Collaborative Research: Predatory Lending, Predatory Borrowing, and the Mortgage Crisis: Evidence from Loan-Level Data from a Large Bank

Columbia University, New York NY

Investigators

Abstract

Developments in the U.S. housing and mortgage debt markets since 2006 are the focus of anxiety and efforts among regulators, researchers, and market participants. This project aims to uncover the causes of, and the paths to, the mortgage crisis from the experience of a major mortgage bank. The bank the PI's study is an ideal place for the study because it provides a epresentative and yet amplified version of the boom-and-bust cycle that the national subprime sector has seen during the past decade. First, the bank was one of the nations ten largest mortgage banks in 2006 and was one of the fastest growing. Second,it specialized in the reduced- and no-documentation loans that has been central to the mortgage crisis, while also providing full-documentation loans. Third, the insolvency of the bank in 2008 was one of the largest bank failures in United States history. Lastly, the borrowers and properties underlying the bank's mortgage loans have fair representations from all the states, and therefore, lessons from the bank's failure have general implications. The project will be based on a new and proprietary data set that represents the most comprehensive, detailed, and disaggregated data sets used in the mortgage loan literature. We have obtained data on more than 700,000 loans made by the bank that were outstanding at any time between January 2004 and March 2008. The dataset includes all the detailed information that the lender collected for loan origination, including loan pricing and other contractual terms, and the borrowers demographic and economic conditions. In addition, the dataset includes detailed information about the loan performance in each month during the sample period, including the payment amount and the loans prepayment, delinquency and foreclosure status. Finally, using the address information in the dataset, the PI's are able to match individual loans to community attributes such as school quality, housing price indices, and business opportunities in narrow localities. The analysis of this unique dataset will include several steps. First, the PI's plan to conduct a descriptive analysis of the evolution of the structuring and performance of loans originated by the bank during the sample period. Second, they will perform a predictive analysis of default, and analyze the differences in the determinants of default among subsamples partitioned by loan types and borrower characteristics. They will also analyze the time series variations of such. Most importantly, they will identify the two-sided moral hazard problems in the mortgage market. On the one hand, there is the possibility of predatory lending, where the lender misleads an uninformed borrower into a high-cost loan when the latter could qualify for a lower-cost alternative; or the lender makes a loan that will cause expected harm to the borrower. On the other hand, predatory borrowing points to the possibility that borrowers falsify or hide unfavorable information in their loan applications. The intellectual merit of the proposed activity: Using a unique dataset, the proposed study will help settle the controversies over lending practice, most importantly the presence of discrimination in loan pricing and predatory lending. The research also aims at identifying key factors in causing the mortgage crisis by assessing the relative importance of irresponsible lending and irresponsible borrowing. The novel empirical design to separately identify the opportunistic behavior of lenders and borrowers will also represent a contribution to the empirical literature on two-sided information asymmetry and moral hazard. The broader impacts resulting from the proposed activity: By conducting an inside study of a major mortgage bank through its expansion and failure, this work will provide a better understanding of the causes of the recent mortgage crisis. The findings will provide useful reference for policy makers who work on laws and rules in order to prevent a crisis of this scale from recurring. The lessons from this study will also benefit banks and financial institutions for better practices in loan provision and securitization, risk management, and monitoring.