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Why are aggressive mortgage products bad for the housing market?

Working paper #796
Andrew Davidson, Alex Levin, Andrey D. Pavlov and Susan M. Wachter

In this paper we identify the relationship of the pricing of residential mortgage lending products to their market share during the run up to the financial crisis of 2007. We then use this relationship to decompose the total impact of nontraditional mortgage products on house price declines during the crisis into impact due to their pricing and due to other characteristics. Using alternative measures of mortgage pricing, we document that pricing has a statistically significant but small impact on the difference in market share of nontraditional mortgage products by State. We further document that factors which lead to the increased market share of nontraditional products other than pricing are likely responsible for the impact of those products on the house price declines during the crisis. Our findings imply that going forward underwriting standards and other characteristics of nontraditional mortgage products should be monitored and regulated.

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