Origins of the Current Mortgage Problems
A rapid expansion in the supply of credit to zip codes with high 1996 latent demand for mortgages -- namely sub-prime customers who were traditionally marginal borrowers unable to access the mortgage market -- led to both greater house price appreciation and the subsequent sharp increase in defaults from 2005 to 2007.
The current credit crisis has increased the anxiety level of policymakers, investors, and financial markets. Before the crisis, there was a rise in mortgage credit, an increase in the homeownership rate, and a sharp increase in housing prices. But now, as defaults on recently issued mortgages continue to climb, many fear that the reversal in housing and mortgage markets might lead to a real downturn in the economy. For example, the Federal Open Market Committee statement of January 22, 2008 justified a 75-basis-point reduction in the federal funds rate, in part because "...information indicates a deepening of the housing contraction..."
In The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis (NBER Working Paper No.13936), authors Atif Mian and Amir Sufi, investigate the causes of the sharp rise in mortgage credit and house prices followed by the subsequent spike in mortgage defaults. Based on their analysis, the authors conclude that, at the very minimum, 15 percent of total home purchase loans and 10 percent of aggregate house price appreciation in the United States can be attributed to a credit supply shift (to lower interest rates and increased securitization of mortgage loans.)
To answer the supply-versus-demand question that they pose about the mortgage crisis, the authors put together a new, comprehensive dataset constructed from a number of proprietary and public sources. The data contain zip code-year level information from 1996 through 2007 on a number of key variables of interest including: outstanding consumer debt of different types, defaults, house prices, mortgage loan application characteristics, mortgage terms, and demographic variables such as income and crime.
The authors conduct their analysis at the zip code level, while isolating variation only within counties. They show that zip codes that had high latent (unfulfilled) demand for mortgages in 1996 -- defined as the percentage of mortgage applications that are denied -- continue to get rationed out of the credit market for a few years but then see a sharp reduction in their mortgage denial rates. Was the increase in mortgage acceptance rates in zip codes with high 1996 denial rates driven by an improvement in demand-side factors, such as income and economic growth? According to the authors, such a demand-side explanation is highly unlikely: zip codes with high 1996 denial rates subsequently saw (relatively) declining growth in income, wages, and business creation until 2005.
The authors go on to show that a rapid expansion in the supply of credit to zip codes with high 1996 latent demand for mortgages -- namely sub-prime customers who were traditionally marginal borrowers unable to access the mortgage market -- led to both greater house price appreciation and the subsequent sharp increase in defaults from 2005 to 2007. The expansion in the supply of credit was accompanied by a shift in the mortgage industry towards "disintermediation," which the authors define as the process by which originators sell mortgages in the secondary market shortly after origination. Zip codes that saw the largest increase in mortgage credit, house price appreciation, and subsequent defaults also saw the largest increase in rates of disintermediation. Moreover, the increase in sales to the secondary market is related to a subsequent increase in default rates only when the secondary sale is to a "non-affiliated" entity, they find, thus signaling possible moral hazard concerns.
-- Les Picker
