Developments in the U.S. housing and mortgage debt markets since 2006 are the focus of anxiety and efforts among regulators, researchers, and market participants. This project aims to uncover the causes of, and the paths to, the mortgage crisis from the experience of a major mortgage bank. The bank the PI's study is an ideal place for the study because it provides a epresentative and yet amplified version of the boom-and-bust cycle that the national subprime sector has seen during the past decade. First, the bank was one of the nations ten largest mortgage banks in 2006 and was one of the fastest growing. Second,it specialized in the reduced- and no-documentation loans that has been central to the mortgage crisis, while also providing full-documentation loans. Third, the insolvency of the bank in 2008 was one of the largest bank failures in United States history. Lastly, the borrowers and properties underlying the bank's mortgage loans have fair representations from all the states, and therefore, lessons from the bank's failure have general implications. The project will be based on a new and proprietary data set that represents the most comprehensive, detailed, and disaggregated data sets used in the mortgage loan literature. We have obtained data on more than 700,000 loans made by the bank that were outstanding at any time between January 2004 and March 2008. The dataset includes all the detailed information that the lender collected for loan origination, including loan pricing and other contractual terms, and the borrowers demographic and economic conditions. In addition, the dataset includes detailed information about the loan performance in each month during the sample period, including the payment amount and the loans prepayment, delinquency and foreclosure status. Finally, using the address information in the dataset, the PI's are able to match individual loans to community attributes such as school quality, housing price indices, and business opportunities in narrow localities. The analysis of this unique dataset will include several steps. First, the PI's plan to conduct a descriptive analysis of the evolution of the structuring and performance of loans originated by the bank during the sample period. Second, they will perform a predictive analysis of default, and analyze the differences in the determinants of default among subsamples partitioned by loan types and borrower characteristics. They will also analyze the time series variations of such. Most importantly, they will identify the two-sided moral hazard problems in the mortgage market. On the one hand, there is the possibility of predatory lending, where the lender misleads an uninformed borrower into a high-cost loan when the latter could qualify for a lower-cost alternative; or the lender makes a loan that will cause expected harm to the borrower. On the other hand, predatory borrowing points to the possibility that borrowers falsify or hide unfavorable information in their loan applications.
The intellectual merit of the proposed activity: Using a unique dataset, the proposed study will help settle the controversies over lending practice, most importantly the presence of discrimination in loan pricing and predatory lending. The research also aims at identifying key factors in causing the mortgage crisis by assessing the relative importance of irresponsible lending and irresponsible borrowing. The novel empirical design to separately identify the opportunistic behavior of lenders and borrowers will also represent a contribution to the empirical literature on two-sided information asymmetry and moral hazard.
The broader impacts resulting from the proposed activity: By conducting an inside study of a major mortgage bank through its expansion and failure, this work will provide a better understanding of the causes of the recent mortgage crisis. The findings will provide useful reference for policy makers who work on laws and rules in order to prevent a crisis of this scale from recurring. The lessons from this study will also benefit banks and financial institutions for better practices in loan provision and securitization, risk management, and monitoring.
This project provided new evidence on the micro-level causes of, and paths to, the mortgage crisis from the experience of a major mortgage bank. We acquired and organized a data set from a leading national mortgage bank containing all loans originated by the bank between January 2004 and February 2008. We combined this data set with several publically available data sets. We used the resulting combined data set to analyze the determinants of mortgage default as well as the incentive problems between the originating bank and borrowers, and between the originating bank and the secondary market investors. Our results highlight the role that information (including information falsification) and incentive issues played in the mortgage crisis. We found that loans originated through a broker were substantially more likely to go delinquent than loans originated by the bank, and we explored the incentive issues that explain this result. We found substantial evidence of falsification of loan applications by some borrowers of low-documentation loans, especially of low-documentation loans originating through a broker, and again explored the role of incentives and information in explaining this result. We examined the role of the secondary market on which loans are originated by the bank, and on which of these loans are sold by the bank to the secondary market. We find evidence that the originating bank lowered standards on loans it thought it could sell on the secondary market, but, of that pool of loans, the secondary market was able to purchase the loans least likely to go delinquent while leaving the originating bank with those loans most likely to go delinquent. We examine the incentive issues that help explain this result, along with the role of what information is known by the bank when deciding to originate a loan and what information is known by the secondary market when deciding whether to purchase a loan. These results appear in a series of papers that we have published in leading, peer-reviewed, economics and finance journals. In addition, in on-going research, we are using our data to analyze the Community Reinvestment Act (CRA), and whether the CRA contributed to the mortgage crisis by pressuring banks to loosen lending standards for low- and moderate-income individuals and neighborhoods. In our initial analysis, we find limited causal evidence that the CRA increased delinquency rates around CRA-defined income thresholds.find that the CRA did not contribute to the recent surge of mortgage delinquencies. Our findings provide useful reference for regulators and policy makers whose challenge it is to set rules and policies that will prevent a mortgage crisis from recurring. Our findings emphasize the incentive and information problems in the mortgage market, findings that should directly inform regulation of the mortgage market. Likewise, these findings should also benefit banks and financial institutions by helping inform better practices in loan provision and securitization, risk management, and monitoring. Our analysis of the Community Reinvestment Act should directly inform policy makers of the effect (or lack thereof) of this policy on mortgage delinquencies.
