What went wrong with subprime loans in 2006?

Yuliya Demyanyk and Otto Van Hemert report:

We analyze the subprime mortgage crisis:
an unusually large fraction of subprime mortgages originated in 2006
being delinquent or in foreclosure only months later.  We utilize a
loan-level database, covering about half of all US subprime mortgages,
and identify two major causes.  First, over the past five years, high
loan-to-value borrowers increasingly became high-risk borrowers, in
terms of elevated delinquency and foreclosure rates.  Lenders were aware
of this and adjusted mortgage rates accordingly over time.  Second, the
below-average house price appreciation in 2006-2007 further contributed
to the crisis.

Neither point is shocking news, but the mystery deepens upon inspection.  After 2006, 2001 was the next worst performing year for mortgage repayment, a puzzling fact.  I had expected a rising crescendo of failures; why did things suddenly get so much worse when they did?  Furthermore variable rate loans and low documentation loans do not seem to worsen disproportionately in 2006, contrary to common suppositions.  The ratio of loan value to house value is a critical variable, but again there is the puzzle of why 2006 was so much worse for these loans than preceding years.  Unless you think everyone is "flipping," (not the case), falling home prices don’t stop you from repaying your loan.  Note also that lenders could see the risk of these loans worsening, and it was reflected in the rates they charged, although apparently not enough.

Addendum: Here is James Hamilton on same.


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