The Role of Mortgage Brokers in the Subprime Crisis

We study the role of mortgage brokers in the subprime crisis using a detailed sample of loans originated by, formerly, one of the largest subprime loan originators, New Century Financial Corporation. Prior to the subprime crisis, mortgage brokerage firms originated about 65% of all subprime mortgages and yet little is known about their behavior and contribution to the subprime crisis. Is there empirical support for the allegation that lenders like New Century compensated brokers in a fashion that encouraged them to originate higher cost loans? Did the incentive scheme change as New Century’s loan volume surged? How did the mortgage brokers respond to the incentive scheme? How did the lender-broker relationships and broker competition interact with broker compensation? We decompose the broker revenues into a cost and profit component and find evidence consistent with broker market power that is greater for more complex mortgages and for borrower who may be less informed. We relate the broker profits to the subsequent performance of the loans. A probit model for loan performance shows that the increased broker profits lead to worse loan performance suggesting that brokers earned high profits on loans that turned out to be riskier ex post.