The Impact of Credit Risk Mispricing on Mortgage Lending during the Subprime Boom
James Kahn () and
Benjamin S. Kay
No 2019-046, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)
We provide new evidence that credit supply shifts contributed to the U.S. subprime mortgage boom and bust. We collect original data on both government and private mortgage insurance premiums from 1999-2016, and document that prior to 2008, premiums did not vary across loans with widely different observable characteristics that we show were predictors of default risk. Then, using a set of post-crisis insurance premiums to fit a model of default behavior, and allowing for time-varying expectations about house price appreciation, we quantify the mispricing of default risk in premiums prior to 2008. We show that the flat premium structure, which necessarily resulted in safer mortgages cross-subsidizing riskier ones, produced substantial adverse selection. Government insurance maintained an even flatter premium structure even post-crisis, and consequently also suffered from adverse selection. But after 2008 it reduced its exposure to default risk through a combination of hi gher premiums and rationing at the extensive margin.
Keywords: Default Risk; Financial Crisis; Housing Finance; Mortgage Insurance (search for similar items in EconPapers)
JEL-codes: E32 G21 E44 (search for similar items in EconPapers)
Pages: 60 pages
New Economics Papers: this item is included in nep-ias, nep-mac and nep-ure
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2019-46
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