Securitization Networks and Endogenous Financial Norms in U.S. Mortgage Markets∗†

We develop a theoretical model of a network of intermediaries, which we apply to the U.S. mortgage market. 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 one million privatelabel mortgages originated and securitized in 2006. 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 market. JEL classification: G14. ∗We thank seminar participants at the 2015 meeting of the Western Finance Association, the 2015 NBER Summer Institute conference on Risks of Financial Institutions, Carnegie Mellon, the Consortium for Systemic Risk Analytics (MIT), the Institute for Pure and Applied Mathematics (IPAM, UCLA), London Business School, NYU Stern, Swedish Institute of Financial Research (SIFR), and Stanford GSB. We are grateful to Daron Acemoglu, Maryam Farboodi, Xavier Gabaix, George Papanicolaou, and Stijn Van Nieuwerburgh for helpful comments and suggestions. Walden thanks the 2015 IPAM program on financial mathematics for hosting his visit, during which part of this research was carried out. †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].