The Effect of Mortgage Broker Licensing On Loan Origination Standards and Defaults: Evidence from U.S. Mortgage Market 2000-2007

We study the U.S. origination-to-distribution mortgage financing market from the mid 1990s to the late 2000s. Mortgage loan brokers originated close to two thirds of the mortgage loans in this period. We examine whether stricter licensing requirements of loan brokers raise lending standards by i) admitting only higher quality brokers who benefit more from a long-term career and thus have greater incentives to protect borrowers and lenders' long-term interests, ii) raising entry costs and thus generating higher future rents that reduce brokers' incentives to chase short-term profits, e.g., by lowering loan origination standards, that jeopardize their likelihood of winning future business from borrowers and lenders. We exploit the cross-state and over time variations in licensing requirements and find that originated loans in states with more stringent requirements had higher standards: FICO score were higher, and LTV and DTI were lower and there were fewer negative amortization, interest only, balloon, ARM, Low Doc, and subprime loans. The requirements on surety bonds and net worth, education, and office in state have the greatest impact on loan origination standards. The education (and exam) requirements for employees are more effective than those for licensees. The effect of licensing on loan origination standards is greater for neighborhoods with greater minority percentages and lower income, and for lenders that specialize in sub-prime lending. Corroborating findings on loan origination standards, states with more stringent licensing requirements had lower default rates: Moving from the 25th to the 75th percentile in licensing requirements is associated with close to 20 percent reduction from the mean of the 90 days or more delinquency rate. These findings point to the value of broker licensing when lenders' incentives to screen are compromised with the securitization of mortgages. Key words: Mortgage; brokers; securitization; information asymmetry; moral hazard; incentives; occupational licensing JEL codes: D82; G21; G28; J44; L1