IDEAS home Printed from
   My bibliography  Save this article

Policy incentives and the extension of mortgage credit: Increasing market discipline for subprime lending


  • Xudong An

    (Assistant Professor, Department of Finance, College of Business Administration, San Diego State University)

  • Raphael W. Bostic

    (Professor, School of Policy, Planning, and Development and the Lusk Center for Real Estate, University of Southern California)


The lax underwriting in non-prime mortgage markets is widely perceived as one cause of the recent difficulties in the housing market. Policymakers are currently considering moves such as enforcing more careful underwriting to provide additional discipline to mortgage markets. This research explores the possibility of another approach to supplement or replace some of these efforts, namely the use of policy to create incentives for Fannie Mae and Freddie Mac (together, the GSEs) to help “check” behavior in non-prime markets. The hypothesis is that the GSE Act affordable housing goals have increased GSE focus on targeted loan purchases, which in turn has led prime market lenders to compete more aggressively for borrowers on the margin between prime and subprime credit quality. As a consequence, these marginal borrowers will be more inclined to take prime mortgages rather than higher-cost subprime loans. We test this hypothesis and find empirical support for it. We observe a negative relationship between the growth in GSE market share and the growth in subprime market share over time, and find that the impact of the GSEs on subprime lending tends to be stronger in high-minority neighborhoods, where subprime lending has been concentrated and growing the fastest. Simulations show that a 10 percent increase in GSE market share (for example, from 20 to 22 percent) can cause 45,000 borrowers using prime instead of subprime loans a cost savings of about $1.7 billion. These results suggest that the GSEs, regardless of their postconservatorship form, should continue to devote attention to serving underserved populations and suggest that significant welfare benefits will accrue. © 2009 by the Association for Public Policy Analysis and Management.

Suggested Citation

  • Xudong An & Raphael W. Bostic, 2009. "Policy incentives and the extension of mortgage credit: Increasing market discipline for subprime lending," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 28(3), pages 340-365.
  • Handle: RePEc:wly:jpamgt:v:28:y:2009:i:3:p:340-365
    DOI: 10.1002/pam.20436

    Download full text from publisher

    File URL:
    File Function: Link to full text; subscription required
    Download Restriction: no

    References listed on IDEAS

    1. Jonathan Hershaff & Karl Russo & Susan M. Wachter, 2005. "Subprime lending: neighborhood patterns over time," Proceedings 954, Federal Reserve Bank of Chicago.
    2. Bostic, Raphael W. & Gabriel, Stuart A., 2006. "Do the GSEs matter to low-income housing markets? An assessment of the effects of the GSE loan purchase goals on California housing outcomes," Journal of Urban Economics, Elsevier, vol. 59(3), pages 458-475, May.
    3. Marsha J. Courchane & Brian J. Surette & Peter M. Zorn, 2004. "Subprime Borrowers: Mortgage Transitions and Outcomes," The Journal of Real Estate Finance and Economics, Springer, vol. 29(4), pages 365-392, December.
    4. Paul S. Calem & Kevin Gillen & Susan Wachter, 2004. "The Neighborhood Distribution of Subprime Mortgage Lending," The Journal of Real Estate Finance and Economics, Springer, vol. 29(4), pages 393-410, December.
    5. Kathleen C. Engel & Patricia A. McCoy, 2001. "The law and economics of remedies of predatory lending," Proceedings 790, Federal Reserve Bank of Chicago.
    6. Keith D. Harvey & Peter J. Nigro, 2004. "Do Predatory Lending Laws Influence Mortgage Lending? An Analysis of the North Carolina Predatory Lending Law," The Journal of Real Estate Finance and Economics, Springer, vol. 29(4), pages 435-456, December.
    7. Brent W. Ambrose & Michael LaCour‐Little & Anthony B. Sanders, 2004. "The Effect of Conforming Loan Status on Mortgage Yield Spreads: A Loan Level Analysis," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 32(4), pages 541-569, December.
    8. Elizabeth Renuart, 2004. "An overview of the predatory mortgage lending process," Housing Policy Debate, Taylor & Francis Journals, vol. 15(3), pages 467-502.
    9. Ambrose, Brent W. & Thibodeau, Thomas G., 2004. "Have the GSE affordable housing goals increased the supply of mortgage credit?," Regional Science and Urban Economics, Elsevier, vol. 34(3), pages 263-273, May.
    10. Joseph Nichols & Anthony Pennington-Cross & Anthony Yezer, 2004. "Borrower Self-Selection, Underwriting Costs, and Subprime Mortgage Credit Supply," The Journal of Real Estate Finance and Economics, Springer, vol. 30(2), pages 197-219, November.
    11. Souphala Chomsisengphet & Anthony Pennington-Cross, 2006. "The evolution of the subprime mortgage market," Review, Federal Reserve Bank of St. Louis, vol. 88(Jan), pages 31-56.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Levitin, Adam & Wachter, Susan, 2012. "Explaining the Housing Bubble," MPRA Paper 41920, University Library of Munich, Germany.
    2. Ashlyn Aiko Nelson, 2010. "Credit scores, race, and residential sorting," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 29(1), pages 39-68.
    3. Jonathan Spader & Roberto Quercia, 2012. "CRA Lending in a Changing Context: Evidence of Interaction with FHA and Subprime Originations," The Journal of Real Estate Finance and Economics, Springer, vol. 44(4), pages 505-525, May.

    More about this item


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wly:jpamgt:v:28:y:2009:i:3:p:340-365. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Wiley Content Delivery). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.