The Endogeneity of Risk

I was at a risk manager conference and met someone involved in risk capital allocations at a large bank. Interestingly, she said that mortgages now had the same allocation as credit cards. When I was doing this in 1999, credit cards had the highest risk capital allocation within the bank, and mortgages were just above US Treasuries among 'safe' asset classes. Back then, historical loss rates were near zero, and 'underwriting innovations' were just a gleam in Bill Syron's eye.



So, in only 10 years a major asset class transmogrifies from safest to riskiest. The underwriting (credit risk minimums and money down payment), the loss-in-event-of-default assumption (new legal risks), the 'willingness to pay', and collateral price volatility, have all changed significantly. Perhaps this is all endogenous, that a 'safe' asset like mortgages must become risky because everyone--investors, mortgage issuers, home builders, legislators, non-profits--all see it as a vehicle to achieve various ends.