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

Which of the following best describes the 'originate-to-distribute' model's contribution to the subprime crisis?

The originate-to-distribute model let lenders sell loans into securitisations and keep little credit risk. That weakened their incentive to screen and monitor borrowers, producing moral hazard and looser underwriting standards, which contributed to deteriorating loan quality in the subprime market.

  1. AOriginators who sold loans onward retained little credit risk, weakening their incentives to screen borrowers carefullyCorrect
  2. BOriginators retained all loans on balance sheet, which led them to lend too aggressively
  3. COriginators were prohibited from selling loans, which concentrated risk in banks
  4. DOriginators relied solely on government guarantees to cover losses

Explanation

Under originate-to-distribute, lenders earned fees on volume and passed loans to investors, so the loss was borne elsewhere. This created a moral hazard problem and lax underwriting standards. Retaining loans would have strengthened screening incentives.

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