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Answer: Frictions between the originator and the arranger
B is correct. The friction between the originator and the arranger is the predatory lending and predatory borrowing problem. It is one of the key frictions in the process of securitization involving an information problem between arranger and originator. In particular, the originator has an information advantage over the arranger with regard to the quality of the borrower. Without adequate safeguards in place, an originator can have the incentive to collaborate with a borrower in order to make significant misrepresentations on the loan application. Depending on the situation, this could be either construed as predatory lending (where the lender convinces the borrower to borrow too large a sum given the borrower's financial situation) or predatory borrowing (the borrower convinces the lender to lend too large a sum). To mitigate the problem, the arranger should have safeguard in place, including carrying out a thorough due diligence on the originator and requiring the originator to have adequate capital to buy back problem loans (see pages 375-376, [CR-18]).
Author: LeetQuiz Editorial Team
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A senior risk manager at a financial regulatory agency has given a task to a risk analyst to examine the subprime mortgage securitization process. The objective is to identify market participants who may be affected by informational issues or frictions caused by predatory lending and predatory borrowing. The analyst delves into the US subprime mortgage crisis of 2007 to 2009 to understand the conditions that nurture these predatory activities. Which of the following correctly identifies the frictions between key participants in the securitization process that are linked with both predatory lending and predatory borrowing?
A
Frictions between the investor and the asset manager
B
Frictions between the originator and the arranger
C
Frictions between the mortgagor and the servicer
D
Frictions between the arranger and the credit rating agency
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