What Fueled the Financial Crisis? An Analysis of the Performance of Purchase and Refinance Loans

Abstract

There is a good deal of debate on the causes of the housing crisis. Using Freddie Mac and Fannie Mae loan-level data, this article compares the default and loss behaviors of purchase, rate refinance, and cash-out refinance loans. The authors’ results show that cash-out refis have the poorest performance, especially during the financial crisis. Purchase loans exhibit much better performance than rate refis before and during the financial crisis; this pattern is weaker thereafter. Furthermore, they also show that loan performance of first-time homebuyers is similar to that of repeat buyers. This evidence indicates that the expansion of lending to include more marginal borrowers may not be the main cause of the financial crisis. Instead, the poor performance of the cash-out refis, and refis more generally, is a more important contributing factor.