Professional Documents
Culture Documents
Douglas D. Evanoff
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May 2009
ABSTRACT
We explore the effects of mandatory third-party review of mortgage contracts on the terms, availability,
and performance of mortgage credit. Our study is based on a natural experiment in which the State of
Illinois required high-risk mortgage applicants acquiring or refinancing properties in 10 specific zip
codes to submit loan offers from state-licensed lenders to review by HUD-certified financial counselors.
We document that the legislation led to declines in both the supply of and demand for credit, with state-
licensed lenders and lower-quality borrowers disproportionately exiting the affected market. Controlling
for the salient characteristics of the remaining borrowers and lenders, we find that the legislation
succeeded in reducing ex post default rates among counseled borrowers by close to 4 percentage points
(approximately a 35% decline). We attribute this result to actions of lenders responding to the presence of
external review and, to a lesser extent, to counseled borrowers renegotiating their loan terms. We also
find that the legislation nudged some borrowers to choose less risky loan products in order to eschew
counseling
Keywords: Financial literacy, Lax screening, Subprime crisis, Household finance
JEL Classification: D14, D18, L85, R21
We thank Edward Zhong for outstanding research assistance and Tom Davidoff, David Laibson and seminar participants at the
2009 AEA meetings, 2009 Bank Structure Conference, University of California-Berkeley, Bocconi University, the Federal
Deposit Insurance Corporation (FDIC), Federal Reserve Bank of Chicago, Tel-Aviv University, Office of the Comptroller of the
Currency, University of California San Diego, University of Illinois at Chicago, and Vanderbilt University for their comments.
The authors thank the FDIC, Paolo Baffi Centre at Bocconi University, and the Dice Center at the Fisher College of Business,
Ohio State University for supporting this research. The views in this paper do not reflect those of the Federal Reserve System, the
Federal Reserve Bank of Chicago, or of the Office of the Comptroller of the Currency.
Contact author: Douglas Evanoff, Federal Reserve Bank of Chicago, devanoff@frbchi.org
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Federal Reserve Bank of Chicago
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Fisher College of Business, The Ohio State University