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Understanding the Subprime Mortgage Crisis
Yuliya Demyanyk, Otto Van Hemert∗ This Draft: December 5, 2008 First Draft: October 9, 2007

Abstract Using loan-level data, we analyze the quality of subprime mortgage loans by adjusting their performance for differences in borrower characteristics, loan characteristics, and macroeconomic conditions. We find that the quality of loans deteriorated forsix consecutive years before the crisis and that securitizers were, to some extent, aware of it. We provide evidence that the rise and fall of the subprime mortgage market follows a classic lending boom-bust scenario, in which unsustainable growth leads to the collapse of the market. Problems could have been detected long before the crisis, but they were masked by high house price appreciationbetween 2003 and 2005.

∗ Demyanyk: Banking Supervision and Regulation, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166, Van Hemert: Department of Finance, Stern School of Business, New York University, 44 W. 4th Street, New York, NY 10012, The authors would like to thank Cliff Asness, Joost Driessen, William Emmons, EmreErgungor, Scott Frame, Xavier Gabaix, Dwight Jaffee, Ralph Koijen, Andreas Lehnert, Andrew Leventis, Chris Mayer, Andrew Meyer, Toby Moskowitz, Lasse Pedersen, Robert Rasche, Matt Richardson, Stefano Risa, Bent Sorensen, Matthew Spiegel, Stijn Van Nieuwerburgh, James Vickery, Jeff Wurgler, anonymous referees, and seminar participants at the Federal Reserve Bank of St. Louis; the Florida AtlanticUniversity; the International Monetary Fund; the second New York Fed—Princeton liquidity conference; Lehman Brothers; the Baruch-Columbia-Stern real estate conference; NYU Stern Research Day; Capula Investment Management; AQR Capital Management,; the Conference on the Subprime Crisis and Economic Outlook in 2008 at Lehman Brothers; Freddie Mac; Federal Deposit and Insurance Corporation (FDIC); U.S.Securities and Exchange Comission (SEC); Office of Federal Housing Enterprise Oversight (OFHEO); Board of Governors of the Federal Reserve System; Carnegie Mellon University; Baruch; University of British Columbia, University of Amsterdam; the 44th Annual Conference on Bank Structure and Competition at the Federal Reserve Bank of Chicago; the Federal Reserve Research and Policy Activities; SixthColloquium on Derivatives, Risk-Return and Subprime, Lucca, Italy; and the Federal Reserve Bank of Cleveland; The views expressed are those of the authors and do not necessarily reflect the official positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System.

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The subprime mortgage crisis of 2007was characterized by an unusually large fraction of subprime mortgages originated in 2006 and 2007 becoming delinquent or in foreclosure only months later. The crisis spurred massive media attention; many different explanations of the crisis have been proffered. The goal of this paper is to answer the question: “What do the data tell us about the possible causes of the crisis?” To this end we use aloan-level database containing information on about half of all U.S. subprime mortgages originated between 2001 and 2007. The relatively poor performance of vintage 2006 and 2007 loans is illustrated in Figure 1 (left panel). At every mortgage loan age, loans originated in 2006 and 2007 show a much higher delinquency rate than loans originated in earlier years at the same ages. Figure 1: Actual andAdjusted Delinquency Rate
The figure shows the age pattern in the actual (left panel) and adjusted (right panel) delinquency rate for the different vintage years. The delinquency rate is defined as the cumulative fraction of loans that were past due 60 or more days, in foreclosure, real-estate owned, or defaulted, at or before a given age. The adjusted delinquency rate is obtained by adjusting the...