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Refinancing Real Estate Loans – Lessons to be Learned from the Subprime Crisis

01/01/2009
Professor Dr. Markus Rudolf and Professor Anthony Saunders

This study aims at analyzing the credit risk implications of the financial market crisis on three types of financial instruments which securitize mortgage loans: Mortgage Pfandbriefe, Mortgage-Backed Securities (MBS), and Collateralized Debt Obligations (CDOs). While Mortgage Pfandbriefe are the predominant financial instrument to securitize mortgage loans in Germany, CDOs and MBS are forms of securitizing mortgage loans in the UK and the US. The study has shown that there are major legal and regulatory differences between the three instruments.

  • MBS and Mortgage Pfandbriefe are both covered by a pool of mortgages. While the cover pool in the case of Mortgage Pfandbriefe is carefully selected and has to satisfy legal requirements, eligibility criteria for MBS exist only for so-called agency MBS. However, the criteria for a mortgage loan to qualify for an agency MBS are significantly less strict than for Mortgage Pfandbriefe.
  • While Pfandbriefe are bonds issued by Pfandbrief Banks on their balance sheets, this is not the case for MBS and for CDOs. MBS are off-balance sheet assets. In the case of agency MBS however, the agency guarantees the underlying loan. Although that reduces the credit risk of an MBS significantly, according to expert opinions on-balance-sheet assets are still of higher quality since this implies that the issuer and the guarantor are the same institution which takes care of the loans. In fact, it is very difficult to find parameter combinations based on which a default of a Pfandbrief is possible at all. AAA tranches of CDOs do not have such a double safety cushion and they are off-balance-sheet liabilities implying significantly higher credit risks.
  • This report shows that with regard to both, theoretical and empirical considerations, the credit risk of Mortgage Pfandbriefe is significantly lower than for MBS and CDOs.

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