Securitization, Ratings, and Credit Supply

Securitization, Ratings, and Credit Supply

By Brett S. Green, Brendan Daley, Victoria Vanasco
March 19,2017Working Paper No. 3514

We explore the effect of credit ratings on loan origination and securitization. The model involves two stages: first, banks decide whether to originate a given loan pool or not, and obtain private information about the pools originated. Second, each bank chooses what portion of the pool’s cash flow rights to retain and what portion to securitize. All securities are rated and sold to competitive investors. We characterize how credit ratings affect the trade-off between productive efficiency (i.e., efficiency of the origination process) and allocative efficiency (i.e., efficiency of the securitization process). In particular, we show that credit ratings increase allocative efficiency by reducing costly retention and increase the supply of credit, but reduce average quality of loans originated and can lead too an oversupply of credit relative to first best. These findings are in contrast to regulators view of credit ratings as a disciplining device. We consider extensions of the model to allow for rating shopping and manipulation. Provided investors are fully rational, shopping/manipulation have effects similar to reducing the informativeness of ratings.

Keywords
asset-backed securitization, credit ratings, credit supply