Asymmetric Information and Vertical Relations in the US Mortgage Industry

This research project will study the cost of financial intermediation services provided by traditional banks and non-bank lenders in the market for mortgages. Financial intermediation consists of three activities: (i) the acquisition of loans from borrowers, (ii) the creation of mortgage-backed securities, and (iii) the servicing of these loans. A unique feature of the supply chain of mortgages in the US is the fact that roughly 50% of loans that are securitized each year are originated and serviced by different institutions. While there exist over 5,000 mortgage originators active in the retail origination market, fewer than 50 financial institutions supply over 90% of securities in the secondary market upstream. Since loans are re-sold often multiple times before being securitized, the cost of financial intermediation includes higher fees indirectly paid by consumers due to the asymmetric information that exists between the different parties at each level of the supply chain, as well as the profits margins that firms with market power potential extract from buying and selling these assets. The objective of this project is to quantify the relative importance of information and market-power frictions in determining the cost of intermediation, and ultimately their impact on the borrowing cost of consumers.

The main focus of the project is the interaction between the wholesale and secondary markets, and in particular the determinants of the wholesale prices and ex-post loan performance. A unique feature of the study is the use of high-frequency auction data for mortgages from one of the leading wholesale loan exchange platforms. The first objective of the study is to assemble the first available data set tracing the supply-chain of funds from origination to securitization. This will be done by constructing a complete history of transactions, prices, security choices, and repayment decisions for a sample of mortgages. The second objective is to construct econometrics tests to measure the importance of asymmetric information in the market. The third objective is to estimate a structural model of loan valuation, using data on loan acquisition (bidding) and securitization (security characteristics choice). This model will be used to quantify each of the components of the cost of intermediation and to identify the sources of market imperfections that cause profit margins and intermediation costs to increase. The project will contribute to the literature by developing a new modeling framework to study the securitization and acquisition of loans; using tools from the Industrial Organization and Finance literatures.