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The Housing Finance Revolution: Implications for the Subprime Market

Working paper #585
Richard K. Green and Susan M. Wachter

The availability and cost of housing finance are critical determinants of how well housing markets function around the world. Changes in housing finance mechanisms, along with the unprecedented decline in interest rates are major factors in the global house price boom of the past decade. In many countries, historically, housing finance relied on funds provided by local lenders, typically depository institutions. With the development of capital markets and mortgage securitization, however, funding for housing comes from a much broader set of investors, including international investors. This paper examines the institutional changes in housing finance in industrialized countries over the past 30 years, including securitization and new types of mortgage contracts. The current US crisis is centered in the private label securitization subprime market. Among the lessons learned from the subprime meltdown is that portfolio diversification cannot substitute for underwriting and pricing of risk.

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