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Leverage and the Foreclosure Crisis

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  • Dean Corbae
  • Erwan Quintin

Abstract

How much of the recent rise in foreclosures can be explained by the large number of high-leverage mortgage contracts originated during the housing boom? We present a model where heterogeneous households select from a set of mortgage contracts and choose whether to default on their payments given realizations of income and housing price shocks. The set of mortgage contracts consists of loans with high downpayments and loans with low downpayments. We run an experiment where the use of low downpayment loans is initially limited by payment-to-income requirements but then becomes unrestricted for 8 years. The relaxation of approval standards causes homeownership rates, high-leverage originations and the frequency of high interest rate loans to rise much like they did in the US between 1998-2006. When home values fall by the magnitude observed in the US from 2007-08, default rates increase by over 180% as they do in the data. Two distinct counterfactual experiments where approval standards remain the same throughout suggest that the increased availability of high-leverage loans prior to the crisis can explain between 40% to 65% of the initial rise in foreclosure rates. Furthermore, we run policy experiments which suggest that recourse could have had significant dampening effects during the crisis.

Suggested Citation

  • Dean Corbae & Erwan Quintin, 2013. "Leverage and the Foreclosure Crisis," NBER Working Papers 19323, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:19323
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    References listed on IDEAS

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    Cited by:

    1. Carlos Hatchondo, Juan & Martinez, Leonardo & Sánchez, Juan M., 2015. "Mortgage defaults," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 173-190.
      • Hatchondo, Juan Carlos & Martinez, Leonardo & Sánchez, Juan M., 2011. "Mortgage defaults," Working Papers 2011-019, Federal Reserve Bank of St. Louis, revised 31 Jul 2015.
      • Leonardo Martinez & Juan Carlos Hatchondo & Juan M. Sanchez, 2012. "Mortgage Defaults," IMF Working Papers 12/26, International Monetary Fund.
      • Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2011. "Mortgage defaults," Working Paper 11-05, Federal Reserve Bank of Richmond.
      • Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2015. "Mortgage Defaults," Caepr Working Papers 2015-011 Classification-D, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    2. repec:eee:dyncon:v:87:y:2018:i:c:p:124-151 is not listed on IDEAS
    3. Fernando Ferreira & Joseph Gyourko, 2015. "A New Look at the U.S. Foreclosure Crisis: Panel Data Evidence of Prime and Subprime Borrowers from 1997 to 2012," NBER Working Papers 21261, National Bureau of Economic Research, Inc.
    4. Wenli Li & Florian Oswald, 2017. "Recourse and residential mortgages: The case of Nevada," Sciences Po publications info:hdl:2441/6ka8i7k76r8, Sciences Po.
    5. Elenev, Vadim & Landvoigt, Tim & Van Nieuwerburgh, Stijn, 2016. "Phasing out the GSEs," Journal of Monetary Economics, Elsevier, vol. 81(C), pages 111-132.
    6. Serdar Ozkan & Kurt Mitman & Fatih Karahan & Aaron Hedlund, 2017. "Monetary Policy, Heterogeneity, and the Housing Channel," 2017 Meeting Papers 1610, Society for Economic Dynamics.
    7. Wenli Li & Florian Oswald, 2017. "Recourse and residential mortgages: The case of Nevada," Sciences Po publications info:hdl:2441/5qjpn9qdt48, Sciences Po.
    8. Gete, Pedro & Zecchetto, Franco, 2017. "Distributional Implications of Government Guarantees in Mortgage Markets," MPRA Paper 80643, University Library of Munich, Germany.
    9. Fang, Hanming & Kim, You Suk & Li, Wenli, 2016. "The dynamics of subprime adjustable-rate mortgage default: a structural estimation," Working Papers 16-2, Federal Reserve Bank of Philadelphia.
    10. van Ooijen, Raun & van Rooij, Maarten C.J., 2016. "Mortgage risks, debt literacy and financial advice," Journal of Banking & Finance, Elsevier, vol. 72(C), pages 201-217.
    11. Dimitris Christelis & Michael Ehrmann & Dimitris Georgarakos, 2015. "Exploring Differences in Household Debt Across Euro Area Countries and the United States," Staff Working Papers 15-16, Bank of Canada.
    12. Leung, Charles Ka Yui & Tse, Chung-Yi, 2017. "Flipping in the housing market," Journal of Economic Dynamics and Control, Elsevier, vol. 76(C), pages 232-263.
    13. Dimitris Christelis & Michael Ehrmann & Dimitris Georgarakos, 2017. "Exploring Differences in Household Debt Across the United States and Euro Area Countries," CSEF Working Papers 465, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    14. Kim, Jiseob, 2015. "Household’s optimal mortgage and unsecured loan default decision," Journal of Macroeconomics, Elsevier, vol. 45(C), pages 222-244.
    15. Nikolai Roussanov & Michael Michaux & Hui Chen, 2011. "Houses as ATMs? Mortgage Refinancing and Macroeconomic Uncertainty," 2011 Meeting Papers 1369, Society for Economic Dynamics.
    16. Manuel Adelino & Antoinette Schoar & Felipe Severino, 2015. "Loan Originations and Defaults in the Mortgage Crisis: The Role of the Middle Class," NBER Working Papers 20848, National Bureau of Economic Research, Inc.
    17. Adam M. Guren & Arvind Krishnamurthy & Timothy J. McQuade, 2018. "Mortgage Design in an Equilibrium Model of the Housing Market," NBER Working Papers 24446, National Bureau of Economic Research, Inc.
    18. Acikgoz, Omer & Kahn, James, 2016. "A Quantitative Model of "Too Big to Fail,"' House Prices, and the Financial Crisis," MPRA Paper 71831, University Library of Munich, Germany.
    19. Leung, Charles Ka Yui & Tse, Chung-Yi, 2017. "Flipping the Housing Market," Globalization and Monetary Policy Institute Working Paper 301, Federal Reserve Bank of Dallas.
    20. repec:eee:juecon:v:101:y:2017:i:c:p:1-13 is not listed on IDEAS
    21. Steinbuks, Jevgenijs, 2015. "Effects of prepayment regulations on termination of subprime mortgages," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 445-456.
    22. Andra Ghent, 2015. "Home Ownership, Household Leverage and Hyperbolic Discounting," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 43(3), pages 750-781, September.
    23. Davis, Morris A. & Van Nieuwerburgh, Stijn, 2015. "Housing, Finance, and the Macroeconomy," Handbook of Regional and Urban Economics, Elsevier.
    24. Aaron Hedlund, 2015. "Failure to Launch: Housing, Debt Overhang, and the Inflation Option During the Great Recession," Working Papers 1515, Department of Economics, University of Missouri.
    25. Silvo, Aino, 2017. "House prices, lending standards, and the macroeconomy," Research Discussion Papers 4/2017, Bank of Finland.

    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • R3 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location

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