Villains or scapegoats? The role of subprime borrowers in driving the U.S. housing boom

An expansion in mortgage credit to subprime borrowers is widely believed to have been a principal driver of the 2002-2006 U.S. house price boom. By contrast, this paper documents a robust, negative correlation between the growth in the share of purchase mortgages to subprime borrowers and house price appreciation at the county-level during this time. Using two different instrumental variables approaches, we also establish causal evidence that house price appreciation lowered the share of purchase loans to subprime borrowers. Further analysis using micro-level credit bureau data shows that higher house price appreciation reduced the transition rate into first-time homeownership for subprime individuals. Finally, the paper documents that subprime borrowers did not play a significant role in the increased speculative activity and underwriting fraud that the literature has linked directly to the housing boom. Taken together, these results are more consistent with subprime borrowers being priced out of housing boom markets rather than inflating prices in those markets.     

Creditor Learning and Discrimination in Lending

I study the implications of creditor learning for the estimated racial disparity in access to credit. Utilizing a dataset of mortgage lending, I find that the estimated racial disparity in loan approval rates declines with the length of the borrower??s credit history. In addition, minority borrowers improve significantly their chances of obtaining a loan by accumulating longer credit histories, with the improvements being the largest for those with no credit history. Importantly, I find no significant racial disparity among borrowers with long credit histories, suggesting that one cannot reject the null hypothesis of no taste-based discrimination taking place. I also conduct a number of tests to detect statistical discrimination, which yield inconclusive results.     

An Early Assessment of Residential Mortgage Performance in China

The residential mortgage market becomes a financial engine for the booming residential housing development and sustained economic growth in China. Our study provides the first rigorous empirical analysis on the earlier performance of residential mortgage market in China based on a unique micro dataset of mortgage loan history collected from a major residential mortgage lender in China. We found that while the option theory fails to explain prepayment and default behavior in the residential mortgage market in China, other non-option theory related financial economic factors play major roles in determining the prepayment and default risks in China. We also found that borrower’s characteristics are significant in determining prepayment behavior, hence may be used as an effective tool for screening potential high risk borrowers in the loan origination process. Adopting a risk-based pricing in residential mortgage lending in China can improve the efficiency of the market, and enhance the credit availability to the most needed households, i.e., the younger households, blue-collar workers, lower income households, and help them become homeowners.     

Differences in the Cost of Mortgage Credit Implications for Discrimination

This paper estimates the mortgage interest rate differences paid by Asian, Hispanic, and African–American borrowers to a national home mortgage lender in the years 1988–1989. Controlling for differences in market rates, rate lock protection, and borrower risk factors, conventional loan interest rates are almost perfectly race-neutral. The single deviation from race-neutrality is that when interest rates fall during the borrower's rate-lock period, only African–American borrowers are unable to capture a share of this decline. Government (FHA and VA) credit models show small premia paid by African–American borrowers of about $1.80 per month on average. In government lending, Hispanic borrowers alone are unable to capture rate declines occurring during the borrower's rate-lock period.     

Legal Restrictions in Personal Loan Markets

This study examines the pricing of personal loans in the form of second mortgages to determine whether state-specific default laws have an effect on the availability and cost of that debt. We examine the pricing of loans to higher risk borrowers and whether borrowers in states that limit lender ability to seek default remedies pay higher credit costs. Our results indicate that, for the most part, lenders rationally price loans to higher risk borrowers. However, when we focus on borrowers with low credit scores, the results indicate that mean actual loan rates are higher than those predicted by our model. The results also indicate that state-specific default laws have an effect on the price of credit. Finally, the results show that there is a greater degree of error in the pricing of second mortgage loans to borrowers with low credit scores than to borrowers with high credit scores.     

Subprime Borrowers: Mortgage Transitions and Outcomes

Public policy concerns increasingly have focused on subprime lending. Our research uses a survey of prime and subprime borrowers to address whether borrowers inappropriately are channeled to the subprime segment, if once having taken out a subprime mortgage borrowers are stuck in this market segment, and whether borrowers face higher costs by taking out subprime mortgages. We find that subprime borrowers are less knowledgeable about the mortgage process, are less likely to search for the best mortgage rates, and are less likely to be offered a choice among alternative mortgage terms and instruments—possibly making them more vulnerable to unfavorable mortgage outcomes. Our analysis of market segmentation confirms that typical mortgage underwriting criteria are most important in explaining whether borrowers obtain prime or subprime mortgages—higher credit risk borrowers are more likely to get a subprime loan. Our results further show that search behavior and other demographic factors including adverse life events, age, and Hispanic ethnicity contribute to explaining market segment, suggesting that borrowers may inappropriately receive subprime mortgages. While we find some persistence to market segment—borrowers are more likely to take out a subprime mortgage if their previous mortgage came from the subprime segment—we also find that market segment is not immutable. Analysis of the survey responses indicates that borrowers with subprime mortgages significantly are more dissatisfied with their mortgage outcomes. This is not surprising because subprime borrowers look worse across typical mortgage underwriting criteria. Consistent with policy concerns, however, despite holding constant these and other factors, taking out a mortgage in the subprime segment, by itself, appears to increase dissatisfaction with mortgage outcomes. We do not provide a definitive answer to the question of whether subprime lending, on balance, serves homebuyers well by providing access to mortgage credit to those otherwise constrained, or rather serves homebuyers poorly by inappropriately assigning them to a market where costs are high and the ability to transition to more attractive prime mortgages remains low. Our analysis, however, does provide some empirical support for concerns raised by critics of subprime lending, and for this reason justifies continued public policy debate and analysis.     

The inefficiency of refinancing: Why prepayment penalties are good for risky borrowers

This paper provides a theoretical analysis of the efficiency of prepayment penalties in a dynamic competitive lending model with risky borrowers and costly default. When considering improvements in the borrower's creditworthiness as one of the reasons for refinancing mortgages, we show that refinancing penalties can be welfare improving and that they can be particularly beneficial to riskier borrowers in the form of lower mortgage rates, reduced defaults, and increased availability of credit. Thus, a high concentration of prepayment penalties among the riskiest borrowers can be an outcome of efficient equilibrium in a mortgage market. We also provide empirical evidence that is consistent with the key predictions of our model.     

Release of a liquidity regulation: What do we learn for credit and house prices?

This paper studies the effects of the release of a limit on banks’ maturity transformation – akin to the Net Stable Funding Ratio – for mortgage supply and house prices. After the regulatory easing, credit supply increased only for the banks that were previously constrained by the regulation and not for the others. We also show that the expansion in mortgages triggered by the deregulation accelerated house prices. The effect was channeled through higher demand for housing and the relaxation of borrowers’ financial constraints. Even though the impact of the credit supply shock persisted, the interaction between credit and house prices was not conducive to a housing market overheating.     

Beyond the Transaction: Banks and Mortgage Default of Low‐Income Homebuyers

We evaluate the effects of the lending institution and soft information on mortgage loan performance for low‐income homebuyers. We find that even after controlling for the propensity of a borrower to get a loan from a local bank based on observable characteristics, those who receive a loan from a local bank branch are significantly less likely to become delinquent or default than other bank or nonbank borrowers, consistent with an unobserved information effect. These effects are most pronounced for loans originated to borrowers with marginal credit, where soft information may have a stronger effect. These findings support previous research on information‐driven lending, and provide additional explanation for observed differences in mortgage loan performance between bank and nonbank lenders.     

Unintended Consequences of Risk Based Pricing: Racial Differences in Mortgage Costs

The following analysis focuses on the role that risk pricing has had in the allocation and access to mortgage funds, specifically how it results in cost differences by race. Using a sample of fixed-rate first lien mortgages, we control for the risk characteristics of borrowers and assets. We find that borrowers with comparable credit quality experience significantly higher costs for mortgages in neighborhoods with a high density of minority households. Further, when the pricing differential is controlled for in a model of mortgage default, there is no support for neighborhood price differences. This finding illustrates a potential inequity that results from efficient/risk pricing in mortgage underwriting.     

Bank Branch Presence and Access to Credit in Low‐ to Moderate‐Income Neighborhoods

Banks specialize in lending to informationally opaque borrowers by collecting soft information about them. Some researchers claim that this process requires a physical presence in the market to lower information collection costs. This paper provides evidence in support of this argument in the mortgage market for low‐income borrowers whose access to credit is limited by their inadequate credit histories. Mortgage originations increase and interest spreads decline when there is a bank branch located in a low‐ to moderate‐income neighborhood.     

Residential Mortgage Lending and Borrower Risk: The Relationship Between Mortgage Spreads and Individual Characteristics

The mortgage banking environment in Hong Kong is quite different from that in the United States. For example, the secondary mortgage market and mortgage insurance only started after 1997. Using a large data set on mortgages, we examine empirically how mortgage rates in this market vary with various individual borrower, property, and loan characteristics. We find that mortgage rates in Hong Kong do vary with individual characteristics, which suggests credit sorting according to both prepayment risk and default risk, as a higher mortgage rate is found to be related to either higher collateral (a lower loan-to-value ratio) or slower prepayment. The empirical results suggest that lenders in Hong Kong can observe the risk type of individual borrowers to a certain extent and charge a corresponding mortgage spread. Overall, the evidence is consistent with the sorting-by-observed-risk paradigm as in Berger and Udell (1990).     

Product market competition and the cost of bank loans: Evidence from state antitakeover laws

The extant literature documents a positive relationship between a firm’s takeover vulnerability and its agency cost of debt. Using state antitakeover laws as an exogenous measure of variation in takeover vulnerability, I investigate whether product market competition has a disciplinary effect that can lower a firm’s cost of bank loans. After taking into account the industry composition of borrowers, I find that banks charge higher spreads to borrowers that are vulnerable to takeovers, but only in concentrated industries. In the absence of disciplinary competitive pressure, the effect of takeover vulnerability on the cost of bank loans is mitigated for larger firms, firms followed by analysts, firms with existing credit ratings, non-family firms, and for borrowers with shorter maturity loans or loans with covenants and collateral in place. Taken together, the results suggest that the effect of governance on the cost of financing is not homogenous across all industries, and that concentrated industry firms may need to use supplementary governance mechanisms to mitigate debt holder agency problems.     

Credit Rationing,Income Exaggeration,and Adverse Selection in the Mortgage Market

We examine the role of borrower concerns about future credit availability in mitigating the effects of adverse selection and income misrepresentation in the mortgage market. We show that the majority of additional risk associated with “low‐doc” mortgages originated prior to the Great Recession was due to adverse selection on the part of borrowers who could verify income but chose not to. We provide novel evidence that these borrowers were more likely to inflate or exaggerate their income. Our analysis suggests that recent regulatory changes that have essentially eliminated the low‐doc loan product would result in credit rationing against self‐employed borrowers.     

个人住房抵押贷款借款人产品选择行为

1998年至今,中国个人住房抵押贷款市场迅速成长,并呈现出持续增长趋势。从完善个贷服务、降低金融风险的角度出发,深入研究借款人个贷产品选择行为具有现实意义。本文以2001年北京个贷市场实际交易数据为基础,采用二元Logit选择模型,定量分析经济因素、借款人个体属性和个贷产品属性对借款人个贷期限和贷款价值比选择行为的影响。实证研究发现,借款人性别对其个贷产品选择的影响并不显著;高收入借款人相对于中低收入借款人更倾向高比例中短期贷款;购置高价住宅的借款人相对于购置中低价格住宅的借款人更倾向选择中低比例长期贷款;未婚借款人更倾向高比例贷款;年轻借款人和高等教育程度借款人更倾向长期贷款。此外,本文结合对特定人群房价收入比的分析,探讨造成借款人选择行为差异的可能原因。本文基本结论为,借款人个贷期限和贷款价值比选择行为相对合理,不存在绝对高风险人群。     

The role of prepayment penalties in mortgage loans

We study the effect of mortgage prepayment penalties on borrowers’ prepayments and delinquencies by exploiting a 2007 reform in Italy that reduced penalties on outstanding mortgages and banned penalties on newly-issued mortgages. Using a unique dataset of mortgages issued by a large Italian lender, we provide evidence that: 1) before the reform, mortgages issued to riskier borrowers included larger penalties; 2) higher prepayment penalties decreased borrowers’ prepayments; and 3) higher prepayment penalties did not affect borrowers’ delinquencies. Moreover, we find suggestive evidence that prepayment penalties affected mortgage pricing, as well as prepayments and delinquencies through borrowers’ mortgage selection at origination, most notably for riskier borrowers.     

The ins and outs of mortgage debt during the housing boom and bust

From 1999 to 2013, U.S. mortgage debt doubled before contracting sharply. I estimate mortgage inflows and outflows that shed light on the sources of volatility. During the boom, inflows from real estate investors tripled, far outpacing other segments such as first-time homebuyers. During the bust, a collapse in inflows keyed the debt decline, while an expansion of outflows due to defaults played a more minor role. Inflow declines partly reflect a dramatic falloff in first-time homebuying, especially for low credit score individuals. Further analysis helps support the notion that the differential decline by credit score reflects markedly tightened credit supply.     

Borrower Self-Selection,Underwriting Costs,and Subprime Mortgage Credit Supply

In the U.S., households participate in two very different types of credit markets. Personal lending is characterized by continuous risk-based pricing in which lenders offer households a continuous distribution of borrowing possibilities based on estimates of their creditworthiness. This contrasts sharply with mortgage markets where lenders specialize in specific risk categories of borrowers and mortgage supply is stepwise linear. The contrast between continuous lending for personal loans and discrete lending by specialized lenders for mortgage credit has led to concerns regarding the efficiency and equity of mortgage lending. This paper sheds both theoretical and empirical light on the differences in the two credit markets. The theory section demonstrates why, in a perfectly competitive credit market where all lenders have the same underwriting technology, mortgage credit supply curves are stepwise linear and lenders specialize in prime or subprime lending. The empirical section then provides evidence that borrowers are being effectively sorted based on risk characteristics by the market.     

The changing structure of local credit markets: Are small businesses special?

In many countries consolidation in the banking industry has reduced the number of small banks and led to significant shifts in market shares; deregulation has fostered entry in local credit markets and the expansion of branch networks, increasing competition in local markets. Small businesses are believed to be more vulnerable to these changes, since they are more dependent on credit from local banks. In this paper we investigate the consequences of consolidation and entry for these borrowers compared with those for large firms. We employ a data set for Italy, which provides information on volumes of loans and bad loans by size of borrower with a detailed geographical partition. We find that mergers are followed by a temporary reduction in outstanding credit to all sizes of borrowers and by an increase in bad loans, most likely due to the reassessment of banks portfolios. Entry has a relatively persistent negative impact on credit supply to small and medium-sized firms. Our results also show that concentration, branch density and the share of branches of small banks affect the volumes of credit and bad loans of small borrowers.     

The role of bankers in the U.S. syndicated loan market

I construct a novel dataset of individual bankers in the U.S. syndicated loan market to analyze the impact of bankers for the largest, most transparent borrowers. Bankers exhibit time-invariant preferences for specific loan characteristics, or styles. In addition, exploiting within-borrower variation in personal relationship strength from banker turnover, I find that stronger relationships lead to significantly lower interest rates. This effect is stronger if borrowers lack a credit rating or issue less frequent and shorter horizon management reports. Relationship loans are associated with fewer bankruptcies and fewer favorable modifications in renegotiations.