Going for broke: New Century Financial Corporation, 2004-2006
AbstractUsing loan level data, we investigate the lending behavior of a large subprime mortgage issuer prior to its bankruptcy in the beginning of 2007. In 2004, this firm suddenly started to massively issue new loans contracts that featured deferred amortization ("interestonly loans") to high income and high FICO households. We document that these loans were not only riskier, but also that their returns were more sensitive to real estate prices than standard contracts. Implicitly, this lender dramatically increased its exposure to its own legacy asset, which is what a standard model of portfolio selection in distress would predict. We provide additional evidence on New Century’s lending behavior, which are consistent with a risk shifting strategy. Finally, we are able to tie this sudden change in behavior to the sharp monetary policy tightening implemented by the Fed in the spring of 2004. Our findings shed new light on the relationship between monetary policy and risk taking by financial institutions.
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Date of creation: Sep 2010
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Other versions of this item:
- Landier, Augustin & Sraer, David & Thesmar, David, 2010. "Going for broke: New Century Financial Corporation, 2004-2006," TSE Working Papers 10-199, Toulouse School of Economics (TSE).
- NEP-ALL-2010-12-11 (All new papers)
- NEP-BAN-2010-12-11 (Banking)
- NEP-FMK-2010-12-11 (Financial Markets)
- NEP-MAC-2010-12-11 (Macroeconomics)
- NEP-URE-2010-12-11 (Urban & Real Estate Economics)
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