Volume 15, Issue 3

2004

 

The debate surrounding predatory lending laws and the subprime mortgage market revolves around two hypotheses. The efficient-pricing hypotheses says that the market is providing broader access to credit, offering higher rates and fees to higher-risk borrowers, and that prices relate directly to risk. The opportunity-pricing hypothesis says that the high interest rates and fees charged in the subprime market are well in excess of risk-related costs.

 

A number of facts about the subprime mortgage market support the second hypothesis. Existing research includes price information, papers inferring a correlation between high prices and high risk of credit loss from observed default rates, theoretical discussions to explain pricing dispersion, and studies trying to determine whether laws that indirectly restrict prices have reduced the supply of mortgage credit. Information asymmetries, seller obfuscation, and search costs contribute to the inefficiencies in this market and suggests several policy responses.