Keywords

agency problems, loan default risk, third-party originators

Abstract

We show how agency problems between lenders (principals) and third-party originators (TPO; agents) imply that TPO-originated loans are more likely to default than similar retail-originated loans. The nature of the agency problem is that TPOs are compensated for writing loans, but are not completely held accountable for the subsequent performance of those loans. Using a hazard model with jointly estimated competing risks and unobserved heterogeneity, we find empirical support for the TPO/default prediction using individual fixedrate subprime loans with first liens secured by residential real estate originated between January 1, 1996, and December 31, 1998. We find that apparently equal loans (similar ability to pay, option incentives and term) can have unequal default probabilities. We also find that, initially, the agency-cost risk was not priced. At first, the market did not recognize the higher channel risk, since TPO and retail loans received similar interest rates even though the TPO loans were more likely to default.We also show that this inefficiency was short-lived. As the difference in default rates became apparent, interest rates on TPO loans rose about 50 basis points above otherwise similar retail loans.

Original Publication Citation

Alexander, W., S. Grimshaw, G. McQueen, and B. Slade, 2002, Some Loans are More Equal than Others: Third-party Originations and Defaults in the Subprime Mortgage Industry, Real Estate Economics, 30:4, pp. 667 – 697.

Document Type

Peer-Reviewed Article

Publication Date

2003

Publisher

Real Estate Economics

Language

English

College

Marriott School of Business

Department

Finance

University Standing at Time of Publication

Full Professor

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