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FRM Part I · FRM Exam Part I · Mortgages and Mortgage-Backed Securities

Which feature of the originate-to-distribute model most directly contributed to weaker underwriting standards in the U.S. subprime mortgage market before 2007?

Originators sold loans to securitizers and so bore little default risk. Because they earned fees on volume and passed credit risk to MBS investors, they had weak incentives to screen borrowers carefully, which contributed to deteriorating underwriting standards in subprime lending.

  1. AOriginators retained the entire credit risk of loans they made
  2. BOriginators sold loans to securitizers and so bore little of the default riskCorrect
  3. CGovernment agencies guaranteed all subprime loan payments
  4. DBorrowers were required to make large down payments

Explanation

When originators sold loans quickly into securitization pools, they earned fees based on volume while transferring default risk to investors. This weakened the incentive to screen borrowers carefully. Retaining risk would have strengthened underwriting, and subprime loans were not agency-guaranteed.

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