Role of Subprime in Housing Boom Exaggerated: St. Louis Fed

The role subprime lending played in the creation of the nation’s housing boom has most likely been overstated, according to a recent analysis released this week from the Federal Reserve Bank of St. Louis. In fact, between 2001 and 2006, the number of terminated subprime purchase-money loans — those used to purchase rather than refinance a house —  outweighed the estimated number of first-time-homebuyers with subprime mortgages. According to the analysis, many subprime borrowers may have intended to make a quick exit from subprime loans — using the loans as “bridge financing” to speculate on house prices and then sell for a profit after values increased. Loans originated between 2001 and 2006 generally lasted less than three years, according to the report. About half the loans exited the market through pre-payment or default within the first two years of origination and nearly 80 percent did so within three years of origination. For loans originated when house prices appreciated the most, terminations were dominated by prepayments. When the housing market slowed, terminations were mostly in the form of defaults. Yuliya Demyanyk, a senior research economist with the Federal Reserve Bank of Cleveland and author of the subprime report, said her findings are in line with an earlier study that found the housing crisis — the unusually high default rates among 2006 and 2007 — did not occur because more recent loans were in some respects much worse than all loans that originated earlier. Demyanyk said the quality of loans was declining for at least six consecutive years before the housing market crashed. “Subprime mortgages were very risky all along,” she said. “The extent of their risk, however, was hidden by the rapid appreciation in house prices, allowing terimination of the mortgage by refinancing or pre-payment. When pre-payment became to costly — with zero or negative equity in the house increasing the closing costs of refinancings — defaults took their place.” The study also found that subprime lending did not increase homeownership, as subprime activists believed it could. The number of defaults in a sample of subprime purchase-money mortgages within two years of origination is almost equal to the estimated number of first-time homebuyers who held subprime mortgages, the analysis found. And if the data for the rest of the market were available, Demyanyk said “the number of defaults would no doubt be even greater.” Write to Kelly Curran at kelly.curran@housingwire.com. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.