Consumer Risk Appetite, the Credit Cycle, and the Housing Bubble

34 Pages Posted: 22 Feb 2016

See all articles by Joseph Breeden

Joseph Breeden

Prescient Models LLC

José J. Canals-Cerda

Federal Reserve Bank of Philadelphia

Multiple version iconThere are 2 versions of this paper

Date Written: 2016-02-18

Abstract

We explore the role of consumer risk appetite in the initiation of credit cycles and as an early trigger of the U.S. mortgage crisis. We analyze a panel data set of mortgages originated between the years 2000 and 2009 and follow their performance up to 2014. After controlling for all the usual observable effects, we show that a strong residual vintage effect remains. This vintage effect correlates well with consumer mortgage demand, as measured by the Federal Reserve Board’s Senior Loan Officer Opinion Survey, and correlates well to changes in mortgage pricing at the time the loan was originated. Our findings are consistent with an economic environment in which the incentives of low-risk consumers to obtain a mortgage decrease when the cost of obtaining a loan rises. As a result, mortgage originators generate mortgages from a pool of consumers with changing risk profiles over the credit cycle. The unobservable component of the shift in credit risk, relative to the usual underwriting criteria, may be thought of as macroeconomic adverse selection.

Keywords: Credit risk, Credit cycle, Mortgages, Lending standards, Financial crisis

JEL Classification: G20, G21, G32

Suggested Citation

Breeden, Joseph and Canals-Cerda, José J., Consumer Risk Appetite, the Credit Cycle, and the Housing Bubble (2016-02-18). FRB of Philadelphia Working Paper No. 16-5. Available at SSRN: https://ssrn.com/abstract=2735282

Joseph Breeden

Prescient Models LLC ( email )

300 Catron St.
Ste. B
Santa Fe, NM 87501
United States

José J. Canals-Cerda (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States
(215) 574-4127 (Phone)
(215) 574-4146 (Fax)

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