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

Under the originate-to-distribute model that grew rapidly before 2007, a mortgage lender typically originated loans and then sold them to a securitization vehicle. Which feature of this model is most commonly cited as weakening underwriting standards?

Originators earned fees based on loan volume while passing most credit risk to investors through securitization. This weakened their incentive to screen borrowers carefully, leading to looser underwriting standards, since they no longer bore the losses if the loans later defaulted.

  1. AThe originator retained the full credit risk of every loan until maturity
  2. BThe originator earned fees on volume while transferring most credit risk to investorsCorrect
  3. CRegulators required originators to hold the equity tranche of every deal
  4. DBorrowers were required to provide full documentation for all loans

Explanation

Because originators were paid on origination volume and passed credit risk to investors, they had weaker incentives to screen borrowers carefully. Retaining all risk or holding equity would strengthen discipline, and full documentation was often absent in subprime and Alt-A lending.

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