A recent analysis from the Federal Reserve Bank of St. Louis suggests the number of subprime mortgage loans terminated between 2001 and 2006 outweighed the number of estimated first-time home buyers who sought subprime mortgages, debunking the idea that subprime mortgages encouraged homeownership among people who otherwise could not afford a home.
The analysis, which appears in the March/April issue of the St. Louis Fed's bimonthly journal, Review, was conducted by Yuliya S. Demyanyk, a senior research economist with the Federal Reserve Bank of Cleveland. The data analysis for this article was conducted when she was an economist in the Banking supervision and regulation division of the Federal Reserve Bank of St. Louis.
Demyanyk focused on whether borrowers intended to keep their subprime mortgages long enough to substantiate an increase in homeownership or planned a quick exit strategy at origination, using subprime loans as bridge financing to speculate on house prices. Her research showed that loans originated between 2001 and 2006 generally lasted less than three years. Almost half the loans exited the market either through prepayment or default within the first two years of origination, and about 80% did so within three years of origination.
Demyanyk says her results are consistent with an earlier study that showed the unusually high default rates among loans originated in immediate pre-crisis years did not occur only months from origination because those subprime mortgages were much worse than all loans that originated earlier. The quality of loans was deteriorating for at least six consecutive years before the crisis occurred.
‘Subprime mortgages were very risky all along,’ she says. ‘The extent of their risk, however, was hidden by the rapid appreciation in house prices, allowing termination of the mortgage by refinancing or pre-payment. When prepayment became costly – with zero or negative equity in the house increasing the closing costs of refinancing – defaults took their place.’
To View Demyanyk's paper, visit the St. Louis Fed's Web site.
SOURCE: St. Louis Fed