Scott D. Grimshaw



Scott D. Grimshaw, Grant R. McQueen, Barrett A. Slade, and William P. Alexander (2003), Some Loans are More Equal than Others: Third-party Originations and Defaults in the Subprime Mortgage Industry, Computing Science and Statistics, 35, I2003Proceedings/GrimshawScott/GrimshawScott.presentation.pdf



Some Loans are More Equal than Others: Third-party Originations and Defaults in the Subprime Mortgage Industry
Scott D. Grimshaw, (Brigham Young University), grimshaw@byu.edu,
Grant R. McQueen, (Brigham Young University Marriott School of Management), mcqueen@byu.edu,
William P. Alexander, (Wachovia Securities), william.alexander@wachovia.com, and
Barrett A. Slade, (Brigham Young University Marriott School of Management), bslade@byu.edu

Abstract

We show how agency problems between lenders (principals) and third-party originators (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 not completely held accountable for the subsequent performance of those loans. Using a competing risks hazard model with unobserved heterogeneity, we find empirical support for the TPO/default prediction using individual fixed-rate subprime loans with first liens secured by residential real estate originated between 1 January 1996 and 31 December 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.


Take me back to the main proceedings page.