Changes in Buyer Composition and the Expansion of Credit During the Boom

Earlier research has suggested that distortions in the supply of mortgage credit during the run up to the 2008 financial crisis, in particular a decoupling of credit flow from income growth, may have been responsible for the rise in house prices and the subsequent collapse of the housing market. Focusing on individual mortgage transactions rather than whole zip codes, we show that the apparent decoupling of credit from income shown in previous research was driven by changes in buyer composition. In fact, the relationship between individual mortgage size and income growth during the housing boom was very similar to previous periods, independent of how we measure income. Zip codes that had large house price increases experienced significant changes in the composition of buyers, i.e. home buyers (mortgage applicants) had increasingly higher income than the average residents in an area. Poorer areas saw an expansion of credit mostly through the extensive margin, i.e. a larger numbers of mortgages originated, but at DTI levels in line with borrower income. When we break out the volume of mortgage origination from 2002 to 2006 by income deciles across the US population, we see that the distribution of mortgage debt is concentrated in middle and high income borrowers, not the poor. Middle and high income borrowers also contributed most significantly to the increase in defaults after 2007. These results are consistent with an interpretation where house price expectations led lenders and buyers to buy into an unfolding bubble based on inflated asset values, rather than a change in the lending technology.