Subprime Borrowers Research Articles

The Impact of Crisis-Period Interest Rate Declines on Distressed Borrowers

Abstract We measure the causal impact of reductions in benchmark interest rates on the renegotiation and performance of distressed loans, using 2000s subprime mortgages as a laboratory. Subprime borrowers treated with larger benchmark rate reductions benefited from increased debt-renegotiation probabilities and lower debt-service payments. Modification rates were similar among current and delinquent borrowers but higher for real estate investors, highlighting the role of financial acumen in renegotiation. Renegotiations also reduced longer-run foreclosures, but treated borrowers who lingered in delinquency offset these benefits. Findings suggest monetary easing can spur debt renegotiation but alone may not lead to longer-run curative outcomes.

Does the CARD Act affect price responsiveness? Evidence from credit card solicitations

The CARD Act restricts consumer credit card issuers’ ability to raise interest rates. We examine whether the Act influences the degree to which an issuer adjusts offered interest rates in response to changes in interest rates offered by other lenders in credit card solicitations—the price responsiveness. Using small business card offers as a control group, we find a significant decline in the price responsiveness after the Act. The decline is concentrated among other lenders’ rate reductions rather than rate increases and is more pronounced in areas with more subprime borrowers. The results underscore an unintended consequence of regulating the consumer credit market.

Disaster Lending: “Fair” Prices but “Unfair” Access

We find the Small Business Administration’s disaster-relief home loan program denies significantly more loans in areas with larger shares of minorities, subprime borrowers, and higher income inequality. We find that risk-insensitive loan pricing, a feature present in many regulated and government-run lending programs, is an important driver of these disparities in access to credit. The differences in denial rates are disproportionately high compared with private-market lending and government-insured risk-sensitive loan pricing programs. Thus, despite ensuring “fair” prices, the use of risk-insensitive pricing may lead to “unfair” access to credit. This paper was accepted by Victoria Ivashina, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2021.03199 .

Global Financial Crisis: Cause, Impact and Response

The subprime crisis is a financial calamity brought on by subprime mortgage companies going bankrupt, investment funds being forced to close, and major stock market shocks. At the start of this century, the US stock market, real estate market, and other asset markets experienced a number of asset bubbles due to excess liquidity, house purchase policy stimulus, financial innovation, and other factors. Along with the tightening of monetary policy, the weakening of the US housing market, and particularly the rise in short-term interest rates, the interest rate for repaying subprime mortgages surged considerably. At the same time, buyers find it challenging to sell their homes or refinance utilising mortgage housing because to the ongoing cooling of the housing market. Due to the failure of many subprime borrowers to make scheduled loan repayments and the failure of banks to sell their properties at high prices, which resulted in significant losses, the subprime crisis was directly caused by these events. Most people agree that the absence of a mechanism for financial monitoring was a major factor in the crisis. The United States has accelerated the adoption of neo liberal economic policies during the past three decades, which is one of the primary causes. However, more than ten years after the United States stabilised the financial system through monetary, fiscal, financial, and other measures, the global economy has been hit considerably more severely and has not yet fully emerged from the shadow of the crisis.

Subprime Crisis: Cause, Effect and Response

After the dot-com bust, the U.S. experienced growth in the housing industry: oversupply of capital, low-interest rates, and deregulated financial system. Financial firms, led by banks, rode on a robust macroeconomic atmosphere. The freedom brought by financial deregulation was taken out of context among the firms in the financial system, resulting in the establishment and widespread use of collateralized debt obligations (CDOs) and mortgage-backed securities (MBS) (CDO); these were unconventional investments for the general populace. In retrospect, the U.S. government limited banks’ participation in private-labeled asset-backed securities to tame interest rates, liquidity, and credit risks only to be loosened the following years by Congress through amendments to the existing laws. Deregulation of the banking system encouraged banks and thrift banks to engage in real estate businesses, which paved the way for the rise of the subprime market. The subprime market grew alongside the prime market due to banks’ circumvention of borrowers' creditworthiness. The domino effect began from the failure of the subprime borrowers to repay. Vertically integrated banking giants felt the heavy blow of loan default, which caused their insolvency. Since then, the whole financial system has collapsed entirely. An increase in job losses, a rise in homelessness, business closures, and U.S. negative growth ensued. Through the TARP program, the Dodd-Frank Wall Street Reform and Consumer Protection Act, and quantitative easing.

Spillover Effects of the Opioid Epidemic on Consumer Finance

AbstractI examine the impact of the opioid epidemic on subprime auto lending. Using a difference-in-differences framework, I find that county-level increases in opioid abuse cause an increase in loan defaults. Moreover, I find that traditional credit scoring attributes (e.g., FICO score) fail to predict loan performance deterioration associated with opioid addiction. The weak predictive performance of traditional credit measures and the resulting higher default rates generate a negative externality for borrowers in opioid-afflicted areas, as evidenced by 5.7% higher loan costs for subprime borrowers.

Credit growth and the financial crisis: A new narrative

Using a nationally representative panel of credit reports, we show that the 2001–2006 credit boom and the 2007–2009 rise in mortgage defaults were concentrated among prime borrowers. Life cycle effects and mortgage investor activity are primary factors behind the evolution of debt and default in this period. These results hold across geographical regions, suggesting other factors, such as demographics, may account for the positive correlation between the concentration of subprime borrowers, the rise in debt and severity of the recession. Our findings provide a new narrative that challenges the role of subprime credit in the housing boom and bust.

Does judicial foreclosure procedure help delinquent subprime mortgage borrowers?

AbstractWe conduct comprehensive analyses on whether and how the judicial foreclosure procedure helps subprime mortgage borrowers to reinstate their delinquent loans outside foreclosure liquidation. Even though the transition rates of various exit types are all higher in non‐judicial states, we argue such higher rates can be mechanically driven by the faster shrinking pool of delinquent mortgages in non‐judicial states over time. Based on the cumulative proportions of various exit types during a period of up to 5 years post the mortgage first become 90 days past due, we find that judicial states offer more opportunities for delinquent borrowers to reinstate their loans outside foreclosure liquidation, especially during a housing market downturn. Cures, modifications, and paid‐offs were all important alternative ways to resolve serious delinquencies during 2007–2008. After modifications became widely available in 2009, loan modifications became the most important alternative for subprime borrowers to reinstate their delinquent mortgages outside foreclosure liquidation. The lion's share of the judicial foreclosure benefit shows up after the start of the foreclosure process.

HOUSING WEALTH REALLOCATION BETWEEN SUBPRIME AND PRIME BORROWERS DURING RECESSIONS

The Survey of Consumer Finances (SCF) indicates that, unlike subprime borrowers, prime borrowers are more likely to own investment homes during recessions than during recoveries. Drawing on this empirical fact, we present and estimate a dynamic stochastic general equilibrium (DSGE) model that distinguishes between borrowers through their credit access. We find that the relative ease of credit access among borrowers explains the divergence in investment homeownership seen in the data. This divergence is amplified when subprime borrowers are subject to lax credit conditions prior to a financial shock or when the nominal interest rate is constrained at the zero lower bound (ZLB). An expansionary monetary policy helps bridge this gap across borrowers.

Villains or scapegoats? The role of subprime borrowers in driving the U.S. housing boom

An expansion in mortgage credit to subprime borrowers is widely believed to have been a principal driver of the 2002-2006 U.S. house price boom. By contrast, this paper documents a robust, negative correlation between the growth in the share of purchase mortgages to subprime borrowers and house price appreciation at the county-level during this time. Using two different instrumental variables approaches, we also establish causal evidence that house price appreciation lowered the share of purchase loans to subprime borrowers. Further analysis using micro-level credit bureau data shows that higher house price appreciation reduced the transition rate into first-time homeownership for subprime individuals. Finally, the paper documents that subprime borrowers did not play a significant role in the increased speculative activity and underwriting fraud that the literature has linked directly to the housing boom. Taken together, these results are more consistent with subprime borrowers being priced out of housing boom markets rather than inflating prices in those markets.

COVID-19 and Auto Loan Origination Trends

We study the impact of the COVID-19 crisis on auto loan origination activity during 2020. We focus on the dynamic impact of the crisis across lending channels, Equifax Risk Score (Risk Score) segments, and relevant geographic characteristics such as urbanization rate. We measure a significant drop in auto loan originations in March‒April followed by a near rebound in May‒June. Originations remain slightly depressed until October and fall again in November‒December. We document the largest drop and the smallest rebound in the subprime segment. We do not find any suggestive evidence that used car loan originations exhibited patterns significantly different from the rest of the market. We also document a more pronounced impact in the Northeast and the Pacific, seemingly influenced by the higher urbanization rate in these regions. Bank-financed originations experienced the largest drop and the smallest rebound, thus resulting in a loss of market share and continuing a 10-year trend of bank share loss in auto lending. We find that the drop in auto loans originated by banks was particularly significant among subprime borrowers. The impact of the COVID-19 crisis across origination channels contrasts with the experience during the Great Recession when banks contributed the largest support to the auto loan origination segment during periods of stress and finance company-originated auto loans were depressed.

The Impact of Crisis-Period Interest Rate Declines on Distressed Borrowers

We measure the causal impact of reductions in benchmark interest rates on the renegotiation and performance of distressed loans, using 2000s subprime adjustable-rate mortgages as a laboratory. Subprime borrowers treated with larger benchmark Libor rate declines benefited from increased debt-renegotiation and lower debt-service payments. The estimated effects are similar across both current borrowers and those in default. Renegotiation of mortgage debt also reduced foreclosures over the longer term. However, following debt-renegotiation, surviving treated borrowers re-entered and lingered in serious delinquency. Findings suggest that while policy may effect reductions in benchmark rates and spur debt-renegotiation, such interventions may not lead to longer-run curative outcomes.

Housing Wealth Reallocation between Subprime and Prime Borrowers during Recessions

The Survey of Consumer Finances indicates that, unlike subprime borrowers, prime borrowers are more likely to own investment homes during recessions than during recoveries. Drawing on this empirical fact, we present and estimate a dynamic stochastic general equilibrium model that distinguishes between borrowers through their credit access. We find that the relative ease of credit access among borrowers explains the divergence in investment homeownership seen in the data. This divergence is amplified when subprime borrowers are subject to lax credit conditions prior to a financial shock or when the nominal interest rate is constrained at the zero lower bound. An expansionary monetary policy helps bridge this gap across borrowers.

Bankcard performance during the Great Recession

This paper investigates factors associated with high credit card loss rates during the period 2008–11 associated with the Great Recession. We examine default at the individual consumer (as opposed to the account) level. Using data available from consumer credit records for the period March 2000–March 2008, we develop and estimate segment-level logistic regression equations to predict default outcomes through 2013. The model fits the data very well in-sample but fails to accurately predict defaults out-of-sample for the Great Recession. On the one hand, default rates throughout the Great Recession are markedly underpredicted for prime consumers, especially those granted large credit limits during the credit expansion that characterized 2000–2008. On the other hand, default rates are overpredicted for subprime borrowers, indicating that lenders’ losses during the Great Recession would have been significantly larger if the repayment performance of subprime borrowers had aligned with extrapolation based on historical performance data.

Optimal Collateralized Contracts

We examine the role of collateral in a dynamic model of optimal credit contracts in which a borrower values both housing and nonhousing consumption. The borrower’s private information about his income is the only friction. An optimal contract is collateralized when in some state, some portion of the borrower’s net worth is forfeited to the lender. We show that optimal contracts are always collateralized. The total value of forfeited assets is decreasing in income, highlighting the role of collateral as a deterrent to manipulation. Some assets—those that generate consumable services—will necessarily be collateralized, while others may not be. Endogenous default arises when the borrower’s initial wealth is low, as with subprime borrowers, and/or his future earnings are highly variable. (JEL D82, D86, G21, G51)

Does Increasing Access to Formal Credit Reduce Payday Borrowing?

The use of high cost “payday loans” among subprime borrowers has generated substantial concern among policymakers. This paper provides the first evidence of substitution between “alternative” and “traditional” credit by exploiting an unexpected positive shock to traditional credit access among payday loan borrowers: the removal of a Chapter 7 bankruptcy flag. We find that the removal of a bankruptcy flag on a credit report results in a sharp increase in access to traditional credit and raises credit scores, credit card limits, and approval rates. However, despite meaningful increases in access to traditional credit, we find no evidence that borrowers reduce their use of payday loans, and our confidence intervals allow us to rule out even very small reductions in payday borrowing. Furthermore, we find evidence that flag removals increase the use of other alternative credit products such as online subprime installment loans. These results indicate that marginally improving access to less expensive formal credit is insufficient to meaningfully shift borrowers away from high cost subprime products. We discuss likely explanations for this including increased marketing of subprime products associated with the flag removal, the imperfect substitutability between cash and credit for low income borrowers, and an insufficiency in the size of the increase in credit access associated with the flag removal. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Villains or Scapegoats? The Role of Subprime Borrowers in Driving the U.S. Housing Boom

An expansion in mortgage credit to subprime borrowers is widely believed to have been a principal driver of the 2002?06 U.S. house price boom. Contrary to this belief, we show that the house price and subprime booms occurred in different places. Counties with the largest home price appreciation between 2002 and 2006 had the largest declines in the share of purchase mortgages to subprime borrowers. We also document that the expansion in speculative mortgage products and underwriting fraud was not concentrated among subprime borrowers.

FinTech Marketplace Lending, Default Risk, and the Business Cycle

This paper explores default in the FinTech marketplace lending market using a dataset of both extensive credit and soft information for borrowers from the largest marketplace lender in the United States. I find that both macro and regional economic conditions play a role in consumer default and should be taken into consideration when assessing credit risk. I show that lenders operating in this market increasingly focus on subprime borrowers, whose default rates are more sensitive to macro and regional economic conditions than those of prime borrowers. Based on estimates from a duration model, I provide counterfactual analyses of what default rates and the associated total losses would look like in different economic scenarios. In the case of a recession, the losses would be 37 percent higher than in the case of an expansion. For the same volume of loans in the recession, doubling the subprime share would lead to an additional 7.5 percent increase in losses.

Unequal and Unstable: Income Inequality and Bank Risk

We provide evidence that regions in the U.S. with higher income inequality tend to have a riskier banking sector. However, not all banks are more risky, as reflected in a higher dispersion of bank risk. We show how a model based on risk-shifting incentives where banks channel insured deposits into subprime loans can account for both findings. In equilibrium, a competition to risk-shift emerges, leading to a subprime lending boom in which loans to high-risk borrowers carry negative NPVs. Some banks engage in risk-shifting by lending to high-risk subprime borrowers, while the rest specialize in lending to low-risk prime borrowers.

Subprime borrowers, securitization and the transmission of business cycles

AbstractA growing literature (e.g., Jaffee et al. 2009, Acharya and Schnabl 2009) argues that securitization improves financial stability if the securitized assets are held by capital market participants, rather than financial intermediaries. I construct a quantitative macroeconomic model with a novel specification for mortgage‐backed securities (MBS) to evaluate this claim. My findings suggest that the existence of the securitization market stabilizes the economy under the condition that financial intermediaries do not engage in the acquisition of securitized assets. In the presence of large negative housing preference shocks, the drop in output in the first year after the shock is halved if subprime MBS are purchased by non‐financial agents rather than held by banks.