'Cream-Skimming' in Subprime Mortgage Securitizations: Which Subprime Mortgage Loans Were Sold by Depository Institutions Prior to the Crisis of 2007?

Abstract

Depository institutions may use information advantages along dimensions not observed or considered by outside parties to "cream-skim," meaning to transfer risk to naïve, uninformed, or unconcerned investors through the sale or securitization process. This paper examines whether "cream-skimming" behavior was common practice in the subprime mortgage securitization market prior to its collapse in 2007. Using Home Mortgage Disclosure Act data merged with data on subprime loan delinquency by ZIP code, the authors examine the bank decision to sell (securitize) subprime mortgages originated in 2005 and 2006. They find that the likelihood of sale increases with risk along dimensions observable to banks but not likely observed or considered by investors. Thus, in the context of the subprime lending boom, the evidence supports the cream-skimming view.