1. BUSINESS SCHOOL Platform Competition of Government Sponsored Enterprises and Private-Label Securitization: A Two-Sided Market Perspective Quan Gan Discipline of Finance University of Sydney

2. Two-Sided Market 2 ›A platform that brings buyers and sellers on board. ›E.g. Video games bring consumers and software developers on board ›Google brings ``eyeballs’’ and advertisers on board. ›Typical Literature: ›Rochet and Tirole (2003, 2006), Armstrong (2006)

3. Mortgage-Backed Securities Market Structure 3

4. Two Platforms in Two-Sided Market 4 ›Platform 1: Government Sponsored Enterprises (Fannie Mae, Freddie Mac) ›Platform 2: Private-Label Securitization (conduits backed by investment banks) ›GSE and PLS are competing platforms ›Side 1: Mortgage borrowers ›Side 2: Mortgage-backed Securities investors

5. Business Model: A Two Sided Market Perspective 5

6. Segmentation of Securitization Market 6 ›Conforming Loans ›Jumbo Loans (loan amount > conforming limit) ›Nonjumbo-nonconforming Loans (e.g. subprime loans) ›GSE can only purchase and securitize conforming loans ›PLS can purchase and securitize all loans

7. GSE Advantages and Disadvantages 7 ›GSEs are supported by governments ›Advantages: ›1) high credit rating; ›2) implicit/explicit government support when things go wrong ›Disadvantages: ›1) conflicting goals: increasing housing affordability v.s. maximizing shareholders’ value ›2) activity is constrained by conforming criteria

8. PLS Advantages and Disadvantages 8 ›Advantages: ›1) competing freely with only goal to maximizing profit ›Disadvantages: ›1) hard to compete in securitizing conforming loans ›2) cost to get insurance on loans

9. Model 9 ›Game Framework for platforms: ›GSE: first mover – setting conforming criteria and dominant conforming loan securitization ›PLS: follower – setting their own securitization standards and try to catch the remaining market ›Both GSE and PLS set mortgage-backed security (passthrough type as to current draft) price to maximize their profit. ›They make profit because pooling decreases the risk for investors (cross externality).

10. Model II 10 ›Mortgage borrowers: Price takers ›Primary lender: risk neutral ›Interest rate: normalize to 0 (mortgage rate is not zero) ›The Loan amount and payment satisfy following equation:

11. Model III 11 ›Investors: maximizing profit ›Hotelling type model ›Uniformly distributed on (0, 1) with same amount of available fund M on each density unit. ›Transportation cost proportional (may change to other specification: e.g. quadratic form) to their distance with GSE (located at 1) or PLS (located at 0) ›Here, ``transportation’’ may be seen as the preference to the government backing.

12. Model IV 12

13. Results 13 ›Proposition 1: If demand effect is strong (many people want to borrow and buy houses), PLS profit is higher than that of GSE. ›Proposition 2: GSE has tendency to set loose conforming criteria when collaterals are deteriorating. ›Proposition 3: If GSE set loose conforming criteria (as priori) to some point, PLS lose money (on average)