Real Estate Research
Real Estate Research provides analysis of topical research and current issues in the fields of housing and real estate economics. Authors for the blog include the Atlanta Fed's Kristopher Gerardi, Carl Hudson, and analysts, as well as the Boston Fed's Christopher Foote and Paul Willen.
May 16, 2014
Are Single-Family Rental Securitizations Here to Stay?
In the fall of 2013, private equity firm Blackstone LP issued the first single-family rental (SFR) securitization: Invitation Homes 2013-SFR 1. In March, Colony Capital released another SFR securitization. The Invitation Homes 2013-SFR 1 was backed by 3,207 single-family rental homes concentrated in Arizona, California, Florida, Georgia, and Illinois. Deutsche Bank arranged the deal. There are a variety of estimates of the size of institutional investors’ activity in the SFR market, but with numbers like 90,000 to 150,000 homes and 15 to 20 billion dollars invested, most agree that we can expect more securitizations like these in the future. So what exactly is this new asset class, and how did it obtain its strong credit rating?
In this post, we look at how the structure of the Invitation Homes SFR emerged and compare it to more familiar commercial mortgage-backed security (CMBS) and residential mortgage-backed security (RMBS) classes to better understand the triple-A rating. We also consider some factors that could determine whether the SFR security class will stick around.
(For a nice discussion about the entry of institution investors into the rental market, read this second-quarter 2013 EconSouth article.)
Please note that much of the information that follows is based on reports from the rating agencies:
- Kroll Bond Rating Agency. "Kroll Bond Rating Agency Assigns Final Ratings to Invitation Homes 2013-SFR1". (November 11, 2013.)
- Kroll Bond Rating Agency. 17g-7 Disclosure (Invitation Homes 2013 SFR1).
- Moody’s Investor Services. “Moody's sees growth for single family rental securitizations; outlines rating approach.” (March 6, 2014.)
- Moody's Investor Services: “Moody's identifies key risk factors in securitizations of single-family rental properties.” (August 23, 2012.)
Commercial or residential—or both?
This product took a long time to come to market. For nearly two years, the industry discussed how to structure this new security class. Discussions in 2012 and 2013 about the rating and pricing of an SFR security focused on three gray areas. The first was housing market risk. Would housing markets, and the underlying value of investor-owned homes, appreciate on a market-wide basis?
The second was property management risk. Could scattered-site, single-family homes be managed cost-effectively? And with a lack of historical data for scattered-site, single-family rentals, how could credit rating agencies predict vacancy rates, maintenance costs, and income streams with any precision?
Finally, there was confusion about how to structure an SFR securitization and what tensions and risks would exist in that structure. There was also some uncertainty about whether an SFR securitization would be more like CMBS or RMBS. Like RMBSs, the underlying assets of SFRs are single-family homes. And many risks—for example, home price depreciation and household income—are the same as in the homeownership market (Joseph Hu 2011). But like CMBSs, the borrower is a corporation, not a homeowner, and the cash flow comes from rental, not mortgage, payments. That means the payments come from highly variable net operating income, which is sensitive to vacancy rates, market rents, and maintenance costs unlike the fixed-income streams of mortgages, which are sensitive to repayment and default risk but otherwise fairly predictable. Also like CMBSs, the sponsor of the SFR deal would be responsible for maintenance, meaning they might have to keep some cash on hand.
Equity pledges or first-priority mortgages?
These issues influenced the structure of the security. High maintenance costs associated with the rental properties created a nontrivial conflict. Ideally, in a security, assets are owned by a tax-neutral, special-purpose vehicle (SPV), with assets and liabilities perfectly matched. However, retaining cash flows for maintenance jeopardizes that tax-neutral status. Early discussions favored a structure in which the borrower, not the SPV, would retain ownership of the properties and instead of mortgages, equity pledges would collateralize the securitization. While these equity pledges might be preferable for maintaining properties and would be less transaction-intensive than issuing individual mortgages, equity pledges would create a weaker claim than first-priority mortgages for investors in the event of default. Further, equity pledges were not deemed to be as bankruptcy-remote as mortgages. All this meant equity pledges could be vulnerable to material consolidation in the event the sponsor were to become bankrupt or if the sponsor were to mismanage the properties, either selling them or borrowing further and creating competing liens on the properties (Matthew Clark 2013). For this reason, Moody’s and Kroll stated that they would cap securitizations using equity pledges at Baa or A.
Ultimately, the Invitation Homes/Blackstone SFR security used first-priority mortgages, not equity pledges, and secured a triple-A rating. In structure, the security is probably more like CMBS than RMBS. Deutsche Bank compared the instrument to CMBS, and the ratings agencies also leaned this way—Kroll and Moody’s compared the security to CMBS on the forms where they express their expectations for representations and warranties. Aspects of the transaction itself suggest that it is more like a CMBS deal than an RMBS one. For instance, the special servicer, Situs Holdings LLC, specializes in CMBS (not RMBS) workouts. Still, the security remains a hybrid. Kroll used a CMBS model to determine the probability of default and an RMBS model to determine severity, working on the assumption that the income-based approach typically used in valuating CMBSs would not be appropriate for pricing the sales of single-family homes in a distressed housing market. Similarly, Morningstar used both Cap Ex and HPI stress tests to generate ratings of the various tranches, feeling that both an income/expense approach and a sales approach to valuation were appropriate.
The structure of the securitization reflects a priority for enhancing an investor’s ability to take ownership and sell the homes in the event of a default, rather than other structures which might have prioritized management of homes to enhance rental income. Moody’s did not base its rating on an evaluation of the income streams from the properties, because the agency did not feel it had the ability to evaluate with certainty vacancy rates, maintenance costs, and other key factors. Instead, it based its rating on the strength of investor claims on the homes in the event of default, and estimated sales prices of the underlying properties assuming a distressed housing market. Another factor in the triple-A credit rating is that the security is overcollateralized. That is, the value of the collateral ($638M) is well above the value of the loans ($479M)—Invitation Homes took a 25 percent advance rate on these homes.
Will they last?
Some negative commentary has surfaced in the five months since the Invitation Homes offering. And S&P has come out strongly against the triple-A rating, arguing that without historical performance data there is too much uncertainty about income streams. Recent appraisals noted that several tranches were trading below par, and that rents had declined 7.6 percent due to increasing vacancy rates. Firms that had hoped to make margin by “pushing rent” or increasing rents every year are now talking about keeping rents stable in order to minimize turnover and the associated vacancy rates. So with all of these issues, how much staying power does the SFR securitization structure really have? To the extent that these transactions are driven primarily by the value of the underlying collateral and not by rental income, they begin to resemble trades that will decline as home prices approach normal levels. Indeed, many SFR investors and managers say they ultimately intend to sell single-family rentals back into the owner-occupied market either 1) when maintenance costs begin to outweigh the potential of the asset’s income stream or 2) it appears that, in the medium term, home prices and mortgage markets have recovered—and thus the opportunity for this market to exist disappears.
Other commentators suggests otherwise: this asset class will grow, possibly driven by fundamental demographic shifts such as increasing labor mobility and shifting preferences for rentals. These attributes, combined with stagnant wages and tight mortgage markets, suggest increased demand for single-family rentals. They may also suggest that SFR securitization represents a new normal.
By Elora Raymond, graduate research assistant, Center for Real Estate Analytics in the Atlanta Fed's research department, and doctoral student, School of City and Regional Planning at Georgia Institute of Technology
August 01, 2013
Government Policy and the Crisis: The Case of the Community Reinvestment Act
Commentators on both the right and left seem to agree on one aspect of the recent mortgage crisis: government policy was at the heart of it. But they disagree on which particular government policy is at fault. The theory from the left is that financial deregulation allowed mortgage lenders and securitizers to exploit both mortgage borrowers and the investors in mortgage-backed securities. On the right, the thinking is that the government instituted policies and programs that were designed to increase credit availability and expand homeownership—policies that induced lenders to make massively risky loans.
To test these theories, researchers must identify a specific change in government policy and then explain the effects this policy change should have. They must then turn to the data to show that the predicted effects occurred soon after the government policy was instituted. A new paper by Sumit Agarwal, Efraim Benmelech, Nittai Bergman, and Amit Seru weighs some evidence related to one government policy that has long been controversial in conservative policy circles: the Community Reinvestment Act (CRA). In particular, the authors claim that the CRA played a role in the mortgage crisis by encouraging banks to make risky loans. How does this research project hold up?
History of the CRA
Before we discuss the details, here is some background on the CRA, which was enacted in 1977. In a 2003 retrospective on the law, William C. Apgar and Mark Duda noted that the CRA "was built on the simple proposition that deposit-taking banking organizations have a special obligation to serve the credit needs of the communities in which they maintain branches" (Apgar and Duda 2003, 169). The act instructed regulators to conduct periodic CRA examinations to make sure that banks were meeting the credit needs of their deposit bases. To enforce compliance, regulators had to take a banking institution's CRA record into account whenever the institution applied to consolidate with some other institution or to expand its operations with new branches (Apgar and Duda 2003, 172).
What economic effect should we expect the CRA to have? For banks, the act changes the economics of mortgage lending. In effect, it adds an extra "shadow return" to each CRA-eligible loan, over and above the loan's usual financial return. For example, the risk-adjusted return on a particular mortgage loan may be 5 percent without the CRA, but this return could rise to 6 percent after the bank factors in the benefit of the loan to its CRA compliance—and by extension, to its ability to perform a profitable merger or open a profitable branch. Simple economic theory implies that after the CRA, banks should make more and riskier loans in CRA-eligible locations, all else being equal.
The Agarwal et al. paper provides evidence that the CRA did indeed lead to more lending and also to riskier lending. The authors argue that in the three quarters before and the three quarters following a CRA examination, the average lender would make more loans and riskier loans in CRA-eligible areas.
In principle, the evidence in the paper seems consistent with the theory: government policy to encourage more lending encouraged more lending. However, other researchers have raised strong objections to the paper's empirical design. Most notably, the University of North Carolina Center (UNC) for Community Capital published a paper that claims to rebut the evidence put forth in the Agarwal et al. study, asserting that the study's entire identification strategy is invalid and therefore the results are spurious. In our reading of the paper, we found three significant issues that make us skeptical of the authors' interpretation that the CRA played a significant role in the crisis by increasing the amount of risky lending during the housing boom.
First issue: Time periods do not correspond
As the authors of the UNC paper note, the six-quarter window that Agarwal et al. use to identify the causal impact of CRA examinations "rarely corresponds to the actual period that is covered by the CRA exam." Instead, the CRA examiners typically analyze loans originated well before the actual exam date. To illustrate the issue, the UNC paper looks at a CRA exam of JPMorgan Chase that occurred in June 2011. The authors, who obtained their information from the public record of the exam (the CRA Performance Evaluation), find that the exam covered mortgage originations from January 2007 through December 2010. In contrast, the Agarwal et al. six-quarter window would have run from October 2010 to March 2012, implying an overlap of only one quarter. And even that one quarter of overlap is unlikely—the authors point out that the CRA examiner evaluated only JPMorgan's market share of lending through 2009, as the 2010 data generated to comply with the Home Mortgage Disclosure Act (HMDA) were unavailable at the time of the exam. The implication is that JPMorgan would have had no incentive to increase CRA-eligible mortgage originations in the three quarters before the examination period, since the CRA examiner was not going to consider those loans anyway.
Another relevant example (obtained from correspondence with economists from the Federal Reserve Board of Governors) is the June 2006 exam of Citibank. That exam used 2004 HMDA data for the market share analysis and used data through 2005 to compute the bank's distribution of loans to low- and moderate-income borrowers or neighborhoods. Thus, there is almost no overlap between the data used by the CRA examiners and the window employed by Agarwal et al. If the UNC paper is correct in its assertion that CRA examiners often consider loans that are outside of the six-quarter window used by Agarwal et al., then their claim that institutions were ramping up their CRA-eligible lending in order to pass their CRA examinations is flawed.
Second issue: CRA treatment effects possibly overestimated
Agarwal et al. find an increase in lending resulting from the CRA in non-CRA-eligible census tracts for both high- and low-income households. Specifically, they stratify their sample based on income terciles and find that origination rates to borrowers in the bottom-income tercile in non-CRA-eligible tracts increased by 6 percentage points around the initiation of CRA exams. This result supports their interpretation because banks would obtain CRA credit for loans to these borrowers. However, the results also show that origination rates for borrowers in the highest-income tercile in the non-CRA-eligible tracts increased by almost 4 percentage points around the initiation of CRA exams. Since these loans did not count toward fulfilling CRA obligations, the effect cannot be interpreted as a CRA treatment effect. Rather, a reasonable interpretation of this estimate is that it is picking up an unobserved factor that happens to be correlated with the timing of the CRA examinations (that is, a spurious correlation). If this is the case, then the true CRA treatment effect in CRA-ineligible tracts is really the difference between the increase in origination rates for the borrowers in the bottom income tercile and the borrowers in the top income tercile, which is an economically small 2 percentage points. Furthermore, by lending to high-income borrowers in non-CRA-eligible tracts, banks would tilt the distribution of their lending away from areas targeted by the CRA, which would end up hurting them in a CRA exam. Thus, it's difficult to imagine a scenario in which banks would target these borrowers for CRA-related purposes.
Issue 3: Securitization an unlikely explanation for effects
Agarwal et al. argue that they find significant CRA effects on lending in the 2004–06 and 2007–09 periods but not during the 1999–2003 period, and they find significant CRA effects on default rates only in the 2004–06 period. The authors' explanation for this pattern is that 2004–06 was the period in which the securitization of mortgage loans peaked, and "banks are more likely to originate loans to risky borrowers around CRA examinations when they have an avenue to securitize and pass these loans to private investors after the exam" (p. 21).
There are at least three problems with this line of reasoning. First, private securitization markets shut down in the 2007–09 period, so they couldn't possibly explain the increase in lending in CRA-eligible tracts during that period. The GSEs were very active in securitizing mortgages during this period—but they were also very active in the early 2000s, so agency securitization doesn't seem like an adequate explanation either.
Second, while it is true that securitization could alter the risk-return tradeoff for mortgage lending—it does so by allowing mortgage originators to offload their credit risk by selling their loans into mortgage-backed securities—securitization would make this offloading possible and appealing to many mortgage originators, not just CRA lenders. The result could easily be a decline in mortgage lending by depository institutions in CRA-eligible areas rather than an increase, thanks to increased competition from nondepository institutions. In fact, we would argue that the empirical evidence supports this interpretation more than Agarwal et al.'s interpretation. The late 1990s and early 2000s saw the emergence of nondepository institutions that specialized in originating subprime mortgages and selling them to securitizers. These aggressive subprime lenders were typically not subject to CRA requirements, a fact that is consistent with the shrinking footprint of CRA institutions, which we discuss in more detail below. According to Bhutta and Canner (2009), only about 6 percent of subprime loans made in 2005 and 2006 were made to CRA-targeted populations by CRA-regulated lenders. In effect, one of the consequences of the dramatic rise in private-label securitization volume was that it created lots of competition among the riskier segments of the mortgage market. This situation likely resulted in less lending by banks in CRA-eligible areas rather than more.
Finally, perhaps a more fundamental reason to doubt that securitization explains the timing of the paper's effects is that securitization has been around a long time. Laws needed to be changed before securitization could take off, but these legal changes occurred in the 1980s. So if the CRA and securitization together formed a lethal combination for the mortgage market, then why did the crisis occur in the late 2000s rather than the late 1980s?
Even if CRA encouraged risk, would it really say much about government policy?
With these caveats in mind, what would a finding that the CRA encouraged risky lending really tell us? In our opinion, a finding that the CRA encouraged risky lending would probably tell us little about the role of government in the financial crisis.
The focus needs to be on quantitative magnitudes. The question of whether or not the CRA led to an increase in risky lending of any size may not be that interesting because it is hard to imagine a world in which the CRA would not have done so. Economists begin with the premise that banks are profit-maximizing entities, so they should make all the loans that increase their expected profits. If a loan is not made, then that is because the bank must have judged the loan to reduce expected profits rather than raise them. As we described above, the CRA increases the risk-adjusted return for certain loans, so that some of the loans a bank deems unprofitable in the absence of the CRA (because of risk-adjusted returns that were too low) become profitable with CRA. Because these are marginal loans in risk-adjusted returns, then risk must be increasing.
If we start with the assumption that the CRA leads to more risky lending, the more interesting question is how much risky lending is encouraged. As it happens, the quantitative magnitudes of the estimates in the Agarwal et al. study are quite small. For example, if we assume that the appropriate CRA treatment effect should only be measured using the difference in the increase in lending between CRA-eligible census tracts and CRA-ineligible tracts, then magnitudes are trivial. Specifically, the paper finds that the CRA increased origination rates in CRA-eligible census tracts relative to CRA-ineligible census tracts by somewhere between 1 and 3 percentage points, depending on the specific quarter around the initiation of the CRA exam. When one considers that the average origination rate in the Agarwal et al. sample is 72 percent, and only 15 percent of loan originations in the sample came from CRA-eligible tracts, this is an extremely small effect. The effect becomes even smaller if you adjust the baseline estimates to take into account the likely simultaneity bias that we discussed above in the subsection titled "Issue 2."
The CRA passed long before the crisis
In concluding, we should point out that the CRA went into effect in 1977, 30 years before the financial crisis. If the CRA did shift the risk-return tradeoff for mortgage lending, then why didn't risky lending take off in 1978 rather than 2003? Moreover, the footprint of CRA-regulated institutions in the mortgage market has shrunk dramatically since the law passed. Figure 1 (taken from Foote, Gerardi, and Willen ) shows that nondepository mortgage companies—which generally are not covered by the CRA—accounted for only 15 percent of mortgage lending when the CRA was passed in 1977. By the late 1990s, however, these non-CRA entities had grown to nearly 60 percent of the mortgage market. If the CRA is so toxic to the mortgage market, then it is puzzling why the act had no effect soon after its enactment, when it covered 85 percent of the mortgage market, yet led to an explosion of risky lending 25 years later, when it covered only 40 percent of the market.
Indeed, any attempt to link the recent crisis to government policies aimed at expanding mortgage credit and homeownership faces an uphill struggle. The basic problem is that the federal government has been deeply involved in housing and mortgage markets since at least the end of World War II. In particular, the Federal Housing Authority (FHA) and Veterans Administration (VA) loan programs began at about that time and were explicitly designed to extend homeownership to underserved populations. As figure 2 (also from Foote, Gerardi, and Willen, 2012) shows, the FHA and VA pioneered no and low down payment loans in the 1950s and 1960s. And as figure 3 shows, FHA loans accounted for 40 percent of loans outstanding in the 1970s and had default rates that were an economically massive 100 percent higher than non-FHA loans. In their size and their effect on housing markets, the FHA and VA were literally orders of magnitude more important than the CRA. Did government lead to risky lending? Yes! But it did so 30 years before CRA and 60 years before the recent financial crisis.
Chris Foote, senior economist and policy adviser at the Federal Reserve Bank of Boston,
Kris Gerardi, financial economist and associate policy adviser at the Federal Reserve Bank of Atlanta, and
By Paul Willen, senior economist and policy adviser at the Federal Reserve Bank of Boston
March 17, 2010
Demand for subprime credit or higher housing prices: Solving the conundrum of which came first
The process of securitizing mortgages has received a lot of negative attention during the financial crisis. An oft-made claim is that by collateralizing risky subprime mortgages, securitization drove an unprecedented expansion of mortgage credit to borrowers with bad credit histories. This increase in available credit fed the housing bubble, which ultimately burst after the expansion of subprime credit had run its course. The implication is that without Wall Street's insatiable appetite for mortgage-backed securities (MBS), less bad credit would have been extended, housing prices would not have soared so high, and the subsequent housing bust would not have been so bad.
On the surface, a link between securitization of subprime mortgages and the housing bubble seems both intuitive and plausible. After all, the vast majority of subprime mortgages were sold by originators to private institutions, not the government-sponsored housing-finance agencies like Freddie Mac and Fannie Mae. These private institutions operated in the secondary mortgage market, where loans are securitized and sold to investors around the world. Figure 1A in Mayer and Pence (2008) provides a nice illustration of this pattern.
Higher housing prices, not MBS, may have encouraged subprime lending
But the arrow of causality may not run from the expansion of securitized subprime credit to higher housing prices. Rather, expectations of higher housing prices may have encouraged more lending to subprime borrowers, whose loans were subsequently securitized. (Any loan is a good loan if prices are rising, because the collateral that backs the loan is getting more valuable over time.) Both interpretations are equally validated by aggregate data. To answer the chicken-or-egg question of what comes first in the logical chain—higher housing prices or increased subprime securitization—you need to perform a more disaggregated analysis.
In a recent paper, Taylor Nadauld of Ohio State and Shane Sherlund of the Federal Reserve Board of Governors attempt to solve this identification problem. Their analysis is based on a change in regulations that could have affected the level of securitization but was plausibly unrelated to either housing prices or the demand for subprime credit. Consequently, by examining the effects of this regulatory change, the authors can ask whether changes in securitization had true, causal effects on the amount of credit extended to subprime borrowers.
Did capital requirements reduction increase the demand for MBS?
The regulatory change at the heart of the paper involves the required capital levels at five broker-dealers: Bear Stearns, Morgan Stanley, Goldman Sachs, Lehman Brothers, and Merrill Lynch. By some accounts, the rule reduced capital requirements at these five institutions by up to 40 percent. Specifically, in April 2004, the Securities and Exchange Commission amended a series of rules that had the effect of reducing capital requirements for the five broker-dealers (hereafter referred to as consolidated supervised entities, or CSEs). The change was made in response to the European Union's Conglomerates Directive that required U.S. broker-dealer affiliates to show proof that their consolidated holding companies were subject to supervision by a U.S. regulator. The rule change established an alternative method of calculating capital requirements for the CSEs, which were not already subject to consolidated capital regulation from a regulatory authority. Basically, the CSEs could use their own internal risk-based models to calculate a capital adequacy measure consistent with those put forth by the Basel Committee on Banking Supervision. (For further detail, see the Nadauld and Sherlund paper.)
The authors hypothesize that the reduction in capital requirements increased the institutions' demand for purchasing subprime mortgages from the primary market for the purpose of securitizing them either to sell to other investors or to hold themselves. That is, lower capital requirements either increased their demand to invest in subprime MBS themselves or increased their capacity as intermediaries to securitize the mortgages and sell to other investors.
Authors use two-stage strategy to support findings
The authors use a two-stage econometric strategy to identify the impact of this exogenous increase in the CSEs' demand to purchase subprime mortgages to securitize, which would have raised the supply of credit to subprime borrowers. In the first stage of their analysis, they verify that the regulatory event did indeed raise secondary-market purchases at the affected institutions. In particular, they ask whether securitization activity among the five institutions increased by more than the securitization activity of institutions that were not affected by the regulatory event. The answer is yes. According to data on privately securitized mortgages from FirstAmerican LoanPerformance, the CSE banks securitized about 32 percent more loans on average than did their non-CSE counterparts after 2003.
In the second stage, the authors ask whether the increase in CSE securitization is linked to an increase in subprime credit supply. For this step, they obtain ZIP-code–level data on mortgage originations and securitization activity from Home Mortgage Disclosure Act data and then merge these data with the LoanPerformance data. Essentially, in this stage, the authors ask whether ZIP codes that experienced higher CSE securitization activity (relative to non-CSE securitization activity) also experienced higher levels of subprime mortgage originations. The answer again is yes. The authors interpret their findings as evidence that increased demand for the CSEs to securitize mortgages resulted in increased access to subprime mortgage credit at the household level.
Analysis may need refinement
In our opinion, this paper is one of the few that has come up with a reasonable way to identify the effect of the secondary mortgage market on the ability of households to obtain mortgages. But the paper needs to address two issues in order to offer a more convincing analysis.
The first issue concerns the authors' measure of subprime credit supply. They use the ratio of subprime mortgages originated to total housing units in a given ZIP code. But this is a measure of mortgage credit issued in equilibrium. Many factors could create cross-sectional variation in this variable (across ZIP codes) that have nothing to do with differences in access to credit. For example, differences in homeownership rates, the fraction of homeowners with a mortgage, and wealth and income differences could all affect the quantity of mortgage lending in a ZIP code without explaining differences in access to credit. Of course, the authors try their best to control for such factors in their estimates, but ultimately it is impossible to control for all of them.
The second substantive issue concerns the link between the regulatory event and demand and supply for MBS in the secondary market. The authors argue that the regulatory event could have affected the secondary mortgage market through two channels. First, they argue, relaxing capital requirements may have increased the CSE banks' demand for highly rated subprime MBS. We know for certain that the five CSE institutions were heavily involved in the supply of MBS to other investors, but we also think that these institutions were investors as well. It shouldn't be too hard for the authors to find evidence of this connection, but what would be even more convincing, and perhaps more difficult, would be to review whether the CSE banks substantially increased their holdings of subprime MBS after the regulatory event.
The second potential channel involved relaxing the constraints associated with the supply of subprime MBS. In this case, capital is needed to warehouse mortgages during the process of creating securities. In addition, most deals required over-collateralization, which usually meant that the issuer would take the first-loss position. If these constraints were binding for these institutions before the regulatory event (that is, the secondary market had pent-up demand for subprime MBS), then the relief on capital requirements after the event may have resulted in increased supply. This hypothesis seems a little far-fetched to us, not to mention virtually impossible to test in the data, so the authors may be better off focusing on the demand-side effects.
Note: The authors were given an opportunity to respond to this blog posting. As of this publishing, the author has not commented.
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