The Effect of Large Investors on Asset Quality: Evidence from Subprime Mortgage Securities

Manuel Adelino, W. Scott Frame, and Kristopher S. Gerardi
Working Paper 2014-4
April 2014

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This paper examines how the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, the largest investors in subprime private-label mortgage-backed securities (PLS), influenced the risk characteristics and prices of the deals in which they participated. To identify the causal effect of the GSEs, we use the fact that PLS deals in which Fannie Mae and Freddie Mac purchased securities included separate mortgage pools: one specifically created for the GSEs and one or more others directed at other triple-A investors. Using within-deal variation, we find that the pools bought by Fannie Mae and Freddie Mac had similar ex-ante risk characteristics but performed much better ex-post relative to other mortgage pools in the same deals. These effects were concentrated in low-documentation loans and in issuers that were highly dependent on Fannie Mae and Freddie Mac. Our results extend the importance of disciplining effects of large claimholders beyond information-sensitive securities, such as equities and bank debt, to information-insensitive arm's-length debt.

JEL classification: G17, G21, G23

Key words: mortgage default, GSEs, securitization, private information

For helpful comments and discussions, the authors thank Brent Ambrose, Andra Ghent, Laurie Goodman, Robert Hansen, Peter Niculescu, Larry Wall, and Paul Willen as well as seminar participants at the Kellogg Junior Finance Conference. They also thank Neil Desai for outstanding research assistance. Frame also thanks the Federal Reserve Bank of Richmond for financial support. This paper was previously circulated under the title "The Role of Blockholders in Debt Markets: Fannie Mae, Freddie Mac, and Subprime MBS." The views expressed here are the authors' and not necessarily those of the Federal Reserve Banks of Cleveland or Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Manuel Adelino, Fuqua School of Business, Duke University, 100 Fuqua Drive, Durham, NC 27708, 919-660-7981,; Scott Frame, the University of North Carolina-Charlotte and the Federal Reserve Bank of Atlanta, Friday Building, 9201 University City Boulevard, Charlotte, NC 28223, 704-687-7642,; or Kristopher Gerardi, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, GA 30309-4470, 404-498-8561,

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