DP11083 A Simple Model of Subprime Borrowers and Credit Growth

Author(s): Alejandro Justiniano, Giorgio E Primiceri, Andrea Tambalotti
Publication Date: January 2016
Keyword(s): collateral constraint, credit supply, house price, household debt, housing boom
JEL(s): E21, E44, G21
Programme Areas: Financial Economics, International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11083

The surge in credit and house prices that preceded the Great Recession was particularly pronounced in ZIP codes with a higher fraction of subprime borrowers (Mian and Sufi, 2009). We present a simple model with prime and subprime borrowers distributed across geographic locations, which can reproduce this stylized fact as a result of an expansion in the supply of credit. Due to their low income, subprime households are constrained in their ability to meet interest payments and hence sustain debt. As a result, when the supply of credit increases and interest rates fall, they take on disproportionately more debt than their prime counterparts, who are not subject to that constraint.