Journal of Credit Risk

Consumer risk appetite, the credit cycle and the housing bubble

Joseph Breeden and José Canals-Cerdá

  • Analyzing a large US mortgage dataset with a discrete time survival model shows a significant component of the credit cycle that cannot be explained by origination factors available to lenders.
  • The unexplained credit cycle does correlate well to changes in consumer loan demand, suggesting the presence of a cycle in consumer risk appetite.
  • This unexplained credit cycle also correlates to measures of attractiveness of mortgage loans from a consumer perspective, reinforcing the consumer risk appetite or macroeconomic adverse selection interpretation.

In this paper, we explore the role of consumer risk appetite in the initiation of credit cycles and as an early trigger of the US mortgage crisis. We analyze a panel data set of mortgages originated between 2000 and 2009 and follow their performance up to 2014. After controlling for all of 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 with 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.

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