Arnold Kling  

Local Knowledge and Mortgage Lending

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A Controversial Issue Resolved... My Grad School Entering Class...

Kristle Romero Cortes writes (abstract)


This paper shows that mortgage lenders with a physical branch near the property being financed have better information about home-price fundamentals than non-local lenders. During the real estate run-up from 2002-06, home price growth negatively correlates with the share of loans made by local lenders, namely lenders with a branch in the respective county. Moreover, home prices fell less from 2006-09 in areas where more of the loans were made by local lenders. California foreclosure rates during the crisis are negatively correlated with local lending during the run-up. A 1 standard deviation increase in local loans is associated with 5 fewer foreclosures for every one thousand houses. When local lenders retain loans for their portfolio rather than securitizing, the results for both home price growth and foreclosures are even stronger.

And yet, the political consensus is that we need to revive securitization. Thanks to Peter Van Doren for the pointer.


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COMMENTS (4 to date)
MG writes:

We should value both: local knowledge as a comparative advantage, and securitization as a form of trade. Local knowledge should yield better performing mortgages, and securitization should facilitate their trade -- to those who want to access this risk and away from those who are too exposed to it (however adeptly proced it is.) The underwriting -> securitization channel can get gummed up by all the same perversions that can gum up trade flows: non-market susbsidies or disincentives affecting the production or demand of the goods, conflicts of interest, fraud, etc. Why don't we work on fixing the latter.

Thomas DeMeo writes:

Forget the political consensus; why is there any market demand for these securities?

Let's say you are a local bank and you write a mortgage. If you know you are able to unload the risk, won't that affect your behavior? Can anyone speak to how the market can hold the mortgage originators accountable for the quality of their mortgages, when they probably won't go bad until the next housing recession?

Ted Craig writes:

How are local branches and securitization not compatible?

JeffM writes:

The primary benefit from securitization from a prudent lender's viewpoint is diversification of risk. A local lender may very well have better information about local conditions, but a portfolio of loans highly concentrated in one geographic locale represents risk no matter how skilled the lender.

Now the same benefit can (at least in principle) be realized if the lender is big enough to have a local presence and underwriting skills in every major market of the US. Hello, too big to fail?

There are other benefits from securitization (such as liquidity). The pertinent question about securitization is how much (if any) right of recourse against the initial lender is needed to prevent moral hazard. (The moral hazard, although real, is much less than is commonly supposed given the warranty right to return loans to the original lender for misrepresentation or errors of documentation.)

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