The Importance Of Consumer Lending Became Obvious During The Great Recession

The Importance Of Consumer Lending Became Obvious During The Great Recession

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The importance of consumer lending became obvious during the Great Recession. One key factor of the Great Recession was due to the increase subprime and near-prime lending which was further aggravated by the securitization of these loans. The Financial Crisis of 2008 followed similar trends to other crisis (Demyanyk & Van Hemert, 2011). First, there was an evident boom in the subprime mortgage market. Second, a bust occurred in 2007 which is signaled by house foreclosures, high delinquencies and default rates. The subprime crisis led to spill over into other credit markets. The crisis intensified when underwriting standards deteriorated along with loan quality which led to an increase in loan risk that was not reflected by an increase in price, which led to a collapse in the market.
Kwan (2001), using data from nine years from Merrill Lynch and Fannie Mae , finds the average annual growth rate of subprime mortgages was 26 percent. Kwan concludes that subprime loans can affect credit values and the loans that are tied in with them. With an increase of subprime lending in the 2000s due to predatory practices, it was only a matter of time for a banking crisis to occur. The credit boom ran from 2001 – 2006 and bust in 2007, mainly due to the large subprime securitized mortgage market (Demyanyk & Hasan, 2010). In 2008, the subprime securitized mortgage market was roughly around $1.8 trillion which is about one-third of the securitized market and 16% of total mortgage debt. Though many people doubted that such a comparatively small market could induce such a crisis, the complexity, however, of the innovated security contributed to the collapse. Keys et al. (2008) studied the link between securitization and screening subprime mortgage ...


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...% drop in lending during September through November period prior to the past three month period and 68% drop since the peak in 2007. The authors argue however, that a decrease in lending doesn’t necessary mean a reduction in credit supply. A decrease in lending is due to a reflection in the increase in risk. However, they noted that banks with a “strong base of deposits” will cut their lending less. For example, in August-November 2008 period, the median range bank reduced lending by 38% while a bank with deposit of one standard deviation below (above) reduced their lending by 51% (14%). Thus a bank with a solid deposit intake are inherently less risky and are capable of lending even through crisis. Wheelock and Wilson (2000) found that banks are more likely to fail if they have low capitalization, higher ratios of loan to asset, and poor quality of loan portfolios.

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