Securitization Networks and Endogenous Financial Norms in U

We develop a theoretical model of a network of intermediaries, which we apply to the U.S. mortgage supply chain. In our model, heterogeneous financial norms and systemic vulnerabilities arise endogenously. Intuitively, the optimal behavior of each intermediary, in terms of its attitude toward risk, the quality of the projects that it undertakes, and the intermediaries it chooses to interact with, is influenced by the behavior of its prospective counterparties. These network effects, together with intrinsic quality differences between intermediaries, jointly determine financial health and systemic vulnerability at the aggregate level as well as for individual intermediaries. We apply our model to the mortgage-origination and securitization network of financial intermediaries, using a large data set of more than twelve million mortgages originated and securitized through the private-label supply chain from 2002–2007. We then track the ex-post foreclosure performance of each loan in the network and compare the evolution of credit risk by vintage with the model’s predictions. We find that credit risk evolves in a concentrated manner among highly linked nodes, defined by the geography of the network and the interactions between originator and counterparty over time. This confirms that network effects are of vital importance for understanding the U.S. mortgage supply chain. JEL classification: G14. ∗We are grateful for financial support from the Fisher Center for Real Estate and Urban Economics. †Haas School of Business, U.C. Berkeley, [email protected]. ‡Haas School of Business, U.C. Berkeley, [email protected]. §Haas School of Business, U.C. Berkeley, [email protected].