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The Industrial Organization of Bad Mortgage Loans

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  • D.P. Baron

Abstract

At the heart of the recent financial crisis were subprime mortgages, many of which were revealed to be bad. This paper shows that the opportunity to sell mortgage loans in an opaque securitization market explains subprime loans with a negative expected return when held to maturity. The paper also shows that lenders that maintain traditional lending standards employ their own brokers and compensate them with a salary. In contrast, subprime lenders contract with independent mortgage brokers and compensate them with a positive piece rate and a negative franchise fee paid to the lender. Subprime lenders are larger and more profitable than prime lenders whenever subprime loans are made.

Suggested Citation

  • D.P. Baron, 2010. "The Industrial Organization of Bad Mortgage Loans," Review of Business and Economic Literature, Intersentia, vol. 55(2), pages 117-136, June.
    • Handle: RePEc:sen:rebelj:v:55:i:2:y:2010:p:117-136
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