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Going for broke: New Century Financial Corporation, 2004-2006

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  • Landier, Augustin
  • Sraer, David
  • Thesmar, David

Abstract

Using 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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Bibliographic Info

Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 10-199.

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Date of creation: Sep 2010
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Handle: RePEc:tse:wpaper:23478

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  1. Tomasz Piskorski & Alexei Tchistyi, 2010. "Optimal Mortgage Design," Review of Financial Studies, Society for Financial Studies, vol. 23(8), pages 3098-3140, August.
  2. Gadi Barlevy & Jonas D. M. Fisher, 2010. "Mortgage choices and housing speculation," Working Paper Series WP-2010-12, Federal Reserve Bank of Chicago.
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Cited by:
  1. Sylvain Champonnois, 2011. "The limits of market discipline: proprietary trading and aggregate risk," 2011 Meeting Papers 1013, Society for Economic Dynamics.
  2. González-Aguado, Carlos & Suarez, Javier, 2011. "Interest Rates and Credit Risk," CEPR Discussion Papers 8398, C.E.P.R. Discussion Papers.
  3. repec:hal:psewpa:hal-00719952 is not listed on IDEAS
  4. Rancière, Romain & Tornell, Aaron, 2011. "Financial Black-Holes: The Interaction of Financial Regulation and Bailout Guarantees," CEPR Discussion Papers 8248, C.E.P.R. Discussion Papers.
  5. Edouard Challe & Benoit Monjon & Xavier Ragot, 2012. "Equilibrium Risk Shifting and Interest Rate in an Opaque Financial System," Working Papers hal-00719952, HAL.
  6. John Thanassoulis, 2011. "Industrial Structure, Executives' Pay And Myopic Risk Taking," Economics Series Working Papers 571, University of Oxford, Department of Economics.
  7. Benjamin J. Keys & Tomasz Piskorski & Amit Seru & Vikrant Vig, 2012. "Mortgage Financing in the Housing Boom and Bust," NBER Chapters, in: Housing and the Financial Crisis National Bureau of Economic Research, Inc.

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