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

In the originate-to-distribute model that operated before the crisis, which feature most weakened incentives for loan originators to screen borrowers carefully?

Originators earned fees on loan volume and sold the loans to securitizers, passing most credit risk to investors. Because they bore little of the eventual default loss, they had weak incentives to screen borrowers carefully, which lowered underwriting standards.

  1. AOriginators held the entire equity tranche of every securitization on their own balance sheet
  2. BOriginators earned fees on volume and sold the loans to securitizers, transferring most of the credit risk to investorsCorrect
  3. CRegulators required originators to retain 20% of every loan
  4. DMortgage borrowers were required to provide full documentation of income

Explanation

Originators were paid per loan and sold them on, so default losses fell mainly on investors. Retaining equity or risk would have aligned incentives, and full documentation would have improved screening, so the other options do not weaken it.

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