Journal of Credit Risk

Underwriting versus economy: a new approach to decomposing mortgage losses

Ashish Das, Roger M. Stein


This paper presents some stylized facts about the role of mortgage underwriting standards in the current market crisis. The observations are based on an ex post analysis of 136 residential mortgage-backed transactions that were issued between 2002 and 2007. Disentangling the time-varying effects of changes in economic factors, such as home prices, from the time-varying effects of underwriting standards can pose challenges, particularly given the effects of the loan prepayment option common in the US market. This study uses a new simulation tool to model mortgage losses related to conditional prepayment probability, conditional default probability and conditional loss given default. The simulation experiments suggest that introducing an additional factor, based on publicly available underwriting surveys, permits the model to capture better the unusually poor performance of late-vintage subprime mortgages, while also producing reasonable estimates for earlier vintages. This exogenous factor also permits the separation of the effects of economic factors from those of underwriting standards. The results suggest that while the economic downturn is the dominant driver of projected subprime losses, a portion of losses is attributable to the quality of underwriting at the time of origination. The paper presents coarse estimates of effect size by vintage.

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