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

Which of the following best describes the typical 'originate-to-distribute' model that grew in US mortgage markets before the 2007-2009 crisis?

Originate-to-distribute meant lenders made mortgages and sold them into securitization structures. Since the originators passed credit risk to investors, they had weaker incentives to screen borrowers, which contributed to deteriorating underwriting standards before the crisis.

  1. ALenders made mortgage loans and sold them to securitization vehicles, which reduced the originators' incentive to screen borrowers carefullyCorrect
  2. BLenders held all mortgage loans on their balance sheets until maturity, which strengthened credit screening
  3. CLenders funded mortgages only with insured retail deposits and did not transfer credit risk
  4. DLenders issued mortgages only to prime borrowers with full documentation and large down payments

Explanation

Under originate-to-distribute, loans were pooled and sold to investors through securitization. Because originators did not retain the credit risk, their incentive to screen and monitor borrowers weakened. The other options describe a hold-to-maturity or prudent prime lending model, which is the opposite.

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