Competition, Innovation and Crises : Evidence from 20 Million Securitized Loans

We connect three disparate facts associated with the spike in innovation in securitized mortgages before the 2007-09 crisis: a) elevated innovation in MBS collateral associated with greater loan purchases by MBS issuers (“sponsors”), b) an economically large proportion of delinquencies (~$90bn) attributed to innovative collateral of Prime MBS and c) the timing of innovation in Prime MBS collateral which preceded subprime innovation. Using exogenous variation from a regulatory change, we find that increased sponsor competition drove the innovation in securitized mortgages. Sponsor-induced innovation led to riskier mortgages being packaged into Prime deals, consistent with the obfuscation motives of sponsors