In February 2011 the Wall Street Journal published an article about a disagreement among rating firms over the rating of a particular mortgage-backed security (MBS). The stated concern was that the MBS was not sufficiently diversified. An employee of Moody’s is quoted as saying: “Given this geographical concentration, there is ... idiosyncratic risk.” We contend that this is the wrong approach to securitization of mortgages that exhibit significant default risk. A basic result of portfolio theory is that investors can achieve diversification and elimination of idiosyncratic risk on their own by investing in a portfolio of securities. Our analysis in this paper goes further to argue that there may be a distinct disadvantage to diversification in mortgage backed securities, a “diversification discount”.
Starting with the seminal contributions of Bernanke and Gertler (1989) and Kiyotaki and Moore (1997), a large theoretical literature in macroeconomics has studied the implications of credit market imperfections for investment and output dynamics. At the heart of this literature is the inverse relationship between firms’ financial assets, or equivalently internal funds, and the agency costs of investment. When asymmetric information or moral hazard problems entail agency costs in lending relationships, firms’ debt capacity is constrained by the level of assets that can be pledged to outside lenders.
An adverse shock that worsen financial conditions may therefore generate a negative spiral, where low profits reduce debt capacity and hence investment, which further reduces profit, amplifying the initial negative shock, and so forth. This amplification mechanism, known as the credit multiplier or the financial accelerator, has been extremely influential in explaining how relatively small and temporary exogenous shocks to the economy may be amplified and become persistent.
The diabetes system modeling project began in September 2003 primarily as a result of two concerns: first, that existing programmatic strategies focused on reducing the immediate burden of diabetes might soon become overwhelmed or lose effectiveness in the face of rapidly increasing disease prevalence, and, second, that diabetes leaders lacked effective, quantitatively-grounded decision-support tools that could improve diabetes strategies in light of the first concern. SD was determined to be an appropriate technique for looking formally at a broad spectrum of programmatic options and considering their relative effectiveness over the short and long term. Part of the appeal of SD was its flexibility and ability to deal in an integrative and transparent way with the diverse questions and rich information sources that characterize the current state of diabetes prevention and control. Thus, an SD approach held promise as a way of answering tough questions, diminishing the sense of information overload, pointing the way toward a more effective program mix, and thereby improving the ability of DDT to engage effectively with state and local colleagues, as well as other stakeholders who would ultimately be needed as partners to champion any change in programmatic direction.
