Skip to content

FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

Before the 2007-2009 crisis, many US mortgage lenders moved loans off their balance sheets by selling them to securitization vehicles. Which feature of this originate-to-distribute model most directly weakened lenders' incentives to screen borrowers carefully?

Originators earned fees based on loan volume and transferred the credit risk to investors who bought the securitized products. Because they did not bear the eventual default losses, they had less reason to screen and monitor borrowers carefully, which lowered underwriting standards.

  1. ALenders retained the equity tranche of every pool they created
  2. BLenders earned fees on origination volume and passed credit losses on to investorsCorrect
  3. CLenders were required to hold capital against all loans until maturity
  4. DLenders were prohibited from selling loans to non-bank investors

Explanation

Under originate-to-distribute, originators were paid mainly on volume and fees, while default losses were borne by investors who bought the securities. This weakened screening and monitoring incentives. Retaining the equity tranche or holding the loans would have kept the originator exposed to losses and strengthened incentives.

Did you get it right without looking?

One question tells you little. A timed set on Anatomy of the Great Financial Crisis of 2007-2009 shows your real accuracy, how long you take and where you lose marks.

Practise Anatomy of the Great Financial Crisis of 2007-2009Free diagnostic mock

More Anatomy of the Great Financial Crisis of 2007-2009 questions