The Impact of Credit Risk Mispricing on Mortgage Lending during the Subprime Boom

Abstract

We provide new evidence that mispriced mortgage insurance shifted credit supply and contributed to the mortgage boom and bust of the early 2000s. Original data on private mortgage insurance premiums from 1999 to 2016 reveal that before 2008, premiums did not vary across loans with widely different indicators of default risk. We quantify the mispricing of premiums before 2008 and show that even allowing for more optimistic beliefs, the flat premium structure resulted in cross-subsidies and substantial adverse selection.