The AAA tranche of subprime science, revisited

Tom Daula points us to this article, “Mortgage-Backed Securities and the Financial Crisis of 2008: A Post Mortem,” by Juan Ospina and Harald Uhlig. Not our usual topic at this blog, but then there’s this bit on page 11:

We break down the analysis by market segment defined by loan type (Prime, Alt-A, and Subprime). Table 5 shows the results and documents the third fact: the subprime AAA-rated RMBS did particularly well. AAA-rated Subprime Mortgage Backed Securities were the safest securities among the non-agency RMBS market. As of December 2013 the principal-weighted loss rates AAA-rated subprime securities were on average 0.42% [2.2% for Prime AAA same page]. We do not deny that even the seemingly small loss of 0.42% should be considered large for any given AAA security.

Nonetheless, we consider this to be a surprising fact given the conventional narrative for the causes of the financial crisis and its assignment of the considerable blame to the subprime market and its mortgage-backed securities. An example of this narrative is provided by Gelman and Loken (2014):

We have in mind an analogy with the notorious AAA-class bonds created during the mid-2000s that led to the subprime mortgage crisis. Lower-quality mortgages [that is, mortgages with high probability of default and, thus, high uncertainty] were packaged and transformed into financial instruments that were (in retrospect, falsely) characterized as low risk.

OK, our paper wasn’t actually about mortgages; it was about statistics. We were just using mortgages as an example. But if Ospina and Uhlig are correct, we were mistaken in using AAA-rated subprime mortgages as an example of a bad bet. Analogies are tricky things!

P.S. Daula adds:

Overall, I think it fits your data collection/measurement theme, and how doing that well can provide novel insights. In that vein, they provide a lot of detail to replicate the results, in case folks disagree. There’s the technical appendix which (p.39) “serves as guide for replication and for understanding the contents of our database” as well as (p.7) a replication kit available from the authors. As to the latter, (p.15) footnote 15 guides the reader to where exactly where to look for the one bit of modeling in the paper (“For a detailed list of the covariates employed, refer to MBS Project/Replication/DefaultsAnalysis/Step7”).

The post The AAA tranche of subprime science, revisited appeared first on Statistical Modeling, Causal Inference, and Social Science.