Lending Standards in the Subprime Mortgage Market

The combination of historically low interest and active government to extend credit who could walk and talk, the subprime mortgage market experienced rapid growth during the period 2000-2006. A recent International Monetary Fund study by Dell'Ariccia, Igan and Laeven present some compelling findings about the fuel of this growth. Subprime mortgage originations tripled over this period reaching $600 billion in 2006. As a percentage of all mortgage originations, subprime increased from 9% to 20% over this period. In 2006, the size of the subprime market was approximately $1.3 trillion. They also examine the relationship between credit standards and mortgage lending growth. The following conclusions emerge from their analysis: (1) lending standards declined more in areas where the growth in lending was highest; (2) lower leanding were associated with areas that experienced faster house price appreciation; (3) lending standards declined in areas where large and aggressive lenders entered the market; (4) lending standards declined more in regions where a larger proportion of the lender's loan portfolio is sold to third parties (e.g., securitization); and (5) the deterioration of lending standards was more pronounced in the subprime mortgage market.