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Credit Risk, Informed Markets, and Securitization: Implications for CRT and GSEs

Working paper #806
Susan M. Wachter

Mortgage backed securities (MBS) funded the US housing bubble, with the ensuing bust resulting in systemic risk and the Global Financial Crisis. The pricing of MBS and the ABX securitization index failed to reveal growing credit risk. This paper draws lessons from these failures for the future of the US housing finance system and specifically for the use of Credit Risk Transfers (CRT) to price credit risk efficiently. The central question is would the CRT market, as constituted today, have behaved differently than asset markets did in the bubble years? If no, then this is a problem. If yes, then why?

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