Mortgage Origination Research Articles

Spatial dynamic panel data models with interactive fixed effects

This paper studies the estimation of a dynamic spatial panel data model with interactive individual and time effects with large n and T. The model has a rich spatial structure including contemporaneous spatial interaction and spatial heterogeneity. Dynamic features include individual time lag and spatial diffusion. The interactive effects capture heterogeneous impacts of time effects on cross sectional units. The interactive effects are treated as parameters, so as to allow correlations between the interactive effects and the regressors. We consider a quasi-maximum likelihood estimation and show estimator consistency and characterize its asymptotic distribution. The Monte Carlo experiment shows that the estimator performs well and the proposed bias correction is effective. We illustrate the empirical relevance of the model by applying it to examine the effects of house price dynamics on reverse mortgage origination rates in the US.

Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks

Shadow bank market share in residential mortgage origination nearly doubled from 2007-2015, with particularly dramatic growth among online “fintech” lenders. We study how two forces, regulatory differences and technological advantages, contributed to this growth. Difference in difference tests exploiting geographical heterogeneity induced by four specific increases in regulatory burden –capital requirements, mortgage servicing rights, mortgage-related lawsuits, and the movement of supervision to Office of Comptroller and Currency following closure of the Office of Thrift Supervision -- all reveal that traditional banks contracted in markets where they faced more regulatory constraints; shadow banks partially filled these gaps. Fintech lenders appear to offer a higher quality product and charge a premium of 14-16 basis points. Relative to other lenders, they seem to use different information to set interest rates. A quantitative model of mortgage lending suggests that regulation accounts for roughly 60% of shadow bank growth, while technology accounts for roughly 30%.

Prudential Policies and Their Impact on Credit in the United States

We analyze how two types of recently used prudential policies affected the supply of credit in the United States. First, we test whether the U.S. bank stress tests had any impact on the supply of mortgage credit. We find that the first Comprehensive Capital Analysis and Review (CCAR) stress test in 2011 had a negative effect on the share of jumbo mortgage originations and approval rates at stress-tested banks—banks with worse capital positions were impacted more negatively. Second, we analyze the impact of the 2013 Supervisory Guidance on Leveraged Lending and subsequent 2014 FAQ notice, which clarified expectations on the Guidance. We find that the share of speculative-grade term-loan originations decreased notably at regulated banks after the FAQ notice.

The Impact of State Foreclosure and Bankruptcy Laws on Higher-Risk Lending: Evidence from FHA and Subprime Mortgage Originations

State foreclosure and bankruptcy laws govern the rights of mortgage lenders and borrowers during foreclosure and bankruptcy proceedings and thereby affect lenders' exposure to credit risk. In this paper, we examine the impact of these laws on the types of mortgages originated. The empirical identification is based on state-level variations in foreclosure and bankruptcy laws and a border estimation strategy. We find that higher-risk loans (FHA and subprime loans) are more likely to be originated in states with lender-friendly foreclosure laws. Also, higher-risk loans are less likely to be originated in states with a more generous bankruptcy homestead exemption. In addition, our results are consistent with the idea that FHA and subprime loans share a similar clientele and are close substitutes. These results are robust without the ordering assumption among conventional prime, FHA, and subprime loans.

Ditching the Middle Class with Consumer Protection Regulation

We analyze the effects of a recent piece of consumer-protection regulation – Dodd-Frank – on mortgage originations. Dodd-Frank aimed at reducing mortgage fees and abuses against vulnerable borrowers, but increased the costs of originating mortgages. We find it triggered a substantial redistribution of credit from middle-class households to wealthy households. Lenders reduced credit to middle-class households by 15%, and increased credit to wealthy households by 21%, after controlling for drivers of the demand for housing, local house prices, and foreclosures. Large lenders found reacting to Dodd-Frank to be less costly. We thus instrument households’ exposure to Dodd-Frank with the pre-crisis share of mortgages originated by large lenders in each county. The redistribution of credit from the middle class to the wealthy was higher in counties more exposed to large lenders, which are similar to other counties. Results hold at the individual-loan level and zip-code level, at the intensive margin (amount lent) and extensive margin (number of loans originated), and for accepted and rejected loans. Changes in the distribution of refinancing loans do not explain the results.

Regressive Mortgage Credit Redistribution in the Post-crisis Era

We analyze the effects of a recent piece of consumer protection regulation -- Dodd-Frank -- on mortgage originations. Dodd-Frank aimed at reducing mortgage fees and abuses against vulnerable borrowers, but increased the costs of originating mortgages. We find it triggered a substantial redistribution of credit from middle-class households to wealthy households. Lenders reduced credit to middle-class households by 15%, and increased it to wealthy households by 21%, after controlling for drivers of the demand for housing, local house prices, and foreclosures. Large lenders found it less costly to react to Dodd-Frank. We thus instrument households' exposure to Dodd-Frank with the pre-crisis share of mortgages originated by large lenders in each county. The redistribution of credit from the middle-class to the wealthy was higher in counties more exposed to large lenders, which are similar to other counties. Results hold at the individual-loan level and zip-code level, at the intensive margin (amount lent) and extensive margin (number of loans originated), and for accepted and rejected loans. Changes in the distribution of refinancing loans do not explain the results.

Mortgage originations during 2002-2007 as an example of an evolutionary market

The mortgage market in the United States in the early and mid-2000’s underwent a substantial shift in both the quality of loans and the nature of the products offered which eventually led to the financial collapse of 2007. However, this change did not happen all at once, instead there was a gradual shift over time as experimenting firms learned that they could sell lower quality loans into the market and other firms were forced to follow along or lose market share. Mortgages started from a position of a stable market with high-quality loans and then shifted over time to a market characterized by continually declining quality and then shifted again sharply back towards high quality, although now requiring government intervention for support. This same pattern was seen across a number of different characteristics of the market. This paper shows how and why the shift happened from an evolutionary perspective and discusses the implications of this kind of behavior for understanding this period and also for possible developments in the future.

The Causes of Fraud in the Financial Crisis of 2007 to 2009

The financial crisis of 2007 to 2009 was marked by widespread fraud in the mortgage securitization industry. Most of the largest mortgage originators and mortgage-backed securities issuers and underwriters have been implicated in regulatory settlements, and many have paid multibillion-dollar penalties. This article seeks to explain why this behavior became so pervasive. We evaluate predominant theories of white-collar crime, finding that theories emphasizing deregulation or technical opacity identify only necessary, not sufficient, conditions. Our argument focuses instead on changes in competitive conditions and firms’ positions within and across markets. As the supply of mortgages began to decline around 2003, mortgage originators lowered credit standards and engaged in predatory lending to shore up profits. In turn, vertically integrated mortgage-backed securities issuers and underwriters committed securities fraud to conceal this malfeasance and enhance the value of other financial products. Our results challenge several existing accounts of how widespread the fraud should have been and, given the systemic crimes that occurred, which financial institutions were the most likely to commit fraud. We consider the implications of our results for regulations that were based on some of these models. We also discuss the overlooked importance of illegal behavior for the sociology of markets.

Effects of Credit Union Service Organizations on Credit Union Performance

This study examines the effects of credit union service organizations (CUSOs) on credit union performance for the period 2009 through 2014. I use random effects models with Mundlak (1978) correction to estimate the relationships between CUSOs and credit union performance variables. Credit union participation in CUSOs increased over the sample period and participation increases with credit union size. CUSO participation is divided based on whether the credit union wholly owned the CUSO or was required to collaborate with other institutions. I find evidence that participation in wholly-owned CUSOs increases the interest rate spread, collaborative consumer mortgage origination reduces loan rates, and insurance brokerage or agency significantly increases non-interest income for credit unions. The results of the study support existing findings that small organizations are reluctant to give up autonomy and offer insight on which CUSOs benefit credit unions and their members.

Phasing out the GSEs

We develop a new model of the mortgage market that emphasizes the role of the financial sector and the government. Risk tolerant savers act as intermediaries between risk averse depositors and impatient borrowers. Both borrowers and intermediaries can default. The government provides both mortgage guarantees and deposit insurance. Underpriced government mortgage guarantees lead to more and riskier mortgage originations and higher financial sector leverage. Mortgage crises occasionally turn into financial crises and government bailouts due to the fragility of the intermediaries’ balance sheets. Foreclosure crises beget fiscal uncertainty, further disrupting the optimal allocation of risk in the economy. Increasing the price of the mortgage guarantee “crowds in” the private sector, reduces financial fragility, leads to fewer but safer mortgages, lowers house prices, and raises mortgage and risk-free interest rates. Due to a more robust financial sector and less fiscal uncertainty, consumption smoothing improves and foreclosure rates fall. While borrowers are nearly indifferent to a world with or without mortgage guarantees, savers are substantially better off. While aggregate welfare increases, so does wealth inequality.

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

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.

Local Labor Market Shocks and Residential Mortgage Payments: Evidence from Shale Oil and Gas Booms

Understanding how changes to local labor market conditions impact household spending and savings decisions is a central topic in labor economics. Frequently, housing is the largest item on a household's balance sheet, and therefore making monthly mortgage payments is often both the largest regular expenditure as well as a primary savings vehicle for households. To investigate the dynamics of this relationship, we examine mortgage payment choices of homeowners who purchased property in areas that later experienced a positive shock to local economic conditions via the shale oil and gas boom. Using a large loan-level dataset with detailed information about mortgage originations and monthly payments, we find that borrowers with properties located in areas with shale oil and gas booms experienced a 6% reduction in the probability of missing a mortgage payment.

Mortgage Lender Profitability and Its Impacton Market Spreads

Persistent increases in mortgage origination costs affect both lender profitability and borrower costs. This article examines these trends and quantifies the impact of increased loan production expenses on primary–secondary spreads. An important implication for investors and analysts is that persistently wider spreads may dampen prepayment responses for a given change in secondary market rates relative to historical experience.

The Unintended Impacts of Anti-Redlining Legislation

Federal and state legislation intended to curb the practice of geographic loan discrimination or redlining may have the unintended and undesirable effect of preventing mortgage originators from using environmental characteristics as criteria in lending evaluations. Since the California fault rupture zones (special studies zones) do not contain systematic concentrations of poor, black, or elderly households, they should be targets for differential lending policies, such as mandatory earthquake insurance or structural reinforcements as conditions for mortgage loans. A clarification of the wording of the Housing Financial Discrimination Act is needed to alleviate some of the present potentially damaging effects of failing to discourage residential investment in surface fault rupture zones. is a form of geographic discrimination in lending. The term refers to the refusal to grant mortgage loans to otherwise qualified buyers for sound property in certain areas of the city [1]. Redlining was an early practice of the Home Owners Loan Corporation: maps were color coded to represent relative risks to lenders, with hazardous zones coded as red [2]. The decision that a neighborhood is a poor risk for mortgage loans has been based on several factors, including large numbers of renter-occupiers, changing racial composition, or visible signs of property deterioration [3]. This conservative lending policy has been justified on the argument that banks and saving and loans have a fiduciary responsibility to their investors to protect their savings from undue investment risk.

Loan Originations and Defaults in the Mortgage Crisis: The Role of the Middle Class

This paper highlights the importance of middle-class and high-FICO borrowers for the mortgage crisis. Contrary to popular belief, which focuses on subprime and poor borrowers, we show that mortgage originations increased for borrowers across all income levels and FICO scores. The relation between mortgage growth and income growth at the individual level remained positive throughout the pre-2007 period. Finally, middle-income, high-income, and prime borrowers all sharply increased their share of delinquencies in the crisis. These results are consistent with a demand-side view, where homebuyers and lenders bought into increasing house values and borrowers defaulted after prices dropped.

Did Dubious Mortgage Origination Practices Distort House Prices?

ZIP codes with high concentrations of originators who misreported mortgage information experienced a 75% larger relative increase in house prices from 2003 to 2006 and a 90% larger relative decrease from 2007 to 2012 compared with other ZIP codes. Several causality tests show that high fractions of dubious originators in a ZIP code lead to large price distortions. Originators with high misreporting gave credit to borrowers with high ex ante risk, yet further understated the borrowers' true risk. Overall, excess credit facilitated through dubious origination practices explain much of the regional variation in house prices over a decade.

Monetary Stimulus and Bank Lending

In recent business cycle downturns, monetary policymakers worldwide have sought to stimulate their economies by conducting asset purchases. The U.S. Federal Reserve purchased both agency mortgage-backed securities (MBS) and Treasury (TSY) securities, which are generally thought to be comparable in credit quality and stimulative effects. This paper investigates the effect of such purchases on mortgage lending, commercial lending, and firm investment using micro-level data. We find that MBS and TSY purchases have asymmetric effects. In response to MBS purchases, banks that are active in the MBS market increase their mortgage origination market share, compared to other banks. At the same time, these banks reduce commercial lending. As a result, firms that borrow from these banks decrease investment. The effect of TSY purchases is either positive, as expected, or insignificant in most cases. Our results suggest different effects depending on the type of asset purchased, that MBS purchases cause distortionary effects across banks and firms, and that TSY purchases did not cause a large positive stimulus to the economy through the bank lending channel.

Subprime governance: Agency costs in vertically integrated banks and the 2008 mortgage crisis

Research summary: This study uses the 2008 mortgage crisis to demonstrate how the relationship between vertical integration and performance crucially depends on corporate governance. Prior research has argued that the vertical integration of mortgage origination and securitization aligned divisional incentives and improved lending quality. We show that vertical integration improved loan performance only in those firms with strong corporate governance and that this performance‐integration relationship strongly decreases and actually reverses as governance quality decreases. We interpret these findings as suggesting that the additional control afforded by vertical integration can, in the hands of poorly monitored managers, offset gains from aligned divisional incentives. These findings support the view that corporate governance influences the strategic outcomes of a firm, in our case, by influencing the effectiveness of boundary decisions.Managerial summary: One of the unanswered questions of the 2008 mortgage crisis is why some firms produced toxic mortgages and others did not. Many have argued that vertically integrated banks—banks that both originated and securitized mortgages—had incentives to monitor themselves and thereby avoid overaggressive lending and outright fraud. Yet many of the worst lenders, such as Washington Mutual and New Century Financial, were in fact integrated. This study shows that the behavior of these firms critically depended on their corporate governance. We find that poorly monitored executives used their additional control over the integrated businesses to issue low quality loans that supported short‐term growth. Our results suggest that governance is a crucial prerequisite for financial services, particularly for firms whose managers control multiple, interrelated businesses. Copyright © 2015 John Wiley & Sons, Ltd.

How House Price Dynamics and Credit Constraints Affect the Equity Extraction of Senior Homeowners

Households borrow against equity through different channels: closed end home equity loans or revolving lines of credit, cash-out refinancing, and — for senior homeowners — reverse mortgages. We jointly estimate the decision to extract equity through these channels, identifying the influence of credit constraints and house price dynamics on the proportion of seniors in a ZIP code extracting through a given channel from 2004 to 2012. As house prices increased, cash-out refinancing increased in credit-constrained areas, while HELOCs increased in less-credit-constrained areas. When house prices fell, reverse mortgage originations increased — particularly in credit-constrained areas.

Crowding Out Effects of Refinancing on New Purchase Mortgages

We present evidence that binding mortgage processing capacity constraints reduce mortgage originations to borrowers of low to modest credit quality. Mortgage processing capacity constraints typically bind when the demand for mortgage refinancing shifts outward, usually because of lower mortgage rates. As a result, high capacity utilization leads mortgage lenders to ration mortgage credit, completing mortgages that require less underwriting resources, and are thus less costly, to produce. This is hypothesized to have a particularly adverse impact on the ability of low- to modest-credit-quality borrowers to obtain mortgages. What is more, we show that, by lowering capacity utilization, a rise in interest rates can, under certain circumstances, induce an increase in mortgage originations to borrowers of low to modest credit quality. In particular, we find fairly large effects for purchasing borrowers of modest credit quality, in which we find that a decrease in capacity utilization of 4 applications per mortgage employee (similar to that observed from 2012 to 2013) could result in increased purchase mortgage originations, as the relaxed capacity constraint at least partially offsets the higher cost of mortgage credit.