Finance Seminar（2016-04）

Topic: Housing Price Expectations and Subprime Lending: The Incremental Role of Securitization

Speaker: Guodong Chen, University of Michigan

Time: Wednesday, 24 February, 10:40-12:10

Location: Room 217, Guanghua Building 2

Abstract:

A nationwide drop in housing prices, followed by subprime mortgage defaults and downgrades of mortgage-backed securities, precipitated the U.S. financial crisis of 2007-09. I build a simple model with borrowers? optimal default behavior to explore the impact of both house price expectations and the growth of securitization on the extent of subprime lending. I show that high expectations of housing prices not only increase lenders’ willingness to lend to riskier borrowers, but, in addition, enhance the attractiveness of the originate-to-distribute (OTD) model of lending. Access to securitization markets also amplifies banks’ incentives to lend to sub-prime borrowers and leads to a worsening of mortgage market credit quality. Thus, when housing prices decline ex post, the extent of default is magnified with OTD lending. Empirical findings confirm the model predictions. I find that, in markets with higher housing price growth, banks with higher OTD participation extended mortgages to riskier borrowers, and thus, had larger incidence of defaults once house prices declined.

Your participation is warmly welcomed!