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Subprime mortgages and the housing bubble

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  • Jan K. Brueckner
  • Paul S. Calem
  • Leonard I. Nakamura

Abstract

This paper explores the link between the house-price expectations of mortgage lenders and the extent of subprime lending. It argues that bubble conditions in the housing market are likely to spur subprime lending, with favorable price expectations easing the default concerns of lenders and thus increasing their willingness to extend loans to risky borrowers. Since the demand created by subprime lending feeds back onto house prices, such lending also helps to fuel an emerging housing bubble. The paper, however, focuses on the reverse causal linkage, where subprime lending is a consequence rather than a cause of bubble conditions. These ideas are illustrated in a theoretical model, and empirical work tests for a connection between price expectations and the extent of subprime lending.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 11-12.

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Date of creation: 2011
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Handle: RePEc:fip:fedpwp:11-12

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Keywords: Subprime mortgage ; Global financial crisis;

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  1. Matteo Iacoviello & Stefano Neri, 2008. "Housing market spillovers : evidence from an estimated DSGE model," Working Paper Research, National Bank of Belgium 145, National Bank of Belgium.
  2. Christopher L. Foote & Kristopher Gerardi & Paul S. Willen, 2008. "Negative equity and foreclosure: theory and evidence," Public Policy Discussion Paper, Federal Reserve Bank of Boston 08-3, Federal Reserve Bank of Boston.
  3. Charles D. Anderson & Dennis R. Capozza & Robert Van Order, 2011. "Deconstructing a Mortgage Meltdown: A Methodology for Decomposing Underwriting Quality," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 43(4), pages 609-631, 06.
  4. Óscar J. Arce & J. David López-Salido, 2008. "Housing bubbles," Banco de Espa�a Working Papers 0815, Banco de Espa�a.
  5. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  6. Lambertini, Luisa & Mendicino , Caterina & Punzi , Maria Teresa, 2012. "Expectations-driven cycles in the housing market," Research Discussion Papers 2/2012, Bank of Finland.
  7. Dell''Ariccia, Giovanni & Igan, Deniz & Laeven, Luc, 2008. "Credit Booms and Lending Standards: Evidence From The Subprime Mortgage Market," CEPR Discussion Papers 6683, C.E.P.R. Discussion Papers.
  8. Charles Himmelberg & Christopher Mayer & Todd Sinai, 2005. "Assessing High House Prices: Bubbles, Fundamentals, and Misperceptions," NBER Working Papers 11643, National Bureau of Economic Research, Inc.
  9. Andrey Pavlov & Susan Wachter, 2011. "Subprime Lending and Real Estate Prices," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 39(1), pages 1-17, 03.
  10. Atif Mian & Amir Sufi, 2009. "The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 124(4), pages 1449-1496, November.
  11. William C. Wheaton & Gleb Nechayev, 2008. "The 1998 ?2005 Housing "Bubble" and the Current "Correction": What’s Different This Time?," Journal of Real Estate Research, American Real Estate Society, American Real Estate Society, vol. 30(1), pages 1-26.
  12. 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.
  13. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
  14. Karl E. Case & Robert J. Shiller, 2003. "Is There a Bubble in the Housing Market?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(2), pages 299-362.
  15. James B. Kau & Donald C. Keenan & Taewon Kim, 1993. "Transaction Costs, Suboptimal Termination and Default Probabilities," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(3), pages 247-263.
  16. Kau James B. & Keenan Donald C. & Kim Taewon, 1994. "Default Probabilities for Mortgages," Journal of Urban Economics, Elsevier, vol. 35(3), pages 278-296, May.
  17. Coleman IV, Major & LaCour-Little, Michael & Vandell, Kerry D., 2008. "Subprime lending and the housing bubble: Tail wags dog?," Journal of Housing Economics, Elsevier, Elsevier, vol. 17(4), pages 272-290, December.
  18. Giovanni Dell'Ariccia & Luc Laeven & Deniz Igan, 2008. "Credit Booms and Lending Standards," IMF Working Papers 08/106, International Monetary Fund.
  19. Timothy J. Riddiough & Howard E. Thompson, 1993. "Commercial Mortgage Pricing with Unobservable Borrower Default Costs," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(3), pages 265-291.
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Citations

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Cited by:
  1. repec:fip:fedpwp:13-2 is not listed on IDEAS
  2. Nakamura, Leonard I., 2014. "Brewing bubbles: how mortgage practices intensify housing booms," Business Review, Federal Reserve Bank of Philadelphia, issue 1, pages 16-24.
  3. Alice O. Nakamura & Leonard I. Nakamura & Masao Nakamura, 2012. "Building the Innovation Union: Lessons from the 2008 Financial Crisis," Working Papers 12-17, Federal Reserve Bank of Philadelphia.
  4. Robert Hill & Iqbal A. Syed, 2012. "Hedonic Price-Rent Ratios, User Cost, and Departures from Equilibrium in the Housing Market," Discussion Papers, School of Economics, The University of New South Wales 2012-45, School of Economics, The University of New South Wales.
  5. Wall, Larry D., 2012. "Central Banking for Financial Stability: Some Lessons from the Recent Instability in the United States and Euro Area," ADBI Working Papers 379, Asian Development Bank Institute.
  6. Leonard Nakamura, 2014. "Durable Financial Regulation: Monitoring Financial Instruments as a Counterpart to Regulating Financial Institutions," NBER Chapters, in: Measuring Wealth and Financial Intermediation and Their Links to the Real Economy National Bureau of Economic Research, Inc.
  7. W. Scott Frame & Lawrence J. White, 2014. "Technological Change, Financial Innovation, and Diffusion in Banking," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 14-02, New York University, Leonard N. Stern School of Business, Department of Economics.
  8. Jiaqi Ge, 2013. "Endogenous Formation and Collapse Of Housing Bubbles," Staff General Research Papers 36277, Iowa State University, Department of Economics.
  9. Leonard Nakamura, 2012. "Durable financial regulation: monitoring financial instruments as a counterpart to regulating financial institutions," Working Papers 13-02, Federal Reserve Bank of Philadelphia.
  10. Huang, MeiChi, 2014. "Bubble-like housing boom–bust cycles: Evidence from the predictive power of households’ expectations," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(1), pages 2-16.
  11. Larry D. Wall, 2012. "Central banking for financial stability Some lessons from the recent instability in the US and euro area," Public Policy Review, Policy Research Institute, Ministry of Finance Japan, Policy Research Institute, Ministry of Finance Japan, vol. 8(3), pages 247-280, August.
  12. Jan K. Brueckner & Paul S. Calem & Leonard I. Nakamura, 2013. "House-price expectations, alternative mortgage products, and default," Working Papers 13-36, Federal Reserve Bank of Philadelphia.
  13. Ge, Jiaqi, 2013. "Endogenous Rise and Collapse of Housing Prices," Staff General Research Papers 36279, Iowa State University, Department of Economics.

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