Mortgage Securitization Dynamics in the Aftermath of Natural Disasters: A Reply

TL;DR

This paper examines how natural disasters influence mortgage securitization, revealing that climate risks increase moral hazard and adverse selection in mortgage-backed securities, especially after hurricanes, supported by empirical analysis.

Contribution

It provides empirical evidence supporting the climate securitization hypothesis and clarifies the impact of natural disaster risks on mortgage market dynamics.

Findings

Climate risks exacerbate moral hazard in mortgage securitization.

Natural disasters influence securitization incentives immediately after events.

Empirical analysis confirms the theoretical predictions of the CSH.

Abstract

Climate change poses new risks for real estate assets. Given that the majority of home buyers use a loan to pay for their homes and the majority of these loans are purchased by the Government Sponsored Enterprises (GSEs), it is important to understand how rising natural disaster risk affects the mortgage finance market. The climate securitization hypothesis (CSH) posits that, in the aftermath of natural disasters, lenders strategically react to the GSEs conforming loan securitization rules that create incentives that foster both moral hazard and adverse selection effects. The climate risks bundled into GSE mortgage-backed securities emerge because of the complex securitization chain that creates weak monitoring and screening incentives. We survey the recent theoretical literature and empirical literature exploring screening incentive effects. Using regression discontinuity methods, we test key hypotheses presented in the securitization literature with a focus on securitization dynamics immediately after major hurricanes. Our evidence supports the CSH. We address the data construction issues posed by LaCour-Little et. al. and show that their concerns do not affect our main results. Under the current rules of the game, climate risks exacerbates the established lemons problem commonly found in loan securitization markets.