Mortgage Lending Regulatory Arbitrage: A Cross-Sectional Analyses of Nonbank Lenders

Abstract

Nonbank mortgage lenders originated more than half of the risky subprime mortgage loans prior to 2008 and yet escaped much regulatory scrutiny during the 2008 global financial crisis. In this study, we provide new insights into how these nontraditional lenders became important players in the residential mortgage market. We document large variations in the state licensing requirements for mortgage originators and suggest that some opportunistic nonbank lenders may have entered via less regulated states and engaged in large scale risky loan originations. While these risky loans seemingly served the previously underrepresented borrower base, in the long run, they did not help the state economy and did not promote homeownership creation. Thus, we suggest that low entry barriers for the financial industry should be reviewed and new market entrants should be regularly monitored.