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Discussion. Credit Boom and Lending Standard: Evidence from Subprime Mortgage Lending. Satyajit Chatterjee

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(1)

Discussion

Credit Boom and Lending Standard: Evidence from Subprime Mortgage Lending

Satyajit Chatterjee

Research Department Federal Reserve Bank of Philadelphia

(2)

OBJECTIVES AND FINDINGS

Consensus that the source of the current subprime mortgage crisis is increasingly lax lending standards

Why did lending standards decline?

Rapid expansion of credit caused lower lending standards Increase in the number of lenders caused lower lending standards

(3)

OBJECTIVES AND FINDINGS

Consensus that the source of the current subprime mortgage crisis is increasingly lax lending standards Why did lending standards decline?

Rapid expansion of credit caused lower lending standards Increase in the number of lenders caused lower lending standards

(4)

OBJECTIVES AND FINDINGS

Consensus that the source of the current subprime mortgage crisis is increasingly lax lending standards Why did lending standards decline?

Rapid expansion of credit caused lower lending standards

Increase in the number of lenders caused lower lending standards

(5)

OBJECTIVES AND FINDINGS

Consensus that the source of the current subprime mortgage crisis is increasingly lax lending standards Why did lending standards decline?

Rapid expansion of credit caused lower lending standards Increase in the number of lenders caused lower lending standards

(6)

APPROACH

Key Idea

Use loan-level data (HMDA) for 2000 to estimate

Dj k =Xj0β+j k

Identity of lender is proxy for prime or subprime

Useβˆto predict denial rate of mortgage applications in years 2001-2006 for different metropolitan areas (MSAs) Regress prediction error (actual - predicted) on log of the number of loan applicants in the MSA and other MSA-level controls

Log of the number of applicants affects the prediction error negatively – more applicants there are, the less choosy lenders become

(7)

APPROACH

Key Idea

Use loan-level data (HMDA) for 2000 to estimate

Dj k =Xj0β+j k

Identity of lender is proxy for prime or subprime

Useβˆto predict denial rate of mortgage applications in years 2001-2006 for different metropolitan areas (MSAs) Regress prediction error (actual - predicted) on log of the number of loan applicants in the MSA and other MSA-level controls

Log of the number of applicants affects the prediction error negatively – more applicants there are, the less choosy lenders become

(8)

APPROACH

Key Idea

Use loan-level data (HMDA) for 2000 to estimate

Dj k =Xj0β+j k

Identity of lender is proxy for prime or subprime

Useβˆto predict denial rate of mortgage applications in years 2001-2006 for different metropolitan areas (MSAs)

Regress prediction error (actual - predicted) on log of the number of loan applicants in the MSA and other MSA-level controls

Log of the number of applicants affects the prediction error negatively – more applicants there are, the less choosy lenders become

(9)

APPROACH

Key Idea

Use loan-level data (HMDA) for 2000 to estimate

Dj k =Xj0β+j k

Identity of lender is proxy for prime or subprime

Useβˆto predict denial rate of mortgage applications in years 2001-2006 for different metropolitan areas (MSAs) Regress prediction error (actual - predicted) on log of the number of loan applicants in the MSA and other MSA-level controls

Log of the number of applicants affects the prediction error negatively – more applicants there are, the less choosy lenders become

(10)

APPROACH

Key Idea

Use loan-level data (HMDA) for 2000 to estimate

Dj k =Xj0β+j k

Identity of lender is proxy for prime or subprime

Useβˆto predict denial rate of mortgage applications in years 2001-2006 for different metropolitan areas (MSAs) Regress prediction error (actual - predicted) on log of the number of loan applicants in the MSA and other MSA-level controls

Log of the number of applicants affects the prediction error negatively – more applicants there are, the less choosy lenders become

(11)

COMMENTS

Contribution

Use of data reported under the Home Mortgage Disclosure Act for assessing lending standards in local housing

markets (MSAs)

Exploit variations across local housing markets to shed light on determinants of lending standards – great idea!!

(12)

COMMENTS

Contribution

Use of data reported under the Home Mortgage Disclosure Act for assessing lending standards in local housing

markets (MSAs)

Exploit variations across local housing markets to shed light on determinants of lending standards – great idea!!

(13)

COMMENTS

Main Concern

Whydid the number of applicants go up so much across all MSAs?

This question is not directly addressed in the paper because the authors focus ondifferencesacross MSAs But thinking about why the number of applicants went up suggests that the authors are ignoring causal influences running the other way – from lower denial rates to more applicants

(14)

COMMENTS

Main Concern

Whydid the number of applicants go up so much across all MSAs?

This question is not directly addressed in the paper because the authors focus ondifferencesacross MSAs

But thinking about why the number of applicants went up suggests that the authors are ignoring causal influences running the other way – from lower denial rates to more applicants

(15)

COMMENTS

Main Concern

Whydid the number of applicants go up so much across all MSAs?

This question is not directly addressed in the paper because the authors focus ondifferencesacross MSAs But thinking about why the number of applicants went up suggests that the authors are ignoring causal influences running the other way – from lower denial rates to more applicants

(16)

COMMENTS

An Alternative Story

The key event was the arrival of a cost-effective business model for making higher-risk mortgages: “originate and distribute”

This meant lower denial rates on higher-risk loans – so there were more buyers chasing homes

The resulting increase in house prices induced people to updgrade or switch from renting to owning, which

generated more applicantions for mortgages

This story explains how decline in denial rates could lead to an increase in applications and house prices

However, it is possile that the influx of these new applicants may have led to further decline in lending standards thru channels suggested by the authors

(17)

COMMENTS

An Alternative Story

The key event was the arrival of a cost-effective business model for making higher-risk mortgages: “originate and distribute”

This meant lower denial rates on higher-risk loans – so there were more buyers chasing homes

The resulting increase in house prices induced people to updgrade or switch from renting to owning, which

generated more applicantions for mortgages

This story explains how decline in denial rates could lead to an increase in applications and house prices

However, it is possile that the influx of these new applicants may have led to further decline in lending standards thru channels suggested by the authors

(18)

COMMENTS

An Alternative Story

The key event was the arrival of a cost-effective business model for making higher-risk mortgages: “originate and distribute”

This meant lower denial rates on higher-risk loans – so there were more buyers chasing homes

The resulting increase in house prices induced people to updgrade or switch from renting to owning, which

generated more applicantions for mortgages

This story explains how decline in denial rates could lead to an increase in applications and house prices

However, it is possile that the influx of these new applicants may have led to further decline in lending standards thru channels suggested by the authors

(19)

COMMENTS

An Alternative Story

The key event was the arrival of a cost-effective business model for making higher-risk mortgages: “originate and distribute”

This meant lower denial rates on higher-risk loans – so there were more buyers chasing homes

The resulting increase in house prices induced people to updgrade or switch from renting to owning, which

generated more applicantions for mortgages

This story explains how decline in denial rates could lead to an increase in applications and house prices

However, it is possile that the influx of these new applicants may have led to further decline in lending standards thru channels suggested by the authors

(20)

COMMENTS

An Alternative Story

The key event was the arrival of a cost-effective business model for making higher-risk mortgages: “originate and distribute”

This meant lower denial rates on higher-risk loans – so there were more buyers chasing homes

The resulting increase in house prices induced people to updgrade or switch from renting to owning, which

generated more applicantions for mortgages

This story explains how decline in denial rates could lead to an increase in applications and house prices

However, it is possile that the influx of these new applicants may have led to further decline in lending standards thru channels suggested by the authors

(21)

COMMENTS

Endogeneity and the IV Regression

Is the number of applicants for prime mortgages a good instrument for the number of applicants for subprime mortgages?

With decline in the subprime denial rate, homes would sell at a faster rate and if some fraction of departing owners apply forprimemortgages then applications for prime mortgages will go up as well

So, in theory, therecouldbe a causal link from subprime denial rates to the number of prime mortgage applications Suggestion: How about using number of prime mortgage applications in “far away” MSAs as the instrument?

(22)

COMMENTS

Endogeneity and the IV Regression

Is the number of applicants for prime mortgages a good instrument for the number of applicants for subprime mortgages?

With decline in the subprime denial rate, homes would sell at a faster rate and if some fraction of departing owners apply forprimemortgages then applications for prime mortgages will go up as well

So, in theory, therecouldbe a causal link from subprime denial rates to the number of prime mortgage applications Suggestion: How about using number of prime mortgage applications in “far away” MSAs as the instrument?

(23)

COMMENTS

Endogeneity and the IV Regression

Is the number of applicants for prime mortgages a good instrument for the number of applicants for subprime mortgages?

With decline in the subprime denial rate, homes would sell at a faster rate and if some fraction of departing owners apply forprimemortgages then applications for prime mortgages will go up as well

So, in theory, therecouldbe a causal link from subprime denial rates to the number of prime mortgage applications

Suggestion: How about using number of prime mortgage applications in “far away” MSAs as the instrument?

(24)

COMMENTS

Endogeneity and the IV Regression

Is the number of applicants for prime mortgages a good instrument for the number of applicants for subprime mortgages?

With decline in the subprime denial rate, homes would sell at a faster rate and if some fraction of departing owners apply forprimemortgages then applications for prime mortgages will go up as well

So, in theory, therecouldbe a causal link from subprime denial rates to the number of prime mortgage applications Suggestion: How about using number of prime mortgage applications in “far away” MSAs as the instrument?

(25)

COMMENTS

Competition and Lending Standards

In the “originate and distribute model”, incumbent mortgage lenders earn money in origination fees

All else remaining the same, lower denial rates mean more originations per lender

The additional return could have attracted new entrants So, again, in theory there could be a link between a drop in denial rates and entry of new lenders

(26)

COMMENTS

Competition and Lending Standards

In the “originate and distribute model”, incumbent mortgage lenders earn money in origination fees

All else remaining the same, lower denial rates mean more originations per lender

The additional return could have attracted new entrants So, again, in theory there could be a link between a drop in denial rates and entry of new lenders

(27)

COMMENTS

Competition and Lending Standards

In the “originate and distribute model”, incumbent mortgage lenders earn money in origination fees

All else remaining the same, lower denial rates mean more originations per lender

The additional return could have attracted new entrants

So, again, in theory there could be a link between a drop in denial rates and entry of new lenders

(28)

COMMENTS

Competition and Lending Standards

In the “originate and distribute model”, incumbent mortgage lenders earn money in origination fees

All else remaining the same, lower denial rates mean more originations per lender

The additional return could have attracted new entrants So, again, in theory there could be a link between a drop in denial rates and entry of new lenders

(29)

SUMMARY

The idea that expansion of credit leads to lax standards is plausible

Rich data set, but the regressions suffer from potential endogeneity issues

Simultaneous equation approach?

Be more specific about the exact channel via which expansion affects standards?

(30)

SUMMARY

The idea that expansion of credit leads to lax standards is plausible

Rich data set, but the regressions suffer from potential endogeneity issues

Simultaneous equation approach?

Be more specific about the exact channel via which expansion affects standards?

(31)

SUMMARY

The idea that expansion of credit leads to lax standards is plausible

Rich data set, but the regressions suffer from potential endogeneity issues

Simultaneous equation approach?

Be more specific about the exact channel via which expansion affects standards?

(32)

SUMMARY

The idea that expansion of credit leads to lax standards is plausible

Rich data set, but the regressions suffer from potential endogeneity issues

Simultaneous equation approach?

Be more specific about the exact channel via which expansion affects standards?

References

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