Financial Constraints, Inflated Home Prices, and Borrower Default during the Real-Estate Boom

Abstract:     
During the housing boom, many subprime home buyers were not able to make a mortgage down payment and therefore were at risk of being rationed from the market. To resolve the issue, some buyers, sellers and intermediaries articially expanded the scope of transactions by including items that cannot be collateralized. As a result, observed house prices were higher and mortgages larger, ultimately relaxing buyers' financial constraints. I estimate that between 2005 and 2008, up to 16% of highly leveraged (> 95% loan-to-value) transactions in Cook County, Illinois were inflated (with prices higher by 6% to 15%). Inflated transactions are more likely in low-income neighborhoods and when intermediaries have a high stake in the transaction. Although borrowers were twice as likely to default, their mortgage rates were not higher.

Keywords: Manipulation, Fraud, Moral Hazard, Agency Costs,Delegated Monitoring, Mortgage, Collateral, Appraisal, Valuation, Debt, Bank, Financial Intermediation, Cheating, Mortgage, Subprime, Lending, Capital Market, Real-Estate, Forensic Economics, Overpaying, Fannie Mae, Loan buyers, Borrower, Lender

JEL Classifications: D12, D18, G21, L85

Working Paper Series