While the data seem to suggest that lenders did the right thing by tightening standards and increasing denials...the ongoing financial crisis suggests that they did not tighten them enough.Mortgages ; Bank loans

Carlos Garriga

English

Research Papers in Economics

Economic SYNOPSES
short essays and reports on the economic issues of the day
2009 ￿ Number 23
T
he mortgage crisis that exploded in the summer of
2007 made a few major issues apparent: First, the
value of the U.S. housing stock was substantially
lower than most believed. Second, the number of nonper-
forming loans was much greater than lenders had estimat-
ed. Third, the poor performance of real estate loans had a
dramatic effect on banks’ balance sheets, exposing them to
serious solvency issues. These events have had major neg-
ative ramifications, both in the financial markets at home
and around the world. Many have blamed banks for keep-
ing lending standards too loose. But how loose were they?
Many dimensions could be used to analyze the evolu-
tion of credit standards for mortgage loans. A very simple
statistic to compute is the percentage of loan denials in the
total pool of mortgage applications. For example, an increase
in the denial rate could be interpreted as mortgage brokers
and banks tightening the lending standards.
Since 1999 the Home Mortgage Disclosure Act (HMDA)
has registered data regarding mortgage applications, denials,
and originations by type of purchase in the United States.
The chart shows the evolution of the fraction of loan denials
relative to applications by loan type. In addition, the chart
includes house price appreciation as measured by the
Case-Shiller Home Price Index. The
Case-Shiller Index is normalized to
match the scale of the denial rates.
The chart suggests some interesting
observations: First, according to the
Case-Shiller data, national house
prices nearly doubled between 1999
and 2006. That figure represents a
roughly 10 percentage point annual
appreciation (not adjusted for infla-
tion) for the period and close to 15
percentage points during the peak of
the bubble. Second, after the economic
recession began in 2001 the index for
total loan denial rates was at its lowest
point between 2002 and 2003.
Interestingly, in 2004, denials
increased by 33 percentage points rela-
tive to their 2002 low, all the way up to 75 percentage points
for 2007 relative to the 2002 low point. This increase sug-
gests that credit started to tighten well before 2007. Most
of the increase in total denials came via refinancing loans—
not through new home purchases or special loan programs
funded by the Federal Housing Administration (FHA) or
the Veterans Administration (VA). This is consistent with
the fact that around 2003 the flow of new home buyers was
already very small and most new loans came via refinancing
and equity extraction. The rapid increase in denials sug-
gests two intertwined points: One, lenders were concerned
with the risk worthiness of borrowers at all levels, and two,
homeowners were continuing to overvalue their homes.
Lending Standards in Mortgage Markets
Carlos Garriga, Senior Economist
While the data seem to suggest 
that lenders did the right thing 
by tightening standards and 
increasing denials...the ongoing 
financial crisis suggests that they 
did not tighten them enough.
Mortgage Denial Rates by Loan Type
0.45
0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Denials Re•nance
Denials Conventional
Denials FHA and VA
Denials Total
Case-Shiller House Price IndexWhile the HMDA data seem to suggest that lenders
did the right thing by tightening standards and increasing
denials, the ongoing financial crisis and the historically high
level of delinquencies and foreclosures seem to suggest that
after loosening the reins so greatly, they neither tightened
them enough nor did they act quickly enough. ￿
Economic SYNOPSES Federal Reserve Bank of St. Louis 2
research.stlouisfed.org
Posted on May 6, 2009
Views expressed do not necessarily reflect official positions of the Federal Reserve System.

Lending standards in mortgage markets

http://research.stlouisfed.org/publications/es/09/ES0923.pdf

Lending standards in mortgage markets

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