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FRM Part II · FRM Exam Part II · An Introduction to Securitisation

Before the subprime crisis, many originators sold mortgage loans into securitisation pools almost immediately after origination. Which risk problem did this originate-to-distribute model most directly worsen?

The originate-to-distribute model worsened moral hazard in underwriting. Originators who quickly sold loans and earned volume-based fees had little incentive to screen borrowers carefully, because investors rather than the originator bore the credit losses.

  1. AReduced incentive to screen borrowers carefully, creating moral hazard in underwriting standardsCorrect
  2. BHigher interest rate risk on the originator's balance sheet
  3. CGreater reserve requirements for the originator's deposits
  4. DElimination of asymmetric information between originator and investor

Explanation

When originators pass credit risk to investors and earn fees on volume, they have less incentive to verify borrower quality, so underwriting standards deteriorated. Investors knew less about loan quality than originators, so information asymmetry persisted rather than disappearing. Offloading loans reduced, not increased, the originator's balance sheet rate exposure.

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