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The Law & Economics of Subprime Lending


Todd J. Zywicki


George Mason University School of Law; PERC - Property and Environment Research Center

Joseph Adamson


George Mason University - Mercatus Center

December 4, 2008

George Mason Law & Economics Research Paper No. 08-17
University of Colorado Law Review, Vol. 80, No. 1, Winter 2009, pp. 1-86

Abstract:     
The collapse of the subprime mortgage market has led to calls for greater regulation to protect homeowners from unwittingly trapping themselves in high-cost loans that lead to foreclosure, bankruptcy, or other financial problems. Weighed against this catastrophe are the benefits that have accrued to millions of American families who have been able to become homeowners who otherwise would not have access to mortgage credit. Although the bust of the subprime mortgage market has resulted in high levels of foreclosures and even problems on Wall Street, the boom generated unprecedented levels of homeownership, especially among young, low-income, and minority borrowers, putting them on a road to economic comfort and stability. Sensible regulation of subprime lending should seek to curb abusive practices while preserving these benefits.

This article reviews the theories and evidence regarding the causes of the turmoil in the subprime market. It then turns to the question of the rising foreclosures in that market in order to understand the causes of rising foreclosures. In particular, we examine the competing models of home foreclosures that have been developed in the economics literature - the distress model and the option model. Establishing a correct model of the causes of foreclosure in the subprime market is necessary for sensible and effective policy responses to the problem. Finally, we review some of the policy initiatives that have been suggested in response to the crisis in the subprime market. Because new regulatory interventions will have costs as well as benefits, until the causes of the market's problems are better understood it may be that the best policy in the short-term is to do little until well-tailored regulatory approaches are available.

Number of Pages in PDF File: 87

Keywords: bankruptcy, consumer credit, distress model, foreclosure, homeownership, lending practices, mortgages, option model, regulation, subprime

JEL Classification: D10, D14, D18, K35

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Date posted: March 16, 2008 ; Last revised: December 5, 2008

Suggested Citation

Zywicki, Todd J. and Adamson, Joseph, The Law & Economics of Subprime Lending (December 4, 2008). George Mason Law & Economics Research Paper No. 08-17; University of Colorado Law Review, Vol. 80, No. 1, Winter 2009, pp. 1-86. Available at SSRN: http://ssrn.com/abstract=1106907

Contact Information

Todd J. Zywicki (Contact Author)
George Mason University School of Law ( email )
3301 Fairfax Drive
Arlington, VA 22201
United States
703-993-8091 (Phone)
703-993-8088 (Fax)

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PERC - Property and Environment Research Center
2048 Analysis Drive
Suite A
Bozeman, MT 59718
United States

Joseph Adamson
George Mason University - Mercatus Center ( email )
3434 Washington Blvd., 4th Floor
Arlington, VA 22201
United States
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