Asset-Backed Securities Downgrades as Evidence of Skin in the Game prior to the Mortgage Crisis

Abstract

We investigate the effects of ABS downgrades on deal parents/sponsors prior to the mortgage crisis in order to establish whether securitization markets functioned in an incentive-compatible manner before the summer of 2007. We demonstrate that ABS downgrades are not typically caused by weak parents, even if ABS downgrades result in weak parents later on. The effect of ABS downgrades on parents is not only financial, but also arises from significant post- downgrade delays in ABS issuance that are not observed for parents of ABS deals that are not downgraded. The delays are demand- rather than supply-driven. Thus, prior to the crisis, parents had “skin in the game.” parent.