Securitization and the Extension of Mortgage Credit

This project focuses on explaining why the aggressive lending in the sub-prime market is a rational behavior of the sub-prime lenders in a qualitative and quantitative way. Through comparing the differences between a traditional mortgage market and the sub-prime market with the involvement of securitization, we can observe that the borrowers bargaining power has changed accordingly. Securitization has prevented borrowers from behaving strategically when serving the debt. Through modeling, we are able to numerically show that when the borrower has limited options to strategically serve the debt, the lender will respond by extending more credit over per dollar of collateral. This is exactly what the banks were doing when making sub-prime loans to potential homeowners. Based on the game theoretical partial differential equation model, our numerical results suggest that aggressive lending is not a predatory behavior, rather, it is a rational movement of the sub-prime lenders.