The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis*

Abstract

We conduct a within-county analysis using detailed zip code level data to document new findings regarding the origins of the biggest financial crisis since the Great Depression. The recent sharp increase in mortgage defaults is significantly amplified in subprime zip codes, or zip codes with a disproportionately large share of subprime borrowers as of 1996. Prior to the default crisis, these subprime zip codes experience an unprecedented relative growth in mortgage credit. The expansion in mortgage credit from 2002 to 2005 to subprime zip codes occurs despite sharply declining relative (and in some cases absolute) income growth in these neighborhoods. In fact, 2002 to 2005 is the only period in the last eighteen years when income and mortgage credit growth are negatively correlated. We show that the expansion in mortgage credit to subprime zip codes and its dissociation from income growth is closely correlated with the increase in securitization of subprime mortgages. Finally, we show that all of our key findings hold in markets with very elastic housing supply that have low house price growth during the credit expansion years.