Understanding the subprime crisis

This is apparently the most downloaded economics (SSRN) paper on subprime. Van Hemert is a re-tooled theoretical physicist :-)

Understanding the Subprime Mortgage Crisis

YULIYA DEMYANYK
Federal Reserve Bank of St. Louis - Banking Supervision and Regulation

OTTO VAN HEMERT
New York University - Department of Finance

December 10, 2007


Abstract:
Utilizing loan-level data, we analyze the quality of subprime loans by adjusting their performance for differences in borrower characteristics, loan characteristics, and economic circumstances. We find that during the explosive growth of the subprime market in 2001-2006 the quality of loans monotonically deteriorated and underwriting criteria loosened. In this respect, the rise and fall of the subprime market resembles a classic lending boom-bust scenario, in which unsustainable growth leads to the collapse of the market. We show that the problems in the subprime market were imminent long before the crisis in 2007, securitizers were to some extent aware of it, but a high house price appreciation in 2003-2005 masked the true riskiness of subprime mortgages.