bad borrowers or bad loans?

The right-vs-left contest over the credit crisis seems to have crystallized to some extent into whether the crisis was the outcome of regulators forcing banks to loan to bad borrowers (the right-wing version) or of under-regulated banks and financial institutions peddling bad mortgage products and then aggregating them into un-valuable derivatives that “clogged” the credit system (ahh, such metaphors!).

A UNC researchers has produced a rather interesting report (PPT format) suggesting that it is more the latter than the former: “bad” borrowers with “good” loans didn’t default at a particularly high rate; it was “bad” borrowers with “bad” loans who did so.

The implications of this question are vast. If the problem is forcing banks to adopt bad borrowers, the policy implication is to deregulate, repeal the CRA, and so on, which would clearly have major effects on systematic wealth inequality over time. If the problem is the proliferation of weird mortgage-based financial products and instruments, the implication is to re-regulate markets, which would likely sacrifice some degree of growth for greater stability and equality.

Author: andrewperrin

University of North Carolina, Chapel Hill

One thought on “bad borrowers or bad loans?”

  1. Not to put too fine a point on things, but we also find that “good” borrowers who have “bad” loans default at a rate comparable to borrowers with low credit scores who have sub-prime mortgages. This further emphasizes the point that it is the product and not the borrower that most strongly predicts default.

    On a related point, in another study we also find that a homeowner’s risk of default increases significantly as the number of neighborhood foreclosures increases, even when controlling for all the things that you would usually expect to predict default (credit score, income, debt, etc). Simply being in a neighborhood where there are a lot of foreclosures basically triples your risk of mortgage default. So policies that can prevent foreclosure by switching people from sub-prime to prime loans have a lot of benefits, not only for the homeowners but for the neighborhoods in general.

    I think the biggest question this all raises is whether we need to re-think the underwriting criteria for credit.


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