Economic Policy Review
Credit Risk Transfer, Informed Markets, and Securitization
Volume 24, Number 3
December 2018

JEL classification: H81, G28, G01, G14

Author: Susan M. Wachter

Mortgage-backed securities (MBS) funded the U.S. housing bubble, while the ensuing bust resulted in systemic risk and the global financial crisis of 2007-09. In the run-up to the crisis, MBS pricing failed to reveal the growing credit risk. This article draws lessons from this failure that could inform the use of credit risk transfers (CRTs) to price credit risk. The author concludes that the CRT market, as currently constituted, could have appropriately priced and revealed credit risk during the bubble years because it met three key requirements: 1) transparency, through the full provision of information on the mortgages underlying the CRTs and the standardization of mortgages that arose from the predominance of Fannie Mae, Freddie Mac, and Ginnie Mae in the mortgage market; 2) open pricing in liquid markets; and 3) no counterparty risk. The author also describes areas of GSE reform that could either impair or enhance the ability of the CRT market to limit credit risk going forward, including the possible presence of multiple guarantors and the use of a common securitization platform.

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AUTHOR DISCLOSURE STATEMENT(S)
Susan M. Wachter
The author declares that she has no relevant or material financial interests that relate to the research described in this paper.