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Working Papers

Credit Risk Transfer, Informed Markets, and Securitization

Working paper #821
Susan M. Wachter
Federal Reserve Bank of New York Economic Policy Review

• Mortgage-backed securities (MBS) fueled the U.S. housing bubble that led to the financial crisis of 2007-09. Moreover, the pricing of these securities failed to expose the growing credit risk in U.S. mortgage markets.
• Recently, the government sponsored enterprises Fannie Mae and Freddie Mac, which guarantee most U.S. MBS, developed credit risk transfers (CRTs) as a means of shifting some mortgage credit risk to the private sector.
• The author describes the reasons why MBS failed to price risk, and argues that properly structured securitization markets, such as the market for CRTs, could be used to appropriately price and reveal credit risk, thereby limiting real estate bubbles and reducing systemic risk in housing markets.
• To succeed in this regard, CRT markets must be transparent—by providing full information on the underlying mortgages and by standardizing mortgages, potentially through the use of a common securitization platform. In addition, CRTs must trade with open pricing in liquid markets, and avoid counterparty risks and incentives to underprice credit.

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