7uires mort1a1e ori1inators to report statistics on the attri0utes
of mort1a1e applications and ori1inations. +very, %revoort, and Canner D())5E report that #!D+
data cover an estimated *)J of all mort1a1e activity nation4ide. 8n ());, ori1inators 0e1an
reportin1 4hether the interest rate 0ein1 char1ed on a mort1a1e loan 4as three percenta1e points
1reater than the rate on a compara0le2maturity Treasury security. Aoans 4ith at least a three
percent rate spread are deemed Fhi1her2pricedI loans, and are fre7uently used as a pro9y for
su0prime loans in the literature. .e discuss the potential 0ias associated 4ith usin1 Fhi1her2
pricedI loans as a pro9y for su0prime loans in the appendi9. .e also refer the interested reader to
a more thorou1h description of the #!D+ hi1her2priced data and various definitions of su0prime
mort1a1es provided 0y !ayer and =ence D())*E.





1) <8=2code level house price data is availa0le for a0out *)J of the loans in our sample. The remainin1
loans are matched to state2level house price inde9es.
11 8n order to conserve sample si/e 4e report results 4ithout de0t2to2income. 8n unreported results 4e
include de0t2to2income and can confirm that it does not impact the results su0stantially, especially 4ith
re1ard to our result on la11ed rates of house price appreciation.

*
Our analysis of the primary mort1a1e mar3et also re7uires data on the credit attri0utes of all
potential 0orro4ers 4ithin a 1iven <8= code. "7uifa9 provides a file of the share of tract residents
D4hich 4e a11re1ate to <8= codesE 4ith hi1h, medium, and lo4 credit scores. 8n our effort to
control for factors that influence mort1a1e demand in the primary mar3et, 4e utili/e data on
median income levels, housin1 units, o4nership rates, and construction permits made
availa0le from the Census %ureau. The data appendi9 contains a more detailed description of
each of the data sources used in our final dataset.


Section 2b: Summary Statistics
Ta0le 1 reports summary statistics on the attri0utes of securiti/ation deals for the entire sample.
The avera1e su0prime deal has a loan24ei1hted median F8CO score of 6(1, a median com0ined
loan2to2value ratio of *;J and a de0t2to2income ratio of ;1J. The median proportion of the deal
4ith investment21rade ratin1s is -6.HJ, 4hile the median deal has an e9cess spread of K6; 0asis
points.1( The median unemployment rate at deal ori1ination 4as H.1J, the median house price
appreciation in the year precedin1 deal ori1ination 4as 1K.;J, and median overvaluation 4as
5J.1K
Ta0le ( reports summary statistics throu1h time and reveals a su0stantial increase in the num0er
of securiti/ation deals ori1inated over the last decade. !ore deals 4ere ori1inated in ())H and
())6 alone than in the entire precedin1 nine years com0ined. The principal included in the deals
4as also su0stantially lar1er, havin1 increased from an avera1e si/e of P;5* million in ())) to
over P1 0illion in ())6. Ta0le ( also hi1hli1hts an important trend in the structure of
securiti/ation deals throu1h time. The proportion of each deal that 4as rated investment 1rade
declined almost monotonically since ())1.1; 8n ())1, the typical deal had **.)J of the
principal rated +++, compared to Bust 5H.HJ in ())5. The monotonic decline is opposite of the
mar3ed inter2temporal decline in the amount of e9cess spread for the typical deal.1H Ta0le ( also
documents the time series pattern in the default rate of loans in each deal. The default rate is
calculated as the total num0er of loans in the process of foreclosure or already foreclosed in the
year after the deal 4as ori1inated divided 0y the total num0er of loans in the securiti/ation deal.

1( "9cess spread is defined as the difference 0et4een the payments comin1 into the securiti/ation structure
from the underlyin1 mort1a1e collateral and the rate 0ein1 paid to coupon holders.
1K FOvervaluationI references the implied2to2actual rent ratio, a measure of ho4 Fe9pensiveI a housin1
mar3et is relative to its (H2year avera1e. The ratio is calculated and made pu0licly availa0le 0y Chris
!ayer at http'QQ444;.1s0.colum0ia.eduQrealestateQresearchQhousin1.
1;
The same pattern e9ists for the percent of a deal rated +++.
1H
$ecall that su0ordination and e9cess spread are 0oth forms of credit support. Thus, they can 0e vie4ed as
su0stitutes, al0eit imperfect ones. $efer to +ppendi9 1 for a detailed discussion of the institutional details
related to e9cess spread and su0ordination.

-
+s an e9ample, the numerator in the default rate for deals ori1inated in ())6 is calculated as the
total num0er of defaulted loans 0y the end of ())5.
Ta0le K reports the time series attri0utes of the loan characteristics of each deal as 4ell as avera1e
rates of house price appreciation. F8CO scores 1enerally increased throu1h the sample period, as
did loan2to2value and de0t2to2income ratios. The percenta1e of loans ori1inated 4ith adBusta0le
rates also increased su0stantially throu1hout the sample period. 8n 1eneral, aside from F8CO
scores, Ta0le K reveals deterioration in the 7uality of the su0prime loans 0ein1 securiti/ed throu1h
time, a pattern also identified 0y Demyany3 and ?an #emert D())*E and !ayer, =ence, and
Sherlund D())-E. $ates of house price appreciation rose dramatically over the sample period,
reachin1 their pea3 in ())H. The unemployment rate varied little, ran1in1 from a lo4 of K.-5J in
())) to a hi1h of 6.1KJ in ())K. Ta0le ; documents the time series attri0utes of our 0an32<8=2
year panel data set. .hile the time2series attri0utes of the 0an32<8=2year panel are similar to the
time2series data at the deal level, the ta0le provides a snapshot of the difference in <8=2code
attri0utes of loans o4ned 0y CS" 0an3s and non2CS" 0an3s.
=anel + of Ta0le H reports statistics on the num0er of su0prime ori1inations per housin1 unit usin1
hi1her2priced ori1ination data from #!D+ and housin1 unit data from the Census. .e limit our
analysis of ori1ination patterns to a cross2section of <8= codes in ())H 0ecause of the timin1 of the
S"C chan1e in capital re7uirement rules and 0ecause of data availa0ility. The remainder of the
ta0le reports the percent of ori1inated su0prime loans that are sold to the secondary mar3et,
mort1a1e denial rates, and data on chan1es in the mar3et share of the five CS" 0an3s. 8n ())H, on
avera1e, H.*J of all housin1 units 4ere financed 4ith Fhi1her2pricedI loans, our pro9y for
su0prime loans in the ori1ination mar3et. F#i1her pricedI loans 4ere sold to the secondary mar3et
6*.HJ of the time, on avera1e. CS" 0an3s increased their mar3et share in each <8= code 0y an
avera1e of 61J from ())K2())H, a feature of the data 4e e9ploit later in our analysis.


Section : The Determinants of Securitization Deal Structure and Deal Ratin!s
Section 3a: The Economics of the Securitization Structure
8n this section 4e e9amine ho4 the credit ratin1s of securiti/ation deals are determined 0y the
deal collateral. 8n particular, 4e focus on the role of house price appreciation in the ratin1 and
securiti/ation process. .e also analy/e ho4 the collateral impacts the cost of funds for the deal.
%efore discussin1 our empirical strate1y and results, 4e 0riefly discuss an important institutional
feature of a securiti/ation structure.




1)
The structured investment vehicle DS8?E esta0lished 0y investment 0an3s for the purpose of
issuin1 securiti/ed 0onds has cash outflo4s and inflo4s. The lar1est cash outflo4 is the cost of
purchasin1 the portfolio of mort1a1e collateral from loan ori1inators. The lar1est cash inflo4 is
the 1ain on the sale of the 0onds issued 0y the trust and sold to investors. 8t is in this 4ay that the
credit ratin1 of a securiti/ation deal impacts the cash inflo4s of the trust, also referred to as the
cost of funds. %onds rated +++ have lo4er coupon payments Dhi1her pricesE than 0onds 4ith
4orse ratin1s.16 Thus, the 1ains of a securiti/ation deal should 0e increasin1 in the overall credit
ratin1 of the deal. This is the 0asis for our assumption that 0an3s 4ill see3 to purchase loans that
ma9imi/e the potential credit ratin1 of a deal. Fi1ure 1 presents the details of &S+!= Trust ())6
NC21, a sample deal from our data. The fi1ure documents a monotonic increase in coupon
payments as tranche credit 7uality decreases. This pattern should 0e consistent across all the deals
in our sample, as coupon payments should 0e positively related to tranche credit 7uality. The
structure of securiti/ation deals matters for a second reason. On avera1e, deal under4riters paid
themselves an ori1ination fee of 1 to 1.HJ of the deal principal.15 8n order for deals to receive
hi1h 7uality credit ratin1s, deals typically re7uire some amount of over2 collaterali/ation, also
3no4n as the e7uity tranche. The si/e of the e7uity tranche depends on the 7uality of the
underlyin1 collateral R lo4er 7uality deals re7uire a lar1er e7uity tranche. Fundin1 the e7uity
tranche re7uires capital from the 0an3 sponsorin1 the under4ritin1. &iven that the fee structure is
relatively constant, and lucrative 1iven the avera1e si/e of a deal, under4ritin1 0an3s have
incentives to structure a deal that re7uires the smallest e7uity investment.


Section 3b: Credit Ratins! Default Correlation! and "ousin #ar$et %&&reciation
8n this section 4e e9plain ho4 rates of house price appreciation and collateral diversification
could impact the economics of a securiti/ation deal. .e 0e1in 4ith a discussion of the ratin1s
process.1* 8n a cross section of su0prime securiti/ation deals, the proportion of a deal:s principal
assi1ned a +++ ratin1 depends on t4o factorsS the e9pected loss on the pool of mort1a1e
collateral and the correlation of default in that collateral.1-


16
The term FtranchesI can essentially 0e used interchan1ea0ly 4ith the 4ord F0ondsI in this settin1.
15
=er discussion 4ith industry e9pert.
1*
For a detailed discussion of the ratin1s process see +shcraft and Shuermann D())*E, !oody:s D());E and
Standard and =oor:s D())5E, to name a fe4.
1- Technically, Fitch and Standard and =oor:s estimate the pro0a0ility of default. !oody:s estimates
e9pected loss, 4hich is the pro0a0ility of default multiplied 0y the e9pected loss conditional on default. 8n
practice, this difference in ratin1s methodolo1y does not appear to create any su0stantial differences in
ori1inal credit ratin1s.

11
Credit ratin1s reflect a ratin1 a1ency:s assessment of the li3elihood of 0ond default. +s an
e9ample, consider that a +++ ratin1 assi1ned 0y a ratin1 a1ency to a 0ond corresponds to a
1. pro0a0ility that the 0ond 4ill default over a 1iven time period. Default on a +++ 0ond occurs
4hen the entire principal that is Bunior to the +++ tranche is eroded on account of loan defaults.
Thus, a 0ond 4ith a +++ credit ratin1 reflects an opinion of the a1ency that there e9ists a 1J
pro0a0ility that all the collateral Bunior to a senior tranche 4ill 0e eroded 4ithin the e9pected life
of the +++ 0ond. 8n order to determine the pro0a0ility of default, a ratin1 a1ency must estimate
the e9pected loss on the pool of collateral. The e9pected loss in a pool of collateral is estimated as
a function of loan attri0utes, such as F8CO scores, loan2to2value ratios, mort1a1e type, income
documentation, loan purpose Drefinance versus purchaseE, and macroeconomic conditions,
includin1 house prices. The impact of specific loan attri0utes on loan default rates is documented
0y Den1, Tui1ley, and ?an Order D()))E, =ennin1ton2Cross and #o D())6E, Sherlund D())*E, and
&erardi, Aehnert, Sherlund, and .illen D())-E. Aoans 4ith hi1h F8CO scores, lo4 loan2to2value
ratios, and lo4 de0t2to2income ratios default less fre7uently. 8t also has 0een sho4n that rates of
house price appreciation have a stron1 ne1ative association 4ith default rates D&erardi, Shapiro,
and .illen D())5E and Sherlund D())*EE.()
.hile the e9pected loss matters for the entire deal, the shape of the e9pected loss distri0ution
impacts the amount of the deal principal that can 0e rated +++. The shape of the loss distri0ution
depends on the default correlation in the underlyin1 collateral. 8f loan defaults are correlated, the
pro0a0ility of e9periencin1 a 1reater percenta1e loss is hi1her, even thou1h the e9pected loss
remains the same. That is, default correlation simply shifts the shape of the loss distri0ution.
Default correlation also matters in the pricin1 of CDOs. Aon1staff and $aBan D())*E demonstrate
that the e9pected clusterin1 of corporate defaults e9plains (5J of the CDU spread. Co4an and
Co4an D());E document the de1ree of default correlation in a pool of su0prime loans for one
lender and find that the ma1nitude of default correlation increases as an internally assi1ned ris3
1rade declines.
The importance of default correlation in the conte9t of credit ratin1s may 0e 0est understood 0y
e9ample.(1 Fi1ure ( serves as a helpful 1raphical reference for the follo4in1 ar1ument. First
assume a scenario 4here the collateral has /ero default correlation. 8f a deal has
80. of the principal rated +++, the ratin1 a1ency is estimatin1 that the pro0a0ility that the ()J


() Thou1h house price appreciation may not directly cause default, as house prices sta1nate or decline,
some homeo4ners are left 4ith little or no e7uity and have little incentive to continue ma3in1 mort1a1e
payments. 8n the case of adBusta0le2rate mort1a1es, sta1nant house prices could prevent homeo4ners facin1
a payment reset from refinancin1 if the price decline has left the homeo4ner o4in1 more on the mort1a1e
than the current mar3et value of the home.
(1
%arlays Capital D())5E provides detailed discussion and e9amples of the impact of collateral correlation.

1(
of principal Bunior to the +++ tranche 4ill 0e eroded due to defaults is 1J. No4 assume a pool
e9ists 4here collateral default is hi1hly correlated. .hen collateral default is hi1hly correlated,
there e9ists a positive pro0a0ility of a tail event 4hich could tri11er the loss of the ()J collateral
Bunior to the senior tranche. Thus, 4hen the default correlation is hi1h, the structure re7uires more
protection for the senior tranche. 8n this 4ay, for a 1iven e9pected loss distri0ution, default
correlation impacts the amount of deal principal that can 0e rated +++. .e compute t4o
empirical pro9ies of default correlation in our empirical tests. The first is a measure of 1eo1raphic
concentration of the mort1a1e collateral, and the second measures the covariance of housin1
returns in the mort1a1e collateral.
The precedin1 discussion addressin1 e9pected loss and default correlation is fundamental to our
hypothesis re1ardin1 the impact of house price appreciation and deal structure. 8n a cross section
of deals, if a ratin1 a1ency determines that certain pools of loans are li3ely to 0enefit from hi1h
rates of house price appreciation relative to other mort1a1e pools, all else e7ual Dincludin1 default
correlationE, the e9pected loss 4ill 0e lo4er on the pool 4ith hi1her e9pected rates of house price
appreciation, and less su0ordination 4ill 0e re7uired of those deals. The cost of fundin1 the deal
4ill also 0e lo4er. To the e9tent that mort1a1e pools concentrated in areas 4ith hi1h rates of
house price appreciation receive more favora0le credit ratin1s Da1ain, all else e7ualE, deal
arran1ers could rationally purchase mort1a1es of a lo4er mar1inal credit 7uality that are
concentrated in areas 4ith hi1h rates of hi1h price appreciation and still o0tain the credit ratin1s
re7uired to profita0ly mar3et a securiti/ation deal.
"mpirically, 4e test the implications of this hypothesis in three 4ays. First, 4e test 4hether deals
4ith loans concentrated in areas 4ith hi1h rates of e9pected house price appreciation are indeed
a0le to 1et a lar1er portion of the securiti/ation rated +++ andQor investment 1rade, controllin1
for default correlation. .e ne9t test 4hether house price appreciation impacts the cost of funds for
a deal. Finally, 4e analy/e 4hether rates of house price appreciation and loan 7uality impact the
types of loans that investment 0an3s tar1eted for the purpose of securiti/ation.


Section 3c: Collateral Diversification and E'&ected "ouse (rice %&&reciation
Our data set allo4s us to control for the traditional factors that influence the pro0a0ility of
default in a pool of loans, such as avera1e F8CO scores, avera1e loan2to2value ratios, and loan
documentation. The data do not come 4ith Fready2madeI measures of collateral diversification,
or measures of e9pected house price appreciation. +ccordin1ly, 4e construct t4o measures of
diversification and t4o pro9ies for e9pected house price appreciation.


1K
Our first measure of diversification is a #erfindahl inde9, 4hich measures the percent of
each deal:s principal concentrated in a 1iven state. Our second pro9y for diversification, 4hich 4e
refer to as Fhousin1 mar3et correlationI, measures the covariance in the housin1 mar3et returns
for a portfolio of mort1a1e loans. Our motivation for constructin1 t4o separate measures of
diversification is strai1htfor4ard. &eo1raphic diversification does not 1uarantee diversification in
housin1 mar3et returns. To the e9tent that the housin1 mar3et is associated 4ith the pro0a0ility of
loan default, a relevant measure of loan diversification is the correlation 0et4een the returns in
housin1 mar3ets of the loan collateral. +s an illustration of this point consider that despite the
1eo1raphic distance, returns on a California house price inde9 have a correlation coefficient of
).*5 4ith returns on an inde9 measurin1 house price returns in .ashin1ton DC.((
.e construct a #erfindahl inde9 of the 1eo1raphic concentration in each deal as follo4s. For each
deal, 4e calculate the percenta1e of the deal principal that is concentrated in each of the H) states,
plus .ashin1ton, DC. The deal2level #erfindahl inde9 is then calculated as the sum of

n
the s7uared 4ei1hts, e9pressed as
)

i=1
(
i
. .e report summary statistics on deal2level #erfindahl
measures of 1eo1raphic diversification in Ta0les 1 and K. Not reported in Ta0le K is the fact that,
in our sample, the avera1e deal has (*J of total loan principal concentrated in California.(K
Our second measure of diversification in housin1 mar3et returns is calculated in the follo4in1
4ay. +1ain, for each deal, 4e calculate the percent of deal principal concentrated in each state.
.e then calculate the portfolio covariance in housin1 mar3et returns as
* DN
(
Σ σ−
i
E
*
, 4here* is a H191 vector of loan concentration 4ei1hts, and Σ is a H19H1
variance2covariance matri9 of housin1 mar3et returns. .e su0tract the variance of each housin1
mar3et from the 4ei1hted variance2covariance matri9 0ecause 4e are only interested in the
covariance of the housin1 mar3et returns, not the variance of an individual mar3et. Thus the
variance2covariance matri9 has /eros in the dia1onal. The calculation results in a scalar summary
measure of the covariance in housin1 mar3et returns for each deal, 4here the covariance matri9 is
4ei1hted 0y the loan concentration in each state. The intuition is as follo4s. + deal that is hi1hly
concentrated in t4o states 4hose housin1 mar3ets are historically hi1hly correlated Dnot
1eo1raphicallyE 4ill have a lar1er covariance, and thus a hi1her pro0a0ility of e9periencin1





(( The correlation is calculated usin1 the state2level repeat sales house price inde9es from F#F+. The data
are 7uarterly and run from 1--12())5.
(K See !ayer and =ence D())*E for a more thorou1h analysis of the 1eo1raphic dispersion in su0prime loan
ori1inations.

1;
housin1 mar3et declines at the same time. Summary statistics of housin1 mar3et correlation are
also reported in Ta0les 1 and K.
#avin1 constructed pro9ies for collateral diversification 4e turn our focus to e9pected rates of
house price appreciation. Usin1 actual rates of appreciation as a pro9y for e9pected rates, a
common approach in models of empirical asset pricin1, is not a via0le option. This is 0ecause our
hypothesis su11ests the e9istence of a relationship 0et4een deal structure in the secondary mar3et
and the eventual level of credit supplied to the primary mar3et.(; To the e9tent that credit supply
in the primary mar3et influences su0se7uent rates of house price appreciation, an ar1ument found
in !ian and Sufi D())*E, reali/ed rates of house price appreciation measured over a 1iven time
period after deal ori1ination may 0e endo1enously determined 0y the securiti/ation process itself.
8n our attempt to overcome this endo1eneity, 4e use t4o pro9ies for e9pected rates of house price
appreciation at the time of deal ori1ination. The first pro9y is the one2year la11ed rate of house
price appreciation and the second is a measure of housin1 mar3et fundamentals.
!ar3et participants Dratin1 a1encies possi0ly includedE may have 0een stron1ly influenced 0y
prior rates of house price appreciation. Formin1 e9pectations via e9trapolation is not 4ithout
precedent. 8n citin1 and e9plainin1 the results of a series of surveys measurin1 consumers:
e9pectations of future home price 1ains, Shiller D())5E o0serves, Ftimes and places 4ith hi1h
home price increases sho4 hi1h e9pectations of future home price increases and 4hen the rate of
price increases chan1es, so too do e9pectations of future price increases, in the same directionI
Dpa1e 1(E. Our primary pro9y for e9pected rates of appreciation, the one2year la11ed rate of house
price appreciation, is motivated 0y an e9trapolation hypothesis. "9plainin1 deal structure 4ith
la11ed rates of house price appreciation is valid econometrically 0ecause it addresses the possi0le
endo1enous relationship 0et4een deal structure, the supply of credit, and future house prices.
$elyin1 on la11ed rates of appreciation as a pro9y for e9pected appreciation does have a potential
4ea3ness. To the e9tent that rates of house price appreciation are persistent throu1h time, a
documented empirical attri0ute of the data, our estimation could 0e 0iased. The e9istence of an
omitted varia0le that influences rates of house price appreciation and the structure of
securiti/ation deals over all the years of our sample is also possi0le.
8n Ta0le 6 4e estimate an OAS re1ression usin1 the pooled 1--52())5 sample, 4here the
proportion of a deal rated +++ is re1ressed on la11ed rates of house price appreciation and other
controls. .e e9pect the si1n on each of the control varia0les to 0e consistent 4ith the varia0le:s


(; =a1ano and ?olpin D())*E model the relationship 0et4een securiti/ation, specifically the transparency of
credit ratin1s, and li7uidity in the primary mar3et.

1H
influence on the e9pected loss on the pool of mort1a1e loans. Deals 4ith hi1her levels of housin1
mar3et covariance and hi1her 1eo1raphic concentration should 0e associated 4ith lo4er levels of
+++2rated principal. F8CO scores, and the income documentation, o4ner occupied, and purchase
dummy varia0les should all 0e positively related to the proportion rated +++. Aoan2to2value,
unemployment, and adBusta0le2rate loans should 0e ne1atively related to the proportion rated
+++. +ll else e7ual, deals 4ith e9ternal 0ond insurance should have more +++2rated principal.
The controls also include year fi9ed effects to account for any structural chan1es in the
securiti/ation and ratin1s process that may have occurred throu1h time.
The pooled results reported in column 1 indicate the e9istence of a positive, si1nificant, and
economically meanin1ful relationship 0et4een past rates of house price appreciation and credit
ratin1s. Ta0le 6 also reports year20y2year results for the years ())K2())5 estimated separately. 8n
the pooled and cross2sectional re1ressions 4e cluster standard errors 0y the deal arran1er to
account for correlation in standard errors that is specific to a deal arran1er. The results on la11ed
house price appreciation are ro0ust for the maBority of the years 4hen estimated separately, and
appear stron1est for deals ori1inated in ())K, ())H, ())6, and ())5. The results for ())5 su11est
that a HJ increase in the avera1e la11ed rate of house price appreciation Done standard deviationE
increases the si/e of a deal rated +++ 0y a0out 1.HJ Da0out one27uarter standard deviation in the
percent of a deal rated +++E.(H Our results su11est that, conditional on o0serva0le deal
attri0utes, the proportion of a deal rated +++ increases 4ith rates of la11ed house price
appreciation.(6
$esults from the pooled estimation also indicate that deals 4ith a hi1her 1eo1raphic concentration
of collateral receive a lo4er percenta1e of the deal rated +++, thou1h the result is not
particularly ro0ust 4hen estimated in the later years of the sample. The lac3 of a consistent
ne1ative coefficient on our measure of housin1 mar3et covariance in the model is surprisin1. The
t4o measures of collateral diversification have a correlation coefficient of 2).);, su11estin1 our
measures are not collinear. .hile a measure of the correlation in housin1 mar3et returns
Dre1ardless of 1eo1raphyE is theoretically and intuitively appealin1, the results su11est that


(H To facilitate ease of comparison in the relative ma1nitudes of each of the varia0le coefficients, in
unreported results, 4e standardi/e the dependent and independent varia0les 0y su0tractin1 the attri0ute
sample mean from the varia0le and divide 0y the attri0ute sample standard deviation. The economic impact
of house price appreciation is lar1er than other important control varia0les, includin1 loan2to2value ratios
and measures of loan documentation.
(6 Our deal2level measure of house price appreciation uses house price inde9es at the <8=2code and state
levels. One concern 4ith this approach is that the <8=2code inde9es are more volatile than the state inde9es.
Durin1 periods of si1nificant appreciation, this has the potential to create an up4ard 0ias in our measure of
house price appreciation. To address this concern 4e compute deal2level measures of price appreciation
usin1 state house price inde9es only. The results in Ta0le 6 are ro0ust to this approach, su11estin1 that our
estimates are not driven 0y a relatively fe4 fast21ro4in1 <8= codes pac3ed 4ith su0prime loans.

16
1eo1raphic diversification is the more relevant measure in our sample, perhaps 0ecause it is easier
to measure. F8CO scores and loan2to2value ratios have the e9pected impact on deal ratin1s, and
deals that have e9ternal 0ond insurance receive a su0stantially lar1er fraction of the deals principal
rated +++.
.e 0riefly consider a second pro9y for e9pected price appreciation, 0ut do not report the full set
of results for the sa3e of 0revity. Our second pro9y relies on housin1 mar3et fundamentals to
construct a measure of 4hether a housin1 mar3et is Fe9pensiveI or FcheapI relative to its lon1 run
e7uili0rium. Theoretically, home prices should demonstrate an e7uili0rium relationship 4ith rents
and the Fuser costsI of housin1, as discussed in &allin D());E and #immel0er1, !ayer, and Sinai
D())HE. .e assi1n each individual loan in our sample an imputed2to2actual rent ratio that has 0een
calculated for the !S+ in 4hich the loan resides usin1 data provided 0y !ayer D())*E. .e report
summary statistics on the imputed2to2actual rent ratio in Ta0les 1 and K for the purposes of
comparison 4ith statistics on la11ed house price appreciation. 8n unreported results, 4e find that
the relationship 0et4een the percenta1e of a deal rated +++ and a deal2level imputed2to2actual
rent ratio is positive, 0ut not as ro0ust as the results 4hen estimated 4ith la11ed rates of price
appreciation.(5


Section 3d: +ondholders E'&osure to "ouse (rice Declines
The results presented in Ta0le 6, and those unreported that use an alternative pro9y, su11est that
rates of house price appreciation have a meanin1ful economic impact on the structure of
securiti/ation deals. Cet, the results are stri3in1 for another reason. 8f e9pectations of future house
price appreciation are indeed stron1ly influenced 0y prior rates of price appreciation, then
securiti/ation deals ori1inated at the pea3 of a housin1 cycle could 0e structured most a11ressively
precisely at the time they should 0e structured most conservatively. This is 0ecause deals
ori1inated at the pea3 of a housin1 cycle 4ill, 0y definition of a cycle pea3, 0e e9posed to
su0se7uent house price declines, there0y increasin1 the pro0a0ility of default in the underlyin1
loans. #olders of 0onds issued from deals 4ith the hi1hest past rates of house price appreciation
have the least amount of protection a1ainst default 4hen it is needed most. %ecause of this,
investors are e9posed to the a0ility of investment 0an3s and ratin1 a1encies to forecast turns in the
housin1 cycle, a caution first raised 0y +shcraft and Schuermann D())*E and confirmed
empirically in Ta0le 6.
The results also hi1hli1ht a potential 4ea3ness in the use of la11ed rates of house price
appreciation as a pro9y for e9pected rates of house price appreciation. The fact that la11ed rates
(5
These results are availa0le from the authors upon re7uest.
15
of house price appreciation impact deal structure does not 1uarantee that ratin1 a1encies or
investment 0an3s held irrational e9pectations a0out future rates of house price appreciation. =oor
e9 post outcomes could simply represent a 0ad dra4 from a reasona0le distri0ution of
e9pectations formed e9 ante, as alluded to 0y &erardi, Aehnert, Sherlund, and .illen D())-E.


Section 3e: Deal Structure and the Cost of ,unds
The proportion of a securiti/ation deal rated +++ should impact the cost of fundin1 the
underlyin1 portfolio of mort1a1e loans. + deal 4ith 0etter credit ratin1s should 0e a0le to issue a
lar1er fraction of 0onds at a lo4er coupon rate, on avera1e. 8n this section, 4e test 4hether rates of
house price appreciation and our measures of loan diversification impact the cost of funds for a
deal. Deals 4ith a lo4er e9pected loss on account of hi1her e9pected house price appreciation
should have a lo4er cost of funds, 4hile hi1her levels of collateral correlation should 0e positively
related to the cost of funds.
"mpirically, 4e measure the cost of funds for a deal as the spread of each 0ond:s coupon payment
over the interest rate on the relevant ris32free asset. For floatin1 rate tranches, the spread is
calculated as the first coupon payment over one2month A8%O$ at the time of deal close. 8n our
sample of su0prime securiti/ations, -6.HJ of the avera1e principal in a deal is in the form of a
floatin12rate 0ond.(* For the small percenta1e of tranches that pay fi9ed rates, the relevant ris32
free reference rate is less clear. The ideal reference asset 4ould 0e the yield to maturity on a ris32
free asset sellin1 at par 4ith the e9act maturity of the mort1a1e20ac3ed security. #o4ever,
0ecause of un3no4n prepayment and default activity, the e9pected life of a fi9ed2rate !%S is
un3no4n. To overcome this pro0lem, 4e use an estimate of the life of each fi9ed2rate 0ond
produced 0y %loom0er1, and use the rate on the Treasury note 4ith the closest maturity as the
ris32free rate of reference.(-
.e ta3e the follo4in1 steps to create a measure of the deal2level cost of funds. First, for each
0ond, 4e su0tract the 0ond:s first scheduled coupon rate from the relevant ris32free reference
asset. .e then a11re1ate the tranche spreads to the deal level usin1 the si/e of each tranche:s
principal as 4ei1hts. +s an e9ample, Fi1ure 1 reports the spread of each tranche over the
reference asset and the tranche24ei1hted cost of funds for the entire deal, 4hich is a0out (H 0ps.




(* The median deal has 16 tranches, *;.(J of 4hich are floatin12rate 0onds, 0ut -6.HJ of deal principal is
in floatin1 form.
(- 8n the fe4 cases 4here %loom0er1 does not produce an estimate, fi9ed2rate 0onds are matched 4ith the
rate on a five2year Treasury note.

1*
Ta0le 5 reports the results of a pooled OAS re1ression usin1 the 1--52())5 sample and separate
cross2sectional re1ressions 0y year. The deal2level cost of funds is re1ressed on la11ed house price
appreciation, our deal2level measures of diversification, and other measures of deal credit 7uality.
Our estimates su11est that deals 4ith hi1h la11ed rates of house price appreciation appear to have
a statistically si1nificant lo4er cost of funds in years ())K, ());, and ())5. + HJ increase in
la11ed house price appreciation decreases the cost of funds 0y 1)2() 0asis points Done standard
deviation in deal2level coupon spread is e7ual to (; 0asis pointsE. #o4ever, the result is not
consistent in every year, nor is it si1nificant in the pooled sample. Deals 4ith hi1h rates of
appreciation actually had a statistically hi1her cost of funds in ())6, thou1h the ma1nitude is 7uite
small economically Da HJ increase in house prices led to a K 0asis point increase in cost of
fundsE.K) Ta3en to1ether, the results provide some evidence that rates of house price
appreciation are ne1atively related to a deal:s cost of funds for the 0ul3 of our sample.


Section ": Demand for #oans from the Secondary $ort!a!e $ar%et
Section -a: Consolidated Su&ervisory Entities
8n this section 4e e9plore 4hether rates of house price appreciation impact the types of loans deal
arran1ers purchase for the purpose of securiti/ation. Theoretically, our motivation is related to the
ar1ument found in Coval, @ure3, and Stafford D())5E and %rennan, #ein, and =oon D())*E, 4hich
su11ests that ar0itra1e profits are possi0le for a deal arran1er in a securiti/ation mar3et if investors
purchase collaterali/ed 0onds 0ased solely on credit ratin1s. 8f ratin1s ar0itra1e e9isted, deal
arran1ers 4ould see3 to purchase the cheapest portfolio of loans that 4ould deliver +++ credit
ratin1s. 8n a su0prime !%S settin1, the cheapest portfolio of mort1a1e loans that 4ould deliver
+++ credit ratin1s could 0e loans of a poor credit 7uality that are concentrated in areas 4ith hi1h
rates of house price appreciation.
.e ta3e advanta1e of a uni7ue event in order to identify the factors that influence the demand for
su0prime mort1a1e loans from the secondary mar3et. 8n Octo0er ())K, the S"C proposed
amendin1 a series of rules 4hich reduced capital re7uirements on certain independent 0ro3er2
dealers.K1 The rule chan1e came in response to the "uropean Union:s D"UE Con1lomerates
Directive 4hich re7uired that affiliates of U.S. 0ro3er2dealers demonstrate that they 4ere su0Bect
to consolidated supervision 0y a U.S. re1ulator. U.S. 0ro3er2dealers 4ith su0sidiaries operatin1



K) .e repeat our analysis 4ith our measure of deal2level imputed price2to2rent ratios and similar 7ualitative
results.
K1 The chan1e involved the amendment of rules K)2K, 1Hc2K1, 15a2;, 15a2H, 15a211, 15h21T, and 15h2(T
under the Securities "9chan1e +ct of 1-K;.

1-
in the "U that could not meet this re7uirement 4ould have faced si1nificant restrictions on their
"uropean operations 0e1innin1 @anuary ())H. %ro3er2dealers 4ho voluntarily adopted the rule
chan1e 4ould 0e classified as a Consolidated Supervised "ntity DCS"E, there0y su0Bectin1
themselves and their internal ris3 models to the scrutiny of the S"C, 4hile satisfyin1 the
re1ulatory re7uirements of the "U.
The proposed chan1e 4ould esta0lish a voluntary, alternative method of calculatin1 capital
re7uirements for the lar1est independent 0ro3er2dealers that 4ere not already su0Bect to capital
re1ulation from a re1ulatory authority. +s stated 0y the S"C, Fthis alternative method Vfor
calculatin1 capital re7uirementsW permits a 0ro3er2dealer to use mathematical models to calculate
net capital re7uirements for mar3et and derivative2related credit ris3I DS"C ());, pa1e K;;(*E.
=rior to the rule chan1e, independent 0ro3er dealers 4ere su0Bect to the standard net capital rule,
4hich re7uired their net 4orth2to2assets ratio e9ceed (J. Under the rule chan1e, 0an3s 4ould
essentially 0e allo4ed to use their internal ris320ased models to calculate a capital ade7uacy
measure consistent 4ith international standards adopted 0y the %asel Committee on %an3in1
Supervision. 8n particular, 0an3s adoptin1 the rule 4ould 0e re7uired to, Fmaintain an overall
%asel capital ratio of not less than the Federal $eserve:s 1) percent X4ell capitali/ed: standard for
0an3 holdin1 companiesI DS"C ())*, pa1e KE. 8n a document detailin1 the rule amendment, the
S"C estimated that F0ro3er2dealers ta3in1 advanta1e of the alternative capital contri0ution 4ould
reali/e an avera1e reduction in capital deductions of appro9imately ;)JI DS"C ());, pa1e
K;;;HE.K( The S"C further estimated that a 0ro3er2dealer could reallocate capital to fund
0usiness for 4hich the rate of return 4ould 0e appro9imately () 0asis points hi1her. The rule
chan1e did not come 4ithout a cost to the 0ro3er2dealers. 8n e9chan1e for 0ein1 allo4ed to use
internal ris32 0ased models, CS" 0an3s 4ould 0e re7uired to su0mit their ris3 models to an S"C
audit each month.
Thou1h announced in Octo0er ())K, the S"C adopted the CS" rules on +pril (*, ());. +lthou1h
seven firms adopted CS" status, the S"C only re1ulated five 0ecause Citi1roup and @=!or1an
4ere already su0Bect to the re1ulation of the Federal $eserve on account of their status as
depository institutions. Thus, for five of the lar1est independent 0ro3er2dealersY%ear Stearns,
&oldman Sachs, Aehman %rothers, !errill Aynch, and !or1an StanleyYthe adoption of CS"
status satisfied the re1ulatory re7uirements of the "U. +doption of CS" status also resulted in
preferential capital treatment. 8n effect, adoptin1 CS" status freed up a su0stantial fraction of
capital 4hich the 0an3s could su0se7uently use to increase their presence in the su0prime
securiti/ation mar3et.
K(
See &ederal Re!ister Q ?ol. 6-, No. 11* Q !onday, @une (1, ()); Q $ules and $e1ulations, pa1e (-.
()
Section -b: *hy a Reulatory Ca&ital Shoc$ *ould .ncrease Secondary #ar$et Demand for
Sub&rime Loans
Despite the increased availa0ility of capital, it is not o0vious that the CS" investment 0an3s 4ould
deploy the capital to increase their production of su0prime securiti/ation deals. 8n this section 4e
present t4o ar1uments descri0in1 4hy a chan1e in re1ulatory capital re7uirements 4ould increase
CS" 0an3s: demand for su0prime mort1a1e loans. First, 4e ar1ue that the five investment 0an3s
4ould find it 0eneficial to ori1inate and hold portions of +++2rated securiti/ations. #oldin1
+++2rated securities 4ould increase the overall credit 7uality of their capital 0ase, in turn freein1
up additional capital. Second, 4e discuss 4hy capital is necessary in the production function of
securiti/ation deals.
8n a re1ulatory environment in 4hich capital char1es are 0ased on asset 7uality, 0an3s are
incentivi/ed to either purchase or manufacture the cheapest portfolio of loans that 4ill receive a
hi1h 7uality credit ratin1. $eferred to as Fre1ulatory capital ar0itra1e,I 0an3s, on the 0asis of their
private information, can e9ploit the difference 0et4een the true economic ris3 of a portfolio of
loans and the ris3 assessed 0y re1ulators D@ones D()))E and "rel D())HEE. The incentive to en1a1e
in re1ulatory ar0itra1e is clear. Ao4er capital char1es result in freed2up capital 4ith 4hich profits
can 0e 1enerated via increased lendin1 on positive N=? loans, or throu1h the fees 1enerated 0y
under4ritin1 ne4 asset20ac3ed securities.KK +charya and Schna0l D())-E present t4o pieces of
evidence consistent 4ith 0an3s havin1 en1a1ed in re1ulatory capital ar0itra1e over our sample
period. First, the authors ar1ue that 0et4een the years ());2())5, F0an3 0alance2sheets 1re4
t4ofold, V4hileW the re1ulatory assessment of ris324ei1hted assets 1re4 at a far more slu11ish
pace. =ut another 4ay, 0an3s 4ere deemed 0y re1ulatory assessment to have 0een investin1 in
relatively safer assets over this period.I 8n order for re1ulatory ar0itra1e to result in more freed2
up capital, 0an3s 4ould desire to hold some of the Fhi1hly ratedI assets on their 0oo3s. Consistent
4ith this ar1ument, usin1 data on the holdin1s of mort1a1e de0t produced 0y >rishnamurthy
D())*E, +charya and Schna0l D())-E further ar1ue that 0an3s 3ept as much as
30. of all real estate2related, non2a1ency, +++2rated assed 0ac3ed securities and CDOs on their
0alance sheet, 4ith 0ro3erQdealers holdin1 over 1)J, a surprisin1ly lar1e amount if the intent of
securiti/ation is the transferrin1 of ris3.
Capital is re7uired in the production of securiti/ation deals for at least t4o reasons. First, the
avera1e su0prime mort1a1e loan is 4arehoused for (2; months 0y the under4ritin1 0an3 0efore it
is placed into a securiti/in1 S8?. Thus, securiti/ation involves the carryin1 costs
KK
Under4ritin1 fees typically ran1ed 0et4een 1 to 1.HJ of the deal principal.
(1
associated 4ith purchasin1 and o4nin1 mort1a1es 0efore the structure can 0e funded 0y the sale
of the asset20ac3ed securities produced 0y the deal. Second, most deals re7uire
overcollaterali/ation, 4hich comes in the form of an e7uity tranche funded 0y the under4ritin1
0an3. 8n our sample of 1,(65 securiti/ations, the avera1e deal 0enefitted from 1.5HJ
overcollaterali/ation. &iven that the avera1e deal 4as comprised of P-*H million in mort1a1e
principle, fundin1 the e7uity tranche 4ould re7uire a capital outlay of over P15 million, on
avera1e. 8n short, the increased availa0ility of capital could allo4 the five CS" 0an3s to purchase
and 4arehouse more su0prime loans, as 4ell as to fund the e7uity tranche re7uired 0y su0prime
securiti/ation structures.


Section -c: #easurin .ncreased Secondary #ar$et Demand for Sub&rime Loans
.e e9ploit the S"C rule chan1e in order to identify an e9ternal shoc3 to the relative demand for
su0prime loans in the secondary mort1a1e mar3et. The use of this event is desi1ned to control for
the possi0ility that chan1es in demand conditions in the primary mort1a1e mar3et are the primary
driver of activity in the secondary mort1a1e mar3et. That is, the event identifies a relative chan1e
in demand 0et4een investment 0an3s in the secondary mar3et 4hich is presumed to 0e
uncorrelated 4ith any chan1es in demand for mort1a1es from 0orro4ers in the primary mar3et.
%ecause 4e are a0le to 7uantify the relative purchasin1 activity of each 0an3 involved in
su0prime securiti/ation deals, 4e can test 4hether the five CS" 0an3s chan1ed their purchasin1
0ehavior in a systematic 4ay relative to the non2CS" 0an3s in the years after the rule chan1e. 8n
Fi1ure K 4e plot the avera1e share of all securiti/ed su0prime loans that are o4ned 0y
the five CS" 0an3s in each <8= code. 8n ())1, CS" 0an3s o4ned a0out ()J of the securiti/ed
su0prime loans in our sample, on avera1e. %e1innin1 in ())K, the CS" 0an3s 0e1an increasin1
their relative mar3et share until ())H, at 4hich point they o4ned 1reater than ;)J of the
securiti/ed loans in our sample, on avera1e. Fi1ure K also plots -HJ and HJ confidence intervals,
4hich confirm that an increase from ()J to ;)J mar3et share over the event period is a
statistically si1nificant increase. Ta0le * also documents the deal activity of each 0an3 involved
in a securiti/ation deal in our sample. .e ta0ulate the total activity of the five CS" investment
0an3s and compare their activity 4ith the mar3et activity of the competin1 0an3s that did not
adopt CS" status. 8n ())K, the five CS" 0an3s 4ere responsi0le for K( percent of the total
su0prime deals that 4ere ori1inated. That num0er Bumped to ;K percent in ()); and ;* percent 0y
())H. The CS" 0an3s: mar3et share then remained elevated throu1h ())5.
$esults from earlier tests su11est 4hy 0an3s mi1ht demand poor 7uality mort1a1e loans from
areas 4ith hi1h rates of house price appreciation. Our hypothesis su11ests that follo4in1


((
the event, CS" 0an3s 4ould increase their demand for su0prime loans the most in <8= codes 4ith
hi1her reali/ed rates of house price appreciation and lo4er avera1e credit 7uality. 8n order to test
this hypothesis 4e construct a panel dataset of the purchasin1 activity 0y each 0an3 in our sample
at the <8= code level. 8n each 0an32<8=2year, 4e calculate the num0er of su0prime loans o4ned
0y the five CS" investment 0an3s and the total num0er of su0prime loans o4ned 0y the non2CS"
0an3s involved in securiti/ation under4ritin1. .e assi1n a 0an32<8=2year an indicator varia0le
e7ual to one if the 0an3 is a CS" 0an3. .e also assi1n years ());2())5 a post2())K indicator
varia0le.
.e estimate an OAS re1ression usin1 our 0an32<8=2year panel, 4here the lo12num0er of loans
purchased 0y each 0an3 in a 1iven 0an32<8=2year is the dependent varia0le. .e control for the
avera1e credit and housin1 mar3et characteristics of the loans in each year in each <8= code that
could influence secondary mar3et demand. $esults are presented in Ta0le -. Standard errors are
clustered 0y year to account for correlation in su0prime loan demand common across <8= codes in
a 1iven year. .e also cluster our standard errors 0y deal under4riter to account for correlation
across deal under4riters throu1h time. 8n order to identify the effect of the event on the
purchasin1 0ehavior of the five CS" 0an3s 4e create an interaction of the post2event indicator
4ith the CS" 0an3 indicator. 8n our final specification, 4e create an interaction of the 0an3
identifier 4ith the event identifier and varia0les measurin1 <8=2code attri0utes. The interactions
are desi1ned to identify the attri0utes of <8=2codes 4here CS" 0an3s increased their purchasin1
follo4in1 the event.
.e first estimate the relationship 0et4een purchasin1 activity and <8=2code attri0utes usin1 the
entire sample of 0an32<8=2years. 8n column 1 4e estimate the model controllin1 for avera1e <8=2
code attri0utes only. 8n column ( 4e estimate the model 4ith our event indicator, the CS" 0an3
indicator, and the interaction of the t4o indicators. The results in column ( su11est that all 0an3s
increased their purchasin1 activity follo4in1 the event, 0ut that CS" 0an3s increased their
purchasin1 activity relative to competin1 0an3s in a si1nificant manner. On avera1e, CS" 0an3s
purchased KHJ more loans than non2CS" 0an3s follo4in1 the event. 8n column K 4e control for
<8=2code factors that impact mort1a1e demand. Controllin1 for <8=2code factors reduces the
si1nificance of the post2())K varia0le, 0ut the coefficient on the interaction of the post2())K and
CS" 0an3 dummy varia0les indicate that CS" 0an3s after ())K purchased K1J more su0prime
loans than their non2CS" counterparts.
.e are interested in testin1 the hypothesis that CS" 0an3s increased their purchasin1 activity in
<8= codes 4ith hi1her rates of house price appreciation after the event. To test this hypothesis,
4e interact the event and CS" 0an3 dummy varia0les 4ith the avera1e 0an32/ip2year


(K
F8CO score, loan2to2value ratio, and the one2year la11ed rate of house price appreciation. The
results of the full specification presented in columns ; and H can 0e interpreted as the mar1inal
difference in purchasin1 activity 0et4een the CS" 0an3s and non2CS" 0an3s after the event as a
function of avera1e <8=2code attri0utes. Column ; is estimated on the entire 0an32<8=2year
sample. The coefficient on the interaction of the event and CS" dummy:s 4ith rates of house
price appreciation is positive, as predicted, 0ut not si1nificant. #o4ever, after the event, CS"
0an3s o4ned more loans than their counterparts in <8=s 4ith hi1her loan2to2value ratios.K;
Over H)),))) of our 0an32<8=2year o0servations only have one su0prime loan. +s a
result, our estimates of the avera1e <8=2code characteristics of the 0an32<8=2year are the attri0utes
of the one loan in the 1iven 0an32<8=2year. 8n order to have a more precise estimate of the <8=2
code attri0utes impactin1 0an3s purchasin1 decisions, 4e restrict the estimation sample in column
H to 0an32<8=2years 4ith more than one loan. Thou1h 4e lose one2third of our sample, 4e feel
that focusin1 on 0an32<8=2years 4ith more than one su0prime loan allo4s us to hi1hli1ht the
economic forces drivin1 su0prime activity in areas 4here the activity 4as most heavily
concentrated. .e re2estimate the model on the 0an32<8=2year sample 4ith more than one loan and
report the results in column H. The results indicate that at the mar1in, after ())K, and relative to
their peers, CS" 0an3s increased their purchasin1 activity the most in <8= codes 4ith hi1her
reali/ed rates of house price appreciation and hi1her avera1e loan2to2value ratios. Dra4in1 on the
results presented in column H, 4e calculate that CS" 0an3s, on avera1e, purchased 6J more loans
than their competitors in <8= codes that e9perienced a HJ hi1her rate of 1ro4th in house prices in
the previous year. Further, CS" 0an3s, on avera1e, purchased 6J more loans than their
competitors in <8= codes 4ith HJ hi1her avera1e loan2to2value ratios.
Overall, the 0ul3 of the evidence presented in Ta0le - is consistent 4ith the hypothesis that the
five 0an3s 4hich elected CS" status 0ehaved differently than their counterparts after the event
4hich chan1ed their capital re7uirements. The results indicate that they increased their
investment in loans 4ith hi1her avera1e rates of house price appreciation, 0ut lo4er avera1e
credit 7uality in the form of hi1her loan2to2value ratios. To the e9tent that poor credit 7uality
loans are cheaper in the 4holesale mar3et, this type of purchasin1 0ehavior is consistent 4ith a
ratin1s ar0itra1e hypothesis.
+dmittedly, our simple analysis of purchasin1 activity lac3s the po4er to rule out all competin1
hypothesis. The most compellin1 competin1 hypothesis is that once the mar3et o0served that
house prices delivered favora0le credit ratin1s at the deal level, house prices 4ould


K; The correlation 0et4een 0an32<8=2#.=.+. and 0an32<8=2A.T.?. is 2.); in the total sample, and 2.)* in the
/ip20an32sample 4ith more than one loan.

(;
0e FpricedI in the 4holesale loan mar3et. .e do not have data on the 4holesale prices of loan
portfolios. #o4ever, 4e 0riefly consider the alternative hypothesis that rates of house price
appreciation are FpricedI in the ori1ination mar3et for the underlyin1 mort1a1e loans, there0y
ne1atin1 any ar0itra1e 1ains that could 0e made in the secondary mar3et throu1h the purchase of
poor 7uality loans in areas 4ith hi1h price appreciation.
.e can test the relative importance of credit attri0utes and house price appreciation in mort1a1e
spreads at the ori1ination level. 8n unreported tests, 4e evaluate the determinants of the avera1e
spread in ori1ination mort1a1e rates over the ris32free rate at the <8=2code level. 8n each of the
years ())K2())6 separately, F8CO scores, the loan2to2value ratio of the 0orro4er, and loan
documentation 4ere the primary economic determinants of mort1a1e spreads. $ates of house price
appreciation had the fourth lar1est economic impact. The results provide limited evidence that
althou1h house price appreciation is the primary economic determinant of rate spreads at the deal
level, they are not the primary determinant of interest rate spreads at the <8=2code level.


Section -d: Did CSE +an$s (urchase Loans /Do)n the Credit01uality Curve23
Our results from the previous section su11est that CS" 0an3s increased their o4nership of
su0prime loans the most in <8= codes 4ith hi1her avera1e rates of house price appreciation and
hi1her avera1e loan2to2value ratios. .e e9ploit our panel of 0an32<8=2year data and data on the
performance of su0prime mort1a1es to analy/e 0an32specific default rates. The numerator in our
0an32<8=2year default rate calculation is the total num0er of loans o4ned 0y each 0an3 in each
<8=2code in each year that defaulted 0y @uly ())*. The denominator is the total num0er of loans
o4ned 0y each 0an3 in each <8=2code in each year. Thus, in this analysis 4e are considerin1 the
total default rate, as opposed to comparin1 default rates across loan vinta1es. 8n this 4ay, 4e can
capture the sensitivity of each loan:s performance to the recent turn in macroeconomic conditions,
rather than simply comparin1 performance across vinta1es. +s 0efore, 4e assi1n an indicator
varia0le e7ual to one for CS" 0an3 <8=2years, a post2())K indicator e7ual to one for the years
follo4in1 the S"C event, and an interaction of the CS" indicator and post2())K event indicator.
+ su0stantial fraction of our 0an32<8=2year o0servations have a default rate e7ual to /ero. To
adBust for this issue, 4e estimate a To0it re1ression 4ith 0an32<8=2year default rates as our
dependent varia0le. +s in Ta0le -, 4e control for credit and housin1 mar3et factors that are
associated 4ith loan credit 7uality. .e report the results in Ta0le 1). Column 1 reports the results
4hen controllin1 for avera1e rates of house price appreciation, avera1e F8CO scores, avera1e
de0t2to2income ratios, avera1e loan2to2value ratios, and the percenta1e of loans that have


(H
an adBusta0le2rate feature. +s e9pected, <8=2codes 4ith hi1her F8CO scores and hi1her rates of
house price appreciation have lo4er avera1e default rates, thou1h the coefficient on F8CO scores
is not si1nificant. De0t2to2income ratios, loan2to2value ratios, and the avera1e num0er of
adBusta0le rate loans are positively related to default rates. Column ( analy/es default rates as a
function of the event and 0an3 dummy varia0les. .hile the coefficient su11ests a positive
relationship 0et4een default rates and CS" 0an3s after the event, the result is not statistically
si1nificant, even 4hen controllin1 for avera1e <8=2code attri0utes in column K.
8n columns ; and H 4e estimate a full specification of avera1e <8=2code attri0utes, the CS" 0an3
dummy, the event dummy, and the full set of interactions. The test is desi1ned to capture the
mar1inal difference in default rates for CS" 0an3s after the event as a function of avera1e <8=2
code attri0utes. .hen estimated 4ith the full sample, su0prime loans o4ned 0y CS" 0an3s after
the event appear to have mar1inally hi1her default rates than their non2CS" counterparts in <8=
codes 4ith hi1her loan2to2value ratios. Consistent 4ith the estimation procedure presented in
Ta0le -, 4e restrict the estimation sample in column H to 0an32<8=2years 4ith more than one
loan in order to o0tain more precise estimates of avera1e 0an32<8=2year attri0utes. Column H
su11ests the results are ro0ust to the 0an32<8=2years 4ith only one su0prime loan.
8n order to consider the economic ma1nitude of the results from our To0it re1ression, 4e multiply
the re1ression coefficients 0y the adBustment factor, Xsi1ma:, reported at the 0ottom of Ta0le 1).KH
Dra4in1 on the results from column H, a 1)J increase in the <8=2avera1e loan2to2 value ratio
results in 1.(J D.KK;*1)J*.))K5E hi1her default rates for CS" 0an3s after the event relative to
non2CS" 0an3s after the event. 8n sum, the results su11est that the performance of loans o4ned 0y
CS" 0an3s after the event 4ere more sensitive to 0orro4er levera1e than the non2 CS"
counterparts. Thou1h not over4helmin1, this result could 0e interpreted as consistent 4ith the
notion of CS" 0an3s purchasin1 loans further do4n the 7uality curve in order to increase their
mar3et share.


Section ': Secondary $ar%et Demand and Access to $ort!a!e Credit
So far, 4e have sho4n that follo4in1 an event 4hich chan1ed the capital re7uirements for five
of the lar1est securiti/ers of su0prime loans, these five CS" 0an3s increased their purchasin1 of
su0prime loans in <8= codes 4ith hi1her avera1e reali/ed rates of house price



KH 8n a To0it specification, the value of Xsi1ma: ma3es the appropriate adBustment to the interpretation of the
e9pected value of the dependent varia0le conditional on the dependent varia0le 0ein1 positive Das is the
case in our sample of default ratesE.

(6
appreciation and <8= codes 4ith hi1her avera1e loan2to2value ratios. .e also demonstrated that,
at the mar1in, the performance of loans o4ned 0y CS" 0an3s 4as differentially sensitive to
chan1es in 0orro4er levera1e.
8n this section, 4e e9plore the impact of an increase in demand from the secondary mort1a1e
mar3et on the e9tension of credit in the primary mort1a1e mar3et. The central 7uestion is 4hether
the practice of securiti/ation increases 0orro4ers: access to mort1a1e credit. +t issue is the
endo1eneity of mort1a1e demand. +n o0served increase in secondary mar3et activity could
simply 0e driven 0y an increase in demand for mort1a1e credit from 0orro4ers in the primary
mort1a1e mar3et. Thus, demonstratin1 an association 0et4een the e9tension of mort1a1e credit
and increased secondary mar3et activity does not clarify causality. .e e9ploit the S"C2related
chan1e in capital re7uirements for the five independent 0ro3er2dealers discussed in the previous
section to 1ain identification. The event identifies one potential source of a relative chan1e in
demand 0et4een competin1 0an3s in the secondary mar3et 4hich is presumed to 0e uncorrelated
4ith any chan1es in demand for mort1a1es from 0orro4ers in the primary mar3et.
The traditional measure of access to mort1a1e credit in the primary mar3et has 0een the mort1a1e
denial rate D!ian and Sufi D())*E, Dell:+rricia et al D())*E, &a0riel and $osenthal D())5EE. +s
su11ested 0y !ayer and =ence D())*E, denial rates may not accurately reflect 0orro4ers: access
to credit 0ecause of potential pro0lems 4ith the measurement of mort1a1e applications, 4hich
serve as the denominator in the denial rate calculation. Su0prime mort1a1e ori1inators may
a11ressively mar3et to potential 0orro4ers, there0y endo1enously increasin1 the num0er of
applications. 8f mort1a1es are not ori1inated at the same rate as applications endo1enously
increase, the denial rate may 0e 0iased up4ard. 8n addressin1 this issue, !ayer and =ence D())*E
propose scalin1 mort1a1e ori1inations 0y the total num0er of housin1 units in a <8= code. .e
follo4 this convention in calculatin1 our measure of access to mort1a1e credit. .e rely on
mort1a1e ori1ination rates in the year ())H from the #!D+ data set to
measure the e9tension of credit in the primary mort1a1e mar3et. .e calculate the num0er of
ori1inated Fhi1her2pricedI loans as a fraction of the total housin1 units in a <8= code.K6 .e
employ the percenta1e of Fhi1her2pricedI loans that are su0se7uently sold as a pro9y for activity
in the secondary mort1a1e mar3et. .e control for factors that affect the demand for mort1a1e
credit in the primary mort1a1e mar3et, such as avera1e !S+ income, the <8=2code credit
attri0utes of all potential 0orro4ers Dnot Bust the credit attri0utes of ori1inated loans used in

K6 $ecall the discussion of Fhi1her2pricedI loans in Section (. Aoans 4ith at least a three percent rate spread
are deemed Fhi1her2pricedI loans, and are fre7uently used as a pro9y for su0prime loans in the literature.
.e discuss the potential 0ias associated 4ith the use of Fhi1her2pricedI loans in the Data +ppendi9 and
later in this section.

(5
previous specificationsE, unemployment rates, homeo4nership rates, and 0uildin1 permits.K5
.e instrument for secondary mar3et demand usin1 chan1es in CS"20an3 mar3et share
surroundin1 the event. The final sample used in our re1ressions is constrained 0y the num0er of
<8= codes in 4hich the CS" 0an3s o4ned loans as of ())K. Thus, despite havin1 0orro4er
attri0ute data for over 1H,))) <8= codes, our final estimation sample consists of the intersection
of the (,-*1 <8= codes in 4hich CS" 0an3s o4ned loans as of ())K and the 1H,(6; <8= codes for
4hich 4e have 0orro4er attri0ute data. The final cross2section of (,5*6 <8= codes in ())H
includes <8= codes from ;; states, 0ut is most heavily concentrated in California, Florida, and
Te9as.
8n estimatin1 the impact of securiti/ation on 0orro4er:s access to mort1a1e credit, economists
have estimated the follo4in1 relationship usin1 a cross section of <8=2code specific
ε
mort1a1e ori1ination rates, specified as'
? ?
Z of LoansSold,
#ortae DenialRate +orro)erDemora&hics
=⋅ + ⋅ +
it
, β
? ?
γ
it i t
Z of Loans4riinated
, ,
?
4here i is specific to the unit of measurement Dusually <8= codeE and t references time. +side from
the endo1eneity of the denial rate calculation, if the e7uation is estimated usin1 OAS, the estimates
on 0eta may suffer from simultaneity 0ias 0ecause demand for mort1a1e loans, 4hich impacts
mort1a1e denial rates, and secondary mar3et demand are li3ely Bointly determined. .e address the
endo1eneity of mort1a1e demand 0y estimatin1 the relationship usin1 a
t4o2sta1e least s7uares approach, 4here a chan1e in the relative demand for loans in the
secondary mar3et 0et4een under4ritin1 0an3s is used to identify demand in the secondary
mort1a1e mar3et. .e 7uantify the chan1e in relative demand for loans in the secondary mar3et 0y
calculatin1 the chan1e in mar3et share of the five CS" 0an3s in each <8= code surroundin1 the
event. That is, for each <8= code in our sample for 4hich enou1h data is availa0le in the year
2005. 4e calculate the chan1e in the mar3et share of the H CS" 0an3s relative to their
mar3et share at the end of ())K. 8n each specification our dependent varia0le is specified in lo1
form on account of positive s3e4ness in the distri0ution of su0prime ori1inations per housin1 unit.
.e specify and estimate our instrumental varia0le analysis on a cross2section of <8= codes in the
year ())H. .e focus our analysis on the cross2section of <8= codes in ())H for t4o reasons. First,
4e 4ant to limit the 0ias that is introduced into the #!D+ Fhi1her2pricedI sample on account of
chan1es in the yield curve throu1h time.K* Second, 4e see3 to isolate the impact of chan1es in
secondary mar3et demand on the e9tension of su0prime credit surroundin1 the event. The first
sta1e re1ression is estimated as'
K5
.e provide a more detailed description of the data in Section ( and in the Data +ppendi9.
K*
.e discuss this issue in more detail at the end of this section.
(*
ε
γ


of LoansSold =⋅ ∆ + ⋅ +
δ
CSE+an$#$tShare +orro)erDemo
?
?

H
Z of Loans4riinated
i i i
? ?
5.(
i
4here i references a <8= code. .e present the results of the first sta1e
re1ression in column ( of Ta0le 11. The effect of increased demand from the
five CS" 0an3s relative to competitor 0an3s is not trivial. For an avera1e <8=
code, a ten percent increase in relative mar3et share of the five CS" 0an3s is
associated 4ith a .1;J increase in the total percenta1e of loans sold to the
secondary mar3et DTa0le H reports that the median chan1e in mar3et share at
the <8= level for the
H CS" 0an3s in ())H 4as HHJE.
The instrumented percenta1e of ori1inated loans in each <8= code sold to the
secondary mar3et is then used as the 3ey e9planatory varia0le in the
estimation of interest, 4hich 4e specify
as'
? ?
ZofSu0primeOri1inations
ε
lo1 . ,
=⋅ + ⋅ + β
(ercentSold +orro)erDemo
? ?
.
(
Zof #ousin1Units
i i i
? ?
5.(
i
.e report the results of the second sta1e estimation in column K of Ta0le 11.
The ma1nitude of the relationship 0et4een secondary mar3et activity and
ori1ination rates is almost t4ice as lar1e 4hen compared 4ith the standard
OAS estimate presented in column 1 of Ta0le 11. The results presented in
column K su11est that a 1)J increase Da0out one standard deviationE in the
percenta1e of ori1inated loans sold to the secondary mar3et results in a 5)J
increase Dover one2 half standard deviationE in the avera1e num0er of
su0prime loans per housin1 unit Dan additional
; su0prime loans per 1)) housin1 unitsE. Overall, 4e interpret these results
as evidence that the demand for loans from the secondary mar3et is at least
one of the channels that drives the e9tension of credit in the primary
mort1a1e mar3et.
.e 0riefly discuss a potential 0ias introduced into our sample 0y usin1 the
#!D+ Fhi1her2pricedI classification as a pro9y for su0prime activity. Aoans
classified as Fhi1her2 pricedI are considered hi1her2priced relative to a
reference asset of compara0le maturity. This 0ecomes a pro0lem 4hen
considerin1 the interest rate on adBusta0le2rate loans, 4hich technically have a
K)2year maturity 0ut 4hose interest rate is 0ased on short2term rates. The
result is that adBusta0le2rate mort1a1es mi1ht 0e underreported in the #!D+
sample, and the ma1nitude of the 0ias 4ill chan1e throu1h time dependin1 on
the shape of the yield curve. Underreportin1 adBusta0le2rate mort1a1es li3ely
0iases the sample a1ainst our results. Futhermore, 0ecause 4e are not
comparin1 ori1ination rates across years, 4e have no reason to suspect the
presence of a systematic 0ias in the reportin1 of Fhi1her2pricedI loans that are
ori1inated or sold that 4ould adversely affect results in a cross2section of <8=
codes in year ())H.




(-
Section (: Conclusion
This paper analy/es the structure and attri0utes of su0prime mort1a1e20ac3ed securiti/ation deals
ori1inated 0et4een 1--5 and ())5, the purchasin1 activity of 0an3s under4ritin1 the deals, and
the impact of that purchasin1 activity on the e9tension of mort1a1e credit. .e sho4 that the
securiti/ation process, includin1 the assi1nment of credit ratin1s, provided incentives for
securiti/in1 0an3s to purchase loans of poor credit 7uality in areas 4ith hi1h rates of house price
appreciation. 8ncreased demand from the secondary mort1a1e mar3et for these types of loans
appears to have facilitated easier credit in the primary mar3et. Deals comprised of loans
concentrated in areas that e9hi0ited hi1h rates of house price appreciation in the year prior to deal
ori1ination received more favora0le credit ratin1s, all else e7ual. .e also demonstrate that deals
4ith loans concentrated in areas 4ith hi1h rates of house price appreciation have a lo4er cost of
funds, in most years. The impact of price appreciation on deal structure and deal cost of funds is
relevant for t4o reasons. First, ratin1 a1encies have 0een va1ue a0out the ma1nitude 4ith 4hich
house price appreciation impacts deal ratin1s. Second, and perhaps more importantly, the structure
of securiti/ation deals matters 0ecause the economics of the structurin1 process creates incentives
for deal arran1ers to purchase a portfolio of loans that 4ill provide the cheapest fundin1 for a deal.
Usin1 an event 4hich identifies an e9ternal shoc3 to the demand for su0prime loans from the
secondary mar3et, 4e demonstrate that deal arran1ers increased their relative demand for
su0prime loans 4ith hi1her loan2to2value ratios and hi1h rates of house price appreciation. .e
sho4 that loan2to2value ratios have a lar1er mar1inal impact on the default rate of CS" loans
relative to non2CS" loans after the event. Finally, 4e use the event to identify a relative shift in
the demand for su0prime loans from the secondary mort1a1e mar3et. The relative demand shift
allo4s us to identify a causal relationship 0et4een demand in the secondary mar3et and credit
supply in the primary mort1a1e mar3et. .e 0elieve a careful identification of the impact of
securiti/ation on credit supply is an important result 1iven the recent 0oom in securiti/ation
activity and the relative dearth of academic evidence re1ardin1 the impact of securiti/ation on the
primary mar3et of the asset 0ein1 securiti/ed.














K)
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K1
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8mplications for Securiti/ation,I mimeo, Ne4 Cor3 University.
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!ayer, C. =ence, >., ())*. FSu0prime !ort1a1es' .hat, .here and to .homLI 9+ER *or$in (a&er
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!ort1a1e Default Crisis,I 1uarterly Journal of Economics! forthcomin .
!oody:s 8nvestor Services, ());. F8ntroduction to !oody:s Structure Finance +nalysis and !odellin1.I
=resentation 1iven 0y Frederic Drevon, !ay 1K.
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=ennin1ton2Cross, +., #o, &., ())6. FThe Termination of Su0prime #y0rid and Fi9ed $ate !ort1a1es,I
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S"C ());. Federal $e1ister) ?ol. 6-, No. 11*, !onday, @une (1, ());, $ules and $e1ulations, pa1e (-.
S"C. ())*. FS"C:s Oversi1ht of %ear Stearns and $elated "ntities' The Consolidated Supervised "ntity
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,oundation Discussion (a&er 9o6 ;@37.


K(
Standard and =oor:s, ())5. F=rinciples2%ased $atin1 !ethodolo1y for &lo0al Structured Finance
Securities.I Standard O =oor:s $atin1s Direct $esearch, N.C.































































KK
Fi1ure 1. The Structure of a Su0prime Securiti/ation Deal.
This ta0le presents the structural details of a su0prime securiti/ation deal in our sample. The deal, named
&S+!= Trust ())62NC1 4as arran1ed 0y &oldman Sachs and 4as issued in Fe0ruary ())6. The total deal
principal is P51;.( million, 4ith P*.-K million servin1 as overcollaterali/ation. One2month A8%O$ in
Fe0ruary ())6 4as ;.H*. The tranche24ei1hted spread over A8%O$ is .(H*J.
*ri!inal Percent of Spread Spread
*ri!inal Coupon &irst
Class +ame ,alance *-er ./ o-er
Total
Ratin! Type
Coupon
01112s3 Principal 0S4P3 Rate $th
#5,*R
Reference
Treasury
+21 PK1),(-- ;K.;J +++ Floatin1 ;.65HJ ).)-HJ
+2(
P((;,-HH K1.HJ +++ Floatin1 ;.5*HJ ).()HJ



+2K ;(,H6H 6.)J ++ Floatin1 ;.*-HJ ).K1HJ
!21 P(K,(1K K.KJ ++\ Floatin1 ;.-6HJ ).K*HJ !2( P(1,5*; K.)J ++\ Floatin1 ;.-*HJ ).;)HJ !2K P1(,*H5
1.*J ++ Floatin1 H.))HJ ).;(HJ !2; P11,)5) 1.HJ ++ Floatin1 H.1)HJ ).H(HJ !2H P1),51; 1.HJ ++2
Floatin1 H.1(HJ ).H;HJ !26 P-,6;( 1.KJ +\ Fi9ed 6.)))J 1.;K)J %21 P-,(*H 1.KJ + Floatin1 H.()HJ
).6(HJ
%2( P1),))) 1.;J +2 Floatin1 H.5;HJ 1.16HJ %2K P6,;(* ).-J %%%\ Fi9ed 6.)))J 1.HK)J %2; PH,KH5 ).*J
%%% Fi9ed 6.)))J 1.HK)J %2H P5,1;( 1.)J %%%2 Fi9ed 6.)))J 1.HK)J C" P*,-(* 1.KJ N.$.




















K;
Fi1ure (. Default Correlation and "9pected Aoss Distri0ution.
This fi1ure uses a hypothetical distri0ution of e9pected loss to demonstrate ho4
default correlation chan1es the shape of the loss distri0ution, 0ut not the e9pected
loss. "9pected loss in the t4o distri0utions is e7ual.


Zero Default Correlation High Default Correlation
Probability of Loss
50
4
5

4
0

3
5

3
0

2
5

2
0

1
5

1
0

5

0
05 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100
Percent Loss in the Portfolio







Fi1ure K. CS" %an3 Aevera1e and CS" !ar3et Share
This solid line represents the avera1e share of all securiti/ed su0prime loans that
are o4ned 0y the five CS" 0an3s in each <8= code of our sample, 4hile the
dotted lines represent the -Hth and Hth percentile.
CSE Bank Share of Securitized
Loans
Average Market hare 95! "eve
l
5! "eve
l
0
#
7

0
#
6

0
#
5

0
#
4

0
#
3

0
#
2

0
#
1
%
0
o
f
2001 2002 2003 2004 2005 2006 2007
S
u b
p r
i m
e
L o
a n
s
Z
I P

C o
Fi1ure ;. These charts plot the avera1e 0an32<8=2year attri0utes of su0prime loans o4ned 0y
CS" 0an3s and non2CS" 0an3s throu1h time.
Aera!e Loan"to"#alue $atio
C$ %ank& 'on(C$ %ank&
Percent
87
86
85
84
83
82
81
80
79
78
2001 2002 2003 2004 2005 2006 2007
A!% &ouse Price Appreciation' t"(
Percent
14
12 10 8 6 4 2 0
C$ %ank& 'on(C$ %ank&
2001 2002 2003 2004 2005 2006 2007
Aera!e )IC* Score
C$ %ank& 'on(C$ %ank&
)IC* Score
640
620
600
580
560
540
520
500
2001 2002 2003 2004 2005 2006 2007







K6
Ta0le 1. Deal Summary Statistics.
This ta0le reports summary statistics related to the structure of su0prime securiti/ation deals. The sample
runs from 1--52())5. Si/e of the +++ tranche is defined as the total principal 0alance of tranches 4ith a
F+++I ratin1 at the time of deal ori1ination divided 0y the total principal of the deal. Si/e of the
investment21rade tranche is the sum of all tranches 4ith an ori1inal credit ratin1 of F%%%\I or hi1her Dor
the !oody:s e7uivalent 4hen relevantE, divided 0y the total principal 0alance of the deal. "9cess spread is
calculated as the difference 0et4een the deal ori1ination loan24ei1hted mort1a1e rate and the first coupon
promised to investors. Deal F8CO is a loan24ei1hted avera1e of the deal F8CO scores at ori1ination. Deal
CAT? is the loan24ei1hted avera1e of a 0orro4er:s com0ined loan2to2value ratio at deal ori1ination. Deal
DT8 is the loan24ei1hted avera1e of a 0orro4er:s de0t2to2income ratio at deal ori1ination. The deal
unemployment rate is calculated as the loan24ei1hted state unemployment rate at the time of deal
ori1ination. #ouse =rice +ppreciation t21 is calculated as the one2year 1ro4th rate in residential house
prices in the <8=2code or state of loan ori1ination and is a11re1ated to the deal level usin1 loan si/es as
4ei1hts. #ousin1 mar3et diversification is a measure of the correlation of the housin1 mar3ets in 4hich the
loans 4ere ori1inated. &eo1raphic diversification is a #erfindahl inde9 measurin1 the 1eo1raphic
concentration of loans in the deal. The te9t of the paper contains a detailed description of ho4 the t4o
measures of diversification are computed. The implied2to2actual rent ratio is a measure of ho4 Fe9pensiveI
a housin1 mar3et is relative to its (H2year avera1e. The ratio is calculated and made pu0licly
availa0le 0y Chris !ayer at http'QQ444;.1s0.colum0ia.eduQrealestateQresearchQhousin1 . The te9t outlines
ho4 4e a11re1ate !S+2level measures of housin1 mar3et fundamentals to the deal level. Deal coupon
spread is the spread 0et4een coupon rates 0ein1 paid to 0ond investors over 12month li0or D4here 12month
li0or is measured as the monthly avera1e in the month of deal closeE. Deal coupon spread is calculated for
tranches that pay floatin1 coupon payments to 0ond investors. The coupon spread is a11re1ated to the deal
level usin1 tranche si/es as 4ei1hts.




N!ean !ed Std. Dev. HJ -HJ
Si/e of +++ Tranche 1(65 ).*)H ).5-* ).)5K ).515 ).-(-
Si/e of 8nvestment &rade Tranche 1(65 ).-H) ).-6H ).)6( ).*5( ).--; "9cess Spread 1(H) ;.); K.6; 1.K* (.;K
6.K5 Deal Coupon Spread 1(65 ).;;( ).;)H ).(-; ).156 ).*K( Deal F8CO 1(H; 6(K.5 6(1.K (1.5 H6;.1 6H5.( Deal
CAT? 1(66 *K.-1 *K.-H 6.)6 56.6* -(.H* Deal DT8 1)K) ;).51 ;1.)1 (.6* K5.*( ;K.KK Deal +$! 1(65 ).555
).*15 ).15* ).;1; ).-H1 Deal Unemployment $ate 1(65 H.15 H.)H ).6H ;.K1 6.(; #ouse =rice +ppreciation t21
1(65 1(.-H 1K.;1 ;.(H H.)5 1*.*H !ar3et Diversification 1(6; ).K)5 ).K1K ).);K ).(K6 ).K5) &eo1raphic
Concentration 1(6; ).1K; ).115 ).)5; ).)H1 ).(*1 8mplied2to2+ctual $ent $atio 1(;- 1.)-) 1.)5( ).1)- ).-;5
1.(6( =ercent 4ith =repayment =enalty 1(65 ).511 ).5;H ).1*6 ).1K; ).*-5 +vera1e =repayment Term 1(65 1-.*K
1-.-* 6.K*) (.)6) (*.61










K5



Ta0le H. Summary Data on F#i1her2=ricedI !ort1a1e Ori1inations



=anel +' Num0er of #i1her2=riced AoansQTotal #ousin1 Units
Cear Z <ip Codes 1)J !edian !ean -)J Std Dev ())H 1H1K- ).)15 ).)K5 ).)H* ).116
).)56 =anel %' Aoans Sold as a =ercent of Aoans Ori1inated
Cear Z <ip Codes 1)J !edian !ean -)J Std Dev ())H 1H(H- ).H)) ).5() ).6*H ).*1;
).1(- =anel C' <8= Code Denial $ates
Cear Z <ip Codes 1)J !edian !ean -)J Std Dev ())H 1H(6; ).151 ).(66 ).(55 ).;))
).)-) =anel D' Chan1e in !ar3et Share of H CS" %an3s
Cear Z <ip Codes 1)J !edian !ean -)J Std Dev ())H (-(K ).1*( ).H;- ).6)-
1.)-6 ).K-6
Ta0le 6. $ates of #ouse =rice +ppreciation and Deal Credit $atin1s.
This ta0le presents the results of OAS re1ressions usin1 deal data from 1--52())5. The dependent varia0le
is the proportion of the deal:s principal rated +++. The 3ey independent varia0le, la0eled Deal #.=.+. t21
is a measure of house price appreciation in mar3ets 4here individual loans 4ere ori1inated. The varia0le is
a11re1ated to the deal level 0y si/e of the loan. #ousin1 mar3et diversification is a measure of the
correlation of the housin1 mar3ets in 4hich the loans 4ere ori1inated. &eo1raphic concentration is a
#erfindahl inde9 measurin1 the 1eo1raphic concentration of loans in the deal. The te9t of the paper
contains a detailed description of ho4 the t4o measures of diversification are computed. The remainin1
independent varia0les are loan2level 0orro4er attri0utes that have 0een a11re1ated to the deal level. The
deal2level unemployment rate is included to control for macroeconomic conditions in local mar3ets at the
time of deal ori1ination. .e also include time fi9ed effects to control for other macroeconomic factors that
may chan1e throu1h time. Ta0les 12K contain summary statistics and units for each of the varia0les used in
the re1ression.

Dependent ?aria0le' =roportion of the Deal $ated +++ D 1 E D ( E D K E
D ; E D H E D 6 E 1--52())5 ())K ()); ())H ())6 ())5
Deal #.=.+.
t21
).))(*** ).)15*** 2).))5 ).)11*** ).))(** ).))K* D;.(*E D(.-HE D1.HHE DK.(*E D(.;6E D1.6*E
#ousin1 !ar3et Correlation 2).)6( 2).;1;* ).151 2).1K1 2).)H; 2).))5 D).-6E D1.*)E D1.1;E D1.6HE D).-(E D).)5E
&eo1raphic Concentration 2).)-)*** 2).((1** ).15* 2).(5)*** 2).)K* 2).))- D(.*5E D(.;*E D1.;-E DK.HHE D1.K-E D).)6E
F8CO ).))1*** ).))) ).))1** ).))1*** ).))1*** ).))1** D6.;-E D).K6E D(.6HE DK.-)E D1(.15E D(.1(E
Aoan2to2value 2).))1* 2).))K*** 2).))K* 2).))1 2).))1 2).))( D1.*;E DK.6HE D1.5*E D1.1KE D1.6-E D1.H;E
+$! 2).)16 ).)K6 ).)); 2).)-K*** 2).)(; 2).))5 D).-HE D1.;1E D).15E DK.((E D1.1(E D).1-E
O4ner Occ. ).))H ).)-5 2).)K1 2).)1K 2).116 2).)HH D).11E D).;HE D).()E D).K1E D1.()E D).K5E
Full Doc. ).)(6* ).)H( ).)6;* ).);(** ).)K) ).)65 D1.5)E D).-1E D1.*-E D(.;KE D1.;6E D1.;HE
=urchase 2).))- ).)H(** 2).)H) 2).)H6** 2).)11 ).1(6* D).H*E D(.;5E D1.)6E D(.(;E D).;5E D1.--E
Unemployment ).))K 2).)(; 2).);-** ).)H**** 2).)(K* 2).1;(*** D).H;E D1.;)E D(.5HE DK.K)E D1.5(E DK.;6E
"9cess Spread ).))) 2).)1K** ).))* ).))( 2).))6 2).)); D).))E D(.K(E D).5-E D).K*E D1.1KE D).KHE
"9ternal 8nsurance Dummy ).);**** ).)5H*** ).)(* ).)5K** 2).)(5 ).)5H** DH.66E DH.)(E D1.;6E D(.56E D1.;*E D(.;6E
=repayment =enalty 2).)HK*** 2).)5; 2).)H1 ).))( 2).);H* 2).()K*** DK.(5E D1.H(E D1.()E D).)*E D1.-)E D(.-1E
=repayment Term ).))1 ).))1 ).))) 2).))1 ).))1* ).))H** D1.H;E D).-;E D).(*E D).6(E D1.5;E D(.;*E
Constant 1((H 1K( ((5 (-* K15 1K; ).H5K ).;61 ).(;K ).K;6 ).;;* ).;65
Cear Fi9ed "ffects Ces 22 22 22 22 22 Std. "rr. Clustered 0y 8ssuer Ces Ces Ces Ces Ces Ces
O0servations 1((H 1K( ((5 (-* K15 1K;
+dBusted $2s7uared ).H5K ).;61 ).(;K ).K;6 ).;;* ).;65 $o0ust t statistics in parentheses
* si1nificant at 1)JS ** si1nificant at HJS *** si1nificant at 1J










;(
Ta0le 5. $ates of #ouse =rice +ppreciation and the Cost of Funds.
This ta0le presents the results of OAS re1ressions usin1 deal data from 1--52())5. The dependent varia0le
is the spread of coupon rates 0ein1 paid to 0ond investors over 12mth li0or. Deal coupon spread is
calculated for tranches that pay floatin1 coupon payments to 0ond investors. The coupon spread is
a11re1ated to the deal level usin1 tranche si/es as 4ei1hts. Deal #.=.+. t21 is a measure of house price
appreciation in mar3ets 4here individual loans 4ere ori1inated. The varia0le is a11re1ated to the deal level
0y si/e of the loan. #ousin1 mar3et diversification is a measure of the correlation of the housin1 mar3ets in
4hich the loans 4ere ori1inated. &eo1raphic diversification is a #erfindahl inde9 measurin1 the 1eo1raphic
concentration of loans in the deal. The te9t of the paper contains a detailed description of ho4 the t4o
measures of diversification are computed. The remainin1 independent varia0les are loan2level 0orro4er
attri0utes that have 0een a11re1ated to the deal level. The deal2level unemployment rate is included to
control for macroeconomic conditions in local mar3ets at the time of deal ori1ination. .e also include time
fi9ed effects to control for other macroeconomic factors that may chan1e throu1h time. Ta0les 12K contain
summary statistics and units for each of the varia0les used in the re1ression.


Dependent ?aria0le' Deal Coupon Spread
D1E D(E DKE D;E DHE D6E 1--52())5 ())K ()); ())H ())6 ())5
Deal #.=.+.
t21
2).))H 2).);-* 2).)(1** ).))H ).))5*** 2).)(H** D1.(1E D(.6KE D(.5(E D).65E DK.(5E D(.*KE
#ousin1 !ar3et Correlation 2).;6** ).*51 2).))1 2).))6 ).);( ).(H- D1.56E D).6;E D).))E D).)(E D).1*E D).H)E
&eo1raphic Concentration ).(-** 1.15- ).H*) 2).1*6 ).1** ).15H D1.-5E D1.5)E D1.H1E D).*5E D1.)5E D).;)E
F8CO ).))) ).))K 2).))1 2).))1 2).))1* ).))1 D).(6E D1.1)E D1.(;E D1.;5E D1.5;E D).HHE
Aoan2to2value ).))( ).)1H** ).))K 2).))1 2).))) 2).))K D).-)E D(.5*E D1.)-E D).(;E D).1HE D).;(E
+$! 2).HH(*** 2).)5; 2).1)1 2).;***** 2).;*K*** 2).*55*** D*.65E D).K;E D1.)6E DK.6;E D;.1(E DK.H*E
O4ner Occ. 2).6H(** 2K.;**** 2).6K;* ).)H) 2).1KK 1.1**** D(.65E D(.)-E D1.5-E D).(-E D).5(E D(.1KE
Full Doc. ).)H; ).)(( ).))( ).)K5 ).);H 2).161 D).-5E D).)*E D).);E D).6HE D).5-E D1.)-E
=urchase 2).)H; 2).1;* 2).)K6 ).1K; ).11; 2).;K* D).*(E D).H6E D).H;E D1.6;E D1.K)E D1.))E
Unemployment ).)1- 2).15) 2).)H* ).1-K*** ).)*5** ).5*6*** D).5HE D1.(5E D).5-E D;.11E D(.1*E DK.)KE
"9cess Spread 2).);(*** 2).11K* 2).1)K*** 2).);)* ).)1K 2).);H DK.1HE D1.56E D*.5;E D1.5HE D).5*E D).-5E
"9ternal 8nsurance Dummy 2).)(* 2).1HK** 2).)*6*** 2).);; 2).))- ).)H- D).H*E D(.(*E DK.(;E D1.5(E D).()E D).*-E
=repayment =enalty ).(K5** ).6(1 2).)K- 2).)(1 ).(11** ).-5-*** D(.1)E D1.1(E D).;;E D).1HE D(.16E D;.(1E
=repayment Term 2).))( 2).))( ).))K 2).))( 2).))-*** 2).)K(*** D1.1*E D).KHE D).6;E D).6;E D(.--E D(.-(E
Constant 1.;()*** K.((; (.H)5*** ).H)) ).5*) 2K.6(* DK.-(E D1.H(E DH.;6E D).*)E D1.61E D1.K6E
Cear Fi9ed "ffects Ces 22 22 22 22 22 Std. "rr. Clustered 0y 8ssuer Ces Ces Ces Ces Ces Ces
O0servations 1((H 1K( ((5 (-* K15 1K;
+dBusted $2s7uared ).K5- ).((* ).()- ).1HH ).(KK ).;;H $o0ust t statistics in parentheses
* si1nificant at 1)JS ** si1nificant at HJS *** si1nificant at 1J










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Ta0le -. +naly/in1 the =urchasin1 +ctivity of Deal Under4riters.
8n this ta0le 4e estimate an OAS re1ression 4here the natural lo1 of the total num0er of su0prime loans
purchased in each <8= code in each year 0y each under4ritin1 0an3 is the dependent varia0le. Our panel
data set of 0an32/ip2years runs from 1--52())5. The final dataset used in the estimation is created 0y
identifyin1 the total num0er of su0prime loans in each <8= code in each year that 4ere o4ned 0y the five
CS" investment 0an3s and the total num0er of su0prime loans o4ned 0y the non2CS" 0an3s involved in
loan securiti/ation. Column H restricts the sample to 0an32<8=2years 4ith more than one su0prime loan in
order to 1et a more precise estimate on avera1e <8=2code loan attri0utes. The te9t outlines the details
associated 4ith the assi1nment of CS" 0an3 indicator. The estimation controls for <8=2code fi9ed effects,
and clusters standard errors 0y year.



Dependent ?aria0le' Natural Ao1 of the Num0er of Su0prime Aoans
=urchased in "ach <8= Code in "ach Cear 0y "ach %an3
<8= Code #.=.+.
t21
).)KH*** ).)K;*** ).)K)*** ).)(;*** D1K.6(E D1;.;6E DH.1*E D;.*1E
<8= Code +v1. F8CO ).)))*** ).)))** ).))) ).))) D(.-KE D1.--E D1.;HE D1.))E
<8= Code +v1. DT8 ).));* ).))K ).))K ).))( D1.5-E D1.K*E D1.;(E D1.1(E
<8= Code +v1. A.T.?. ).)1)*** ).))-*** ).)1)*** ).)11*** DH.5KE DH.)HE DH.6HE DH.H)E
<8= Code =ercent +dB. $ate ).1*1*** ).16K*** ).151*** ).15H*** DH.*-E DH.*HE DH.5-E D;.-KE
CS" %an3 8ndicator 2).1)6 2).)6H ).HK5** ).6(;** D1.16E D).6KE D(.15E D(.(6E
=ost2())K 8ndicator ).(K;** ).)6) 2).1-( 2).1H1 D(.(1E D).5)E D).66E D).;KE
=ost2())K * CS" %an3 8ndicator ).KHH*** ).K16*** 2).*-** 2).-;( DK.-1E DK.)5E D1.65E D1.K(E
CS" %an3 8ndicator * <8= Code #.=.+.
t21
).))1 ).))1 D).()E D).((E
CS" %an3 8ndicator * <8= Code +v1. F8CO 2).))) 2).))) D).**E D).H;E
CS" %an3 8ndicator * <8= Code +v1. A.T.?. 2).))6*** 2).))5*** DK.H(E DK.56E
=ost2())K * <8= Code #.=.+.
t21
).))1 ).))K D).(KE D).H*E
=ost2())K * <8= Code +v1. F8CO
).))1* ).)))
D1.-1E D1.1*E
=ost2())K * <8= Code +v1. A.T.?.
2).))1 2).))(
D).H(E D).;-E
CS" %an3 8ndicator * =ost2())K * <8= Code #.=.+. t21
).)11 ).)1(**
D1.H*E D(.(HE
CS" %an3 8ndicator * =ost2())K * <8= Code +v1. F8CO ).))1 ).))) D).-HE D).(HE
CS" %an3 8ndicator * =ost2())K * <8= Code +v1. A.T.?. ).)1)*** ).)1(*** DK.K*E D(.*(E
Constant 2).6*-*** ).56(*** 2).HK)*** 2).H*;*** ).)1H D;.)6E D-.)6E DK.1(E D(.6-E D).)6E
Standard "rror Clustered 0y Under4riter Ces Ces Ces Ces Ces Standard "rror Clustered 0y Cear Ces Ces Ces Ces Ces O0servations 1KHH6)* 1KHH6)*
1KHH6)* 1KHH6)* *1611; +dBusted $2s7uared ).)-* ).)KH ).111 ).11H ).1(*
Ta0le 1). %an32Specific Default $ates
8n this ta0le 4e estimate a To0it re1ression 4here the default rate on su0prime mort1a1e loans o4ned 0y
each of the securiti/in1 0an3s is the dependent varia0le. .e estimate a To0it re1ression to account for the
lar1e num0er of 0an32<8=2year o0servations 4ith /ero defaults. Our 0an32<8=2year default rate is
calculated as the total num0er of defaults as of @uly ())* on loans purchased 0y a 1iven 0an3 in a 1iven <8=
in a 1iven year as a percenta1e of the total num0er of su0prime loans purchased 0y a 0an3 in a 1iven year in
a 1iven <8= code. The panel data set of 0an32<8=2years runs from 1--52())5. .e assi1n a dummy varia0le
e7ual to one for the 0an32<8=2years of the five CS" investment 0an3s. The te9t outlines the details
associated 4ith the assi1nment of CS" 0an3 status. Columns 12; estimate the model 4ith the full sample.
Column H restricts the sample to 0an32<8=2years 4ith more than one su0prime loan in order to 1et a more
precise estimate on avera1e <8=2code loan attri0utes.
Dependent ?aria0le' Natural Ao1 of Default $ate on Su0prime
!ort1a1e Aoans #eld 0y Cross2Section of Securiti/in1 %an3s
<8= Code #.=.+.
t21
2).))(1 2).))1H 2).)(K;*** 2).)15-*** D2).H-1E D2).;1*E D21K.HHE D21(.1KE
<8= Code +v1. F8CO 2).)))6*** 2).)))H*** 2).)))K* 2).)))K* D2;.(6(E D2K.()5E D21.6H-E D21.6HHE
<8= Code +v1. DT8 ).))1)* ).))1(** ).))1H*** ).)))*** D1.5)6E D(.KH;E DK.1)*E D(.);;E
<8= Code +v1. A.T.?. ).))6(*** ).))6**** ).))6H*** ).));)*** D;.K1HE DH.H)*E D5.*((E D;.61)E
<8= Code =ercent +dB. $ate ).155K*** ).1-((*** ).1-K)*** ).1K*(*** D*.1)HE D*.6;(E D*.6-6E DH.H5;E
CS" %an3 8ndicator ).))H( ).));K ).;;*6*** ).K;HK*** D).(6-E D).()(E DK.KHHE DK.))HE
=ost2())K 8ndicator 2).)K-1 2).)**6 2).((1K 2).K(5; D2).6*-E D21.H)KE D21.)6;E D21.H;(E
=ost2())K * CS" %an3 8ndicator ).)KK) ).)(-K 2).K)1*** 2).1K)H D1.K-;E D1.(16E D2(.)**E D2).-(5E
CS" %an3 8ndicator * <8= Code #.=.+.
t21
).))(; ).)))- D1.;-*E D1.115E
CS" %an3 8ndicator * <8= Code +v1. F8CO ).)))) ).)))1 D).(H*E D).;5)E
CS" %an3 8ndicator * <8= Code +v1. A.T.?. 2).))61*** 2).));-*** D2K.H;1E D2;.)K1E
=ost2())K * <8= Code #.=.+.
t21
).)(6)*** ).)156*** D6.;11E D6.;(5E
=ost2())K * <8= Code +v1. F8CO 2).)))6* 2).)))K
D21.-(HE D2).5*-E
=ost2())K * <8= Code +v1. A.T.?. ).))KH*** ).))K;***
D;.;5-E D;.KKHE
CS" %an3 8ndicator * =ost2())K * <8= Code #.=.+. t21
2).))1( 2).)));
D2).5(KE D2).;;KE
CS" %an3 8ndicator * =ost2())K * <8= Code +v1. F8CO 2).)))1 2).)))K D2).*(-E D21.;6HE
CS" %an3 8ndicator * =ost2())K * <8= Code +v1. A.T.?. ).))HK*** ).))K5*** D(.-5*E D(.*H*E
Constant 2).H5-5*** 2).(;***** 2).6;6-*** 2).H;*(*** 2).1)H; D2;.;H5E D2;.6*KE D2H.1*KE D2H.11(E D2).-K6E
Si1ma ).H-)1*** ).H-*)*** ).H**;*** ).H*K6*** ).KKK**** D1;.;6E D1H.))E D1;.55E D1H.((E D1-.)HE
Standard "rror Clustered 0y Cear Ces Ces Ces Ces Ces O0servations 1KH6-5( 1KH6-5( 1KH6-5( 1KH6-5( *16;H( =suedo $2s7uared .)1* .))1 .)() .
)(* .);*













;6
Ta0le 11. The 8mpact of Securiti/ation on +ccess to Credit' 8nstrumentin1 for Secondary
!ort1a1e !ar3et Demand.
8n this ta0le 4e estimate a t4o2sta1e least s7uares re1ression usin1 an instrument for the demand for
mort1a1e loans from the secondary mort1a1e mar3et. The results are estimated on a cross2section of (,5*6
<8= codes in the year ())H only. The first sta1e re1ression, reported in column (, estimates the relationship
0et4een the percent of ori1inated su0prime mort1a1e loans that are sold to the secondary mar3et as a
function of our instrument for secondary mar3et demand, controllin1 for economic and demo1raphic
varia0les. The instrument for secondary mar3et demand is computed as the prior (2year chan1e D())K2
2005. in su0prime mar3et share for the H CS" 0an3s. The second sta1e re1ression, reported in
column K, is then estimated usin1 the fitted value from the first sta1e re1ression, and the same set of
economic and demo1raphic control varia0les. .e cluster standard errors at the !S+ level. For purposes of
comparison, 4e estimate an OAS re1ression usin1 the same specification and report the results in Column 1.



*#S &irst Sta!e 56 Second Sta!e 56
Ao1 Num0er of Su0prime Su0prime =ercent Sold AoansQ#ousin1 Unit
Ao1 Num0er of Su0prime
AoansQ#ousin1 Unit
(2Cear Chan1e in CS" !3t. Share ).)1;*** DK.156E
Su0prime =ercent Sold K.;)K*** 5.K6;** D*.561E D(.(;6E
).)(;*** ).))K*** ).)1K DH.;6-E D6.()6E D1.H(KE
!edium 8ncome in %ottom Tuartile ).6H6 ).11-** ).((6 D1.;KHE D(.115E D).KH(E
!edium 8ncome in Second Tuartile ).KH* ).(*H*** 2).51- D).5K*E D;.(;KE D2).6*KE
!edium 8ncome in Third Tuartile ).;(- ).(5H*** 2).6H( D).-H5E DK.56*E D2).6;)E
!edium 8ncome in Fourth Tuartile ).6)* ).1-)*** 2).11* D1.K;6E DK.;)HE D2).16-E
J of <8= =op 4ith Ao4 Credit (.51K*** 2).)5K*** (.-*6*** D1).H;E D2K.51;E D*.5-1E
J of <8= =op 4ith !edium Credit -.K-H*** 2).)); -.K-5*** D1H.;;E D2).)6KHE D1H.-6E
O4nership $ate ).))-*** ).))) ).))**** DH.;;-E D).HK(E D;.*6;E
Aa11ed #ousin1 =ermits in CountyQ#ousin1 Units ).)-K*** ).))1 ).)*-*** D6.;5KE D).H5(E DH.5K)E
Unemployment $ate ).)KK* 2).))1 ).)K- D1.66)E D2).;K6E D1.;65E
Constant 2*.5;;*** ).H56*** 211.)5(*** D2(1.K-E D11.61E D2H.;(6E
Std. "rrors Clustered at !S+ Ces Ces Ces O0servations (5*6 (5*6 (5*6 +dBusted $2s7uared ).6(( ).K51 ).HH*




















;5
Appendix .: 5nstitutional &eatures of the Securitization $ar%et

%&&endi' Section ;a: Deal Structure
8n order to understand ho4 the securiti/ation process can impact mort1a1e mar3ets, 4e provide a
0rief outline of some of the 3ey institutional features of the su0prime securiti/ation structure.
Thou1h no strict definition of a su0prime mort1a1e e9ists, the term usually refers to a mort1a1e
loan 4ith poor credit 7uality, e9cessive levera1e, or no income documentation. %orro4ers 4ho
FstateI a monthly income 4ithout documentation to verify the income can also 0e considered
su0prime.K- #i1h loan2to2value or de0t2to2income ratios are also typical of su0prime 0orro4ers.
Until the late 1--)s, su0prime loans represented a very small portion of total residential mort1a1e
ori1inations.
=ools of su0prime loans are ori1inated 0y retail 0an3s or mort1a1e 0ro3ers and su0se7uently sold
to private financial intermediaries, 4ho are fre7uently .all Street firms or their su0sidiaries, and
4ho are referred to as deal arran1ers or deal under4riters.;) The pool of loans is then placed into
a 0an3ruptcy remote trust, 4hich is a separate le1al entity and 4hich o4ns the ri1hts to each
mort1a1e. Servicin1 of the mort1a1es is outsourced to a loan servicer. The pool of loans is
separated into different [tranches[ a1ainst 4hich 0onds are issued and sold to investors. !ort1a1e
payments from the pool of loans are Fpassed throu1hI to the 0ond holders and are the source of the
0ond:s coupon payment. The type of 0onds issued a1ainst securiti/ed mort1a1es varies
su0stantially. %ond coupon payments can 0e fi9ed or varia0le rate. Some 0onds are issued as
interest only, so that the 0ondholder receives only the interest from an underlyin1 mort1a1e pool,
4hile others are issued as principal only. %onds referred to as the Fe7uity trancheI 1enerally do
not receive any principal.;1
8ndividual loans are not assi1ned to specific tranches. $ather, tranches are or1ani/ed in a seniority
structure that assi1ns a priority payment scheme to payment streams emanatin1 from the
underlyin1 loans. The prioriti/ed payment of principal and interest varies 0y deal. Typically, the


K- %orro4ers 4ho FstateI a monthly income can also fall into a cate1ory of loans called F+lt2+I. +1ain,
thou1h no strict definition e9ists, F+lt2+I loans 1enerally have hi1her credit scores than su0prime
0orro4ers 0ut lac3 income documentation.
;) 8n +ppendi9 +K 4e provide a list of firms 4ho acted as deal under4riters in our sample of securiti/ation
deals.
;1 "7uity tranches can receive payments at the 0e1innin1 of their life. Deals 4ith lar1e mar1ins 0et4een the
underlyin1 mort1a1e rate and coupon payments can pass the e9cess interest payments onto holders of the
e7uity tranche. These payments only occur 4hen every other tranche is receivin1 its full coupon payment.
8n practice, this only occurs in the infancy of a deal. .hen default rates increase, the e9cess mar1in is
re7uired to compensate more senior tranches. .e discuss this concept of Fe9cess spreadI in much 1reater
detail in Section (0.
principal from loans that FprepayI Drefinance or sellE 0efore their stated maturities flo4s first to
holders of senior tranches, 4hile defaults first reduce the principal of the most Bunior tranches
until their principal is e9hausted. #olders of Bunior tranches are su0Bect to default ris3, or the ris3
that the principal 0alance of mort1a1es from 4hich coupon payments flo4 4ill 0e eroded. Fi1ure
( displays a simple dia1ram of a sample securiti/ation structure from our data. The deal,
ori1inated 0y &oldman Sachs in Fe0ruary ())6 had a total deal principal of P51;.( million. The
fi1ure reports the si/e of each tranche, its ori1inal credit ratin1 and the rate of the first scheduled
coupon payment. For a more detailed discussion of the institutional features of the su0prime
securiti/ation mar3et, 4e refer the interest reader to +shcraft and Schuermann D())*E.


%&&endi' ;b: Subordination! E'cess S&read! and 4ther ,orms of Credit Enhancement
=re2specified cash flo4 rules are desi1ned to ensure that 0onds 4ith investment21rade ratin1s
receive the promised coupon payments 4ith a very hi1h pro0a0ility, e9 ante. 8n order to ensure
that holders of investment21rade 0onds receive the promised payments, deals receive Fcredit
supportI a1ainst the potential for mort1a1e defaults. The credit support 4or3s to protect senior
tranches a1ainst the loss of coupon payments stemmin1 from default. The t4o most prevalent
forms of credit support are su0ordination and e9cess spread.;(
For any 1iven tranche, su0ordination is the sum of the amount of principal that e9ists in any
Bunior tranches. For e9ample, if all tranches 4ith an SO= credit ratin1 of +++ represented
80. of the total principal in a deal, the +++ tranches are said to 0enefit from ()J su0ordination.
Su0ordination for investment21rade tranches, 4hich are those 4ith an SO= credit ratin1 of %%%\
Dor !oody:s e7uivalentE or hi1her, is defined in the same 4ay. 8n our sample, the median
proportion of deal principal rated +++ is 5-.*J. The median proportion of principal rated
investment 1rade is -6.HJ. =ortions of the securiti/ation structure not rated investment 1rade are
1enerally made up of one or t4o very small non2investment 1rade 0onds that pay hi1h coupons,
and a tranche referred to as Fover2collaterali/ation.I The over2collaterali/ation tranche does not pay
a coupon and e9ists solely to provide credit protection to more senior tranches. Aoans that default
first 4ill destroy the principal 0alance of the over2collaterali/ation piece 0efore touchin1 any
tranche more senior. Only after the over2collaterali/ation principal has 0een fully e9hausted 4ill
defaults accrue to the ne9t most Bunior tranche. Thus, senior tranches 0enefit from Fthic3I Bunior
tranches, and in this 4ay, su0ordination acts as a form of credit protection.




;( The term credit support is used interchan1ea0ly in the literature 4ith the term Fcredit enhancementI or
Fcredit protection.I .e 4ill also use the terms interchan1ea0ly.

;-
"9cess spread is the second form of credit protection that e9ists to insure senior tranches a1ainst
mort1a1e default. "9cess spread is defined as the difference 0et4een the payments comin1 into
the securiti/ation structure from the underlyin1 mort1a1e collateral and the rate 0ein1 paid to
coupon holders. "9cess spread is calculated net of fees paid to mort1a1e servicers and other
intermediaries, such as interest2rate s4ap counterparties. +s +shcraft and Schuermann D())*E
e9plain, FGVe9cess spreadW is the first line of defense for investors a1ainst credit losses, as no
amount of principal of any tranche is reduced 0y any amount until credit losses reduce e9cess
spread to a ne1ative num0er.I 8n this 4ay, hi1her levels of e9cess spread provide more credit
protection to holders of senior tranches.
Deals 0enefit from other forms of credit enhancement such as Fshiftin1 interest,I Fperformance
tri11ers,I and interest rate s4aps. Shiftin1 interest re7uires that all prepaid principal 0e applied
only to senior tranches for a pre2specified period Dtypically the first K6 monthsE. The practice of
shiftin1 interest serves to increase the su0ordination of senior tranches 0ecause prepayments
reduce their principal 0alance, leavin1 their principal as a smaller percenta1e of the total deal
principal. =erformance tri11ers e9ist to ensure that prepaid principal is not released to any class
until the deal passes prespecified performance tests.;K Thus, if a deal is not performin1 4ell, the
priority rules can 0e shifted to ensure senior tranches receive proper credit support. Finally, deals
4ith floatin1 coupon payments mana1e the ris3 that coupon payments to 0ondholders mi1ht rise
faster than rates on the underlyin1 mort1a1es 0y means of interest rate s4aps.;;


Appendix 2: Deal Structure Data from A,S+et and ,loomber!
+%SNet, a su0scription 0ased su0sidiary of Standard and =oorNs, contains deal2level information
on securiti/ation deals from numerous asset classes, includin1 prime, +lt2+, and su0prime
residential mort1a1e20ac3ed securities. +%SNet:s primary service is in trac3in1 the performance
of a11re1ate loan pools, 0ut it also reports summary information on the structure of securiti/ation
deals at the time of ori1ination. Deal2level summary information includes the name of the deal
ori1inator, the ori1inal 0alance of the deal in total, and the ori1inal 0alances, credit ratin1, and
coupon of each tranche in the deal. 8n most cases, the deal summary also contains information on
the e9istence of credit supports li3e overcollaterali/ation, and sometimes contains

;K
.e do not have data on 4hich deals in our sample 0enefit from the e9istence of performance tri11ers.
;;
+ trust ma3in1 floatin1 coupon payments 0ac3ed 0y a pool of fi9ed2rate mort1a1es could hed1e the
interest rate ris3 0y enterin1 into a s4ap a1reement to pay fi9ed rates to a counterparty in e9chan1e for
varia0le interest payments.

H)
data on the e9istence of interest rate s4aps, and other forms of third party credit support li3e
e9ternal insurance.
.e supplement the +%SNet deal summary data usin1 %loom0er1. 8n particular, 4e use
%loom0er1 to identify the type of 0ond associated 4ith each tranche. Differin1 0ond types
include interest or principal only 0onds, or 0onds that are associated 4ith the e7uity tranche of a
deal. %ond type can vary, even 4ithin a deal. Understandin1 the 0ond type is necessary 4hen
computin1 deal su0ordination rates 0ecause interest only tranches should not 0e included in the
capital structure of a deal. .e also use %loom0er1 to confirm the types of credit support
associated 4ith each deal. Some deals in the later sta1es of our sample had third party credit
enhancement in the form of credit insurance.


Loan(erformance Data
Aoan=erformance, a su0sidiary of First +merican Trust, is the primary source of information on
su0prime and +lt2+ loans at the 0orro4er2level. Aoan=erformance claims to cover over -)J of
recent su0prime and +lt2+ securiti/ation deals. The data0ase contains detailed information on
su0prime loans at the time of ori1ination and trac3s the performance of individual loans throu1h
time. !ost relevant for our purpose is loan2level information on the ori1inal loan 0alance, F8CO
score, com0ined loan2to2value ratio, de0t2to2income ratio, and loan type. +lso crucial to our
analysis is the location of the 0orro4er, 4hich is reported at the <8=2code level. %ecause the unit
of analysis is at the deal level, 4e are re7uired to a11re1ate loan level
data to the deal level. 8n this 4ay, deal structure is computed as a function of the avera1e loan
characteristics. .e compute value24ei1hted sums, 4here the 4ei1hts are determined 0y the si/e
of each individual loan relative to the si/e of the total deal. The loan level data for attri0ute i of
loan $ in deal A is a11re1ated to the deal level as follo4s'
) *
Loan %ttribute +loan &rinci&a
$
,
i
,,
A$
= %ttribute
,
$i
*
9
++ ∑ &rinci&al $
,,
? $=1 -
.

"ouse (rice %&&reciation and Local %rea Economic Conditions
The Aoan=erformance repeat2sales house price data is availa0le at the <8=2code level. $epeat2
sales inde9es capture chan1es in house prices 0y comparin1 ho4 home prices have chan1ed
amon1 a sample of repeat2sales transactions. 8n this 4ay home 7uality is 3ept some4hat constant.
+n e9tensive literature e9ists on the estimation of repeat2sales house price inde9es,



H1
0e1innin1 4ith %ailey, !uth, and Nourse D1-6KE and su0stantially improved 0y Case and Shiller
D1-*-E. The most nota0le dra40ac3 of repeat2sales inde9es is that they are estimated 4ith
considera0le error in smaller samples. +lso, some states, referred to as non2disclosure states, are
not re7uired to report pu0lic housin1 transactions. Thus, there are some <8= codes for 4hich
repeat2sales price inde9es are not availa0le. Our house price appreciation varia0le is a11re1ated to
the deal level 0y computin1 the loan24ei1hted 1ro4th in the house price inde9 in the year prior to
deal ori1ination. .here availa0le 4e use <8=2code level appreciation rates. 8f a <8=2code inde9 is
not availa0le, 4e use the state2level repeat2sales inde9. The %ureau of Aa0or Statistics reports
unemployment rates at the state level. State unemployment data is a11re1ated to the deal level 0y
computin1 the loan24ei1hted avera1e state unemployment rate at the time of loan ori1ination.


#ortae 4riination Data from "#D%
Our 0orro4er attri0ute data has 0een 1enerously provided 0y !ayer and =ence D())*E. Thou1h
discussed in more detail in their research, 4e 0riefly recap the construction of the data for the
purposes of this paper. "7uifa9 8nc. provides data on the share of tract residents 4ith hi1h,
medium, and lo4 credit scores. #i1h credit scores are classified has havin1 a ?anta1eScore
1reater than 5)). !edium credit scores ran1e from 6;) to 5)), and lo4 scores are 0elo4 6;). The
tract data is a11re1ated to the <8=2code level usin1 1eolytics soft4are provided 0y
http'QQmcdc(.missouri.eduQ4e0sasQ1eocorr(3.html. Tract2level medium income, homeo4nership
rates, and housin1 units are provided 0y the ())) Census. !edium income is a11re1ated to the
<8= level and sorted into 7uintiles in the follo4in1 4ay. .ithin each !S+, <8=2code medium
incomes are sorted and then split into 7uartiles accordin1 to their relative income ran3in1 and
assi1ned correspondin1 indicator varia0les indicatin1 their respective income 7uintile. The house
price inde9es used in the mort1a1e ori1ination re1ressions are measured at the !S+ level, and
come from F#F+. The Census %ureau provides county2level data on permits for the construction
of residential 12; family housin1 units. Unemployment data comes from the %AS.
.e 0riefly discuss some of the potential 0ias introduced into our sample usin1 the #!D+
Fhi1her2pricedI classification as a pro9y for su0prime activity. Aoans classified as Fhi1her2pricedI
are considered hi1her2priced relative to a reference asset of compara0le maturity. This 0ecomes a
pro0lem 4hen considerin1 the interest rate on adBusta0le2rate loans, 4hich technically have a K)2
year maturity 0ut 4hose interest rate is 0ased on short2term rates. The result is that adBusta0le rate
mort1a1es 4ill 0e underreported in the #!D+ sample, and the ma1nitude of the 0ias 4ill chan1e
throu1h time dependin1 on the shape of the yield curve. +very, %revoort, and Canner D())5E
ar1ue that 0et4een ()); and ())H, at least 1K percent of the increase in the


H(
num0er of hi1her2priced loans in the #!D+ data is attri0uta0le to a flattenin1 of the yield curve.
.e 0elieve the fact that adBusta0le2rate mort1a1es are underrepresented in the #!D+ sample
li3ely 4ea3ens our results. +nother issue 4orthy of mention is that no uni7ue identifier e9ists
0et4een #!D+ ori1ination data and su0prime data from Aoan=erformance. Our primary
measure of su0prime ori1ination activity is the #!D+ Fhi1her2pricedI data, not
Aoan=erformance. .e use the Aoan=erformance data and +%SNet data on the 0an3 o4nership of
su0prime loans to calculate a pro9y for mort1a1e demand from the secondary mar3et.






















































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