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Where's the smoking gun? a study of underwriting standards for US subprime mortgages

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Author Info
Geetesh Bhardwaj
Rajdeep Sengupta

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Abstract

The dominant explanation for the meltdown in the US subprime mortgage market is that lending standards dramatically weakened after 2004. Using loan-level data, we examine underwriting standards on the subprime mortgage originations from 1998 to 2007. Contrary to popular belief, we find no evidence of a dramatic weakening of lending standards within the subprime market. We show that while underwriting may have weakened along some dimensions, it certainly strengthened along others. Our results indicate that (average) observable risk characteristics on mortgages underwritten post-2004 would have resulted in a significantly lower ex post default if they were to be given a loan in 2001 or 2002. We show that while it is possible that underwriting standards in this market were poor to begin with, deterioration in underwriting post-2004 cannot be the explanation for collapse of subprime mortgage market.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2008-036.

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Date of creation: 2008
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Handle: RePEc:fip:fedlwp:2008-036

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Keywords: Subprime mortgage;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Ambrose, Brent W & Sanders, Anthony B, 2003. "Commercial Mortgage-Backed Securities: Prepayment and Default," The Journal of Real Estate Finance and Economics, Springer, vol. 26(2-3), pages 179-96, March-May. [Downloadable!] (restricted)
  2. Pierre-Andre Chiappori & Bernard Salanie, 2001. "Testing for Asymmetric Information in Insurance Markets," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 56-78, February. [Downloadable!] (restricted)
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  3. Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," NBER Working Papers 13882, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Yuliya Demyanyk & Otto Van Hemert, 2007. "Understanding the subprime mortgage crisis," Supervisory Policy Analysis Working Papers 2007-05, Federal Reserve Bank of St. Louis. [Downloadable!]
  5. John Y. Campbell & Joao F. Cocco, 2003. "Household Risk Management and Optimal Mortgage Choice," NBER Working Papers 9759, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Sengupta, Rajdeep, 2007. "Foreign entry and bank competition," Journal of Financial Economics, Elsevier, vol. 84(2), pages 502-528, May. [Downloadable!] (restricted)
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  7. Ciochetti, Brian A, et al, 2003. "A Proportional Hazards Model of Commercial Mortgage Default with Originator Bias," The Journal of Real Estate Finance and Economics, Springer, vol. 27(1), pages 5-23, July. [Downloadable!] (restricted)
  8. Brueckner, Jan K, 2000. "Mortgage Default with Asymmetric Information," The Journal of Real Estate Finance and Economics, Springer, vol. 20(3), pages 251-74, May. [Downloadable!] (restricted)
  9. Geetesh Bhardwaj & Rajdeep Sengupta, 2008. "Did prepayments sustain the subprime market?," Working Papers 2008-039, Federal Reserve Bank of St. Louis. [Downloadable!]
  10. Chris Mayer & Karen Pence, 2008. "Subprime mortgages: what, where, and to whom?," Finance and Economics Discussion Series 2008-29, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  11. Wayne R. Archer & Peter J. Elmer & David M. Harrison & David C. Ling, 2002. "Determinants of Multifamily Mortgage Default," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 30(3), pages 445-473. [Downloadable!] (restricted)
  12. Pierre-André Chiappori ; Bruno Jullien ; Bernard Salanié ; François Salanié, 2002. "Asymmetric Information in Insurance : General Testable Implications," Working Papers 2002-42, Centre de Recherche en Economie et Statistique. [Downloadable!]
  13. Christopher J. Mayer & Karen Pence, 2008. "Subprime Mortgages: What, Where, and to Whom?," NBER Working Papers 14083, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  14. Souphala Chomsisengphet & Anthony Pennington-Cross, 2006. "The evolution of the subprime mortgage market," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 31-56. [Downloadable!]
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  1. Geetesh Bhardwaj & Rajdeep Sengupta, 2008. "Did prepayments sustain the subprime market?," Working Papers 2008-039, Federal Reserve Bank of St. Louis. [Downloadable!]
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