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Residential Mortgage Securitization and the Financial Crisis

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Residential Mortgage Securitization and the Financial Crisis AlmaAlma MaterMater StudiorumStudiorum –– UniversitUniversitàà didi BolognaBologna DOTTORATO DI RICERCA IN Diritto ed Economia: Law and Economics Ciclo XXIV Settore Concorsuale di afferenza: 12/E3 Settore Scientifico disciplinare: IUS/05 TITOLO TESI Mortgage securitization and its credit risk control Presentata da: Lebing Wang Coordinatore Dottorato Relatore Riccardo Leoncini Gilberto Antonelli Marina Timoteo Esame finale anno 2012 Abstract The burst of the mortgage meltdown in the U.S since 2007 is the gravest financial crisis that we have witnessed until now. This dissertation concentrate on the mortgage securitization and its credit risk, which are criticized as the main causes of the crisis. From the point of the veiw of mortgage's evolution, the nature, structure and function of mortgage has been radically changed, yet the mortgage law did not give appropriate response to this market change. Meanwhile, the U.S legilslations facilitating the mortgage securitization also have rotten the legal foundations for mortgage market self-regulation and sustained development. These constitute the institutional causes of the financial crisis. In contrast, the EU covered bond system has kept financial stability for 200 years' time, and their statutory approach has been proved to be able to control the credit risk and incentive problems very well, in combination of market self-regulation and public regulation. So the future reform should be directed to strengthen the market's capacity of self-regulation and improve the public regulation through reducing the improper intervention, such as the homeownership policy of the U.S. For the development of mortgage securitization in China, it is suggested to introduce the EU covered bond system for the reason of the equilibrium between funding efficiency and financial stability. 2 Acknowledgements First and foremost, I would like to thank my family for their support during my long period of study life. Without the understanding and supportof my parents and my wife, I could not devote all myself to the current research in the past three years. I am extremely grateful for the support and guidance of my supervisors, Professor Fei Anling from China University of Political Science and Law, Professor Gilberto Antonelli and Professor Marina Timoteo. You have created a very friendly and free environment, and I could undertake the research driven by my personal interest and preference. Thanks are also due to the professors in MIDIC, particularly Professor Riccardo Leoncini, Sandro Montresor, and Giovanni Guidetti, for your guidance and discussion of my dissertation in each academis year. Finally, special thanks should be given to the China Scholarship Council for the financial support during my study in Bologna, and also to Professor Wang Hongjian and Zhu Jiangang in the China Embassy who are entrusted to manage my scholarship. 3 Table of Contents Abstract................................................................................................................................................2 Acknowledgements............................................................................................................................. 3 Table of Contents.................................................................................................................................4 I Introduction....................................................................................................................................6 1.1. Background: Residential mortgage securitization and the financial crisis..........................9 1.1.1 Mortgage, housing finance and the economy............................................................9 1.1.2 Housing policy’s effect on the Mortgage lending: Homeownership and government intervention........................................................................................................................14 1.1.3 Mortgage securitization and mortgage market........................................................ 21 1.2 Research questions and the structure of dissertation.......................................................... 32 1.3 Methodology....................................................................................................................... 36 II The evolution of mortgage: From contractual relationship to marketable commodity.............40 2.1 The evolution of the mortgage from a personal right to a real right.................................. 40 2.1.1 The mortgage in the Roman law..............................................................................40 2.1.2 The mortgage in the common law system............................................................... 47 2.2 The Secondary Mortgage Market and Mortgage Securitization: From stagnant lien to marketable commodity..............................................................................................................55 2.2.1 The mortgage covered bonds in German.................................................................56 2.2.2 The mortgage-backed securitization in USA...........................................................64 III The rotten legal foundations of Mortgage Securitization and the institutional causes of the financial crisis....................................................................................................................................80 3.1 The accessoriness of mortgage and mortgage securitization..............................................82 3.1.1 General review of accessoriness principle...............................................................82 3.1.2 The approach of mortgage securitization in common law system.......................... 87 3.1.3 The approach of mortgage securitization in civil law system................................. 94 3.2 The doctrine of true sale....................................................................................................100 3.2.1 The origin and history of Article 9 of United Commercial Code..........................101 3.2.2 Article 9 of UCC and the proliferation of securitization....................................... 102 3.3 Bankruptcy isolation......................................................................................................... 113 3.3.1 The transition of the bankruptcy code from pro-creditor legislation to pro-debtor legislation........................................................................................................................ 114 3.3.2 Bankruptcy Tax: Why mortgage securitization has chosen "true sale" rather than secured lending?..............................................................................................................115 3.3.3 The creation of securitization for the purpose of bankruptcy isolation.................117 3.3.4 The critics to the relationship between true sale and bankruptcy isolation...........119 3.4 The rotten legal foundations for mortgage securitization and the financial crisis........... 121 3.4.1 The secret lien created by law and practices..........................................................121 3.4.2 secret liens deriving from the real property law.................................................... 123 3.4.3 Secret liens deriving from the secured transaction law......................................... 124 IV The mortgage’s role in credit risk control in residential mortgage securitization.....................130 4 4.1 Mortgage’ role as a collateral in the loan contract: Analysis from the point of view of secured lending........................................................................................................................130 4.1.1 The role of mortgage in loan contract: A traditional approach..............................131 4.1.2 The costs of the secured lending............................................................................135 4.1.3 The inherent interest rate risk of the traditional mortgage lending....................... 137 4.2 Mortgage securitization, the death of secured lending and the credit risk control...........139 4.2.1 The transition from secured lending to securitization........................................... 139 4.2.2 The weakening role of mortgage in securitization and the credit risk control......145 4.3 The credit risk control of MBS: Efficient legislation and market self-regulation............151 4.3.1 The credit risk control under the originate-to-diversify mortgage securitization. 151 4.3.2 Is the market self-regulation in MBS market possible?........................................ 155 4.3.3 Efficient legislation and market self-regulation for mortgage securitization: The promotion of statutory mortgage securitization..............................................................161 Ⅴ Developing mortgage securitization in china............................................................................ 169 5.1 The real estate market and the housing finance system of china......................................170 5.1.1 The commercialization of housing since 1978...................................................... 170 5.1.2 The puzzle for the rising home price..................................................................... 172 5.1.3 The affordable housing in china.............................................................................177 5.2 The mortgage securitization in china................................................................................179 5.2.1 The development of securitization in China..........................................................180
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