Information Externalities and Residential Mortgage Lending in the Hardest Hit Housing Market: The Case of Detroit

Lei Ding
Federal Reserve Bank of Philadelphia

The flow of credit to the residential sector is a critical issue in the recovery of the housing market after the Great Recession. This study revisited the effect of the “information externality” from previous transactions on lending decisions during the housing crisis in a hard-hit market of the Detroit metropolitan area. The results of the study suggest that the lack of previous mortgage-financed sales and the concentration of foreclosures in a neighborhood present significant challenges for the access to credit for many mortgage applicants in Detroit. The significant effect of information externality is primarily relevant to the conventional mortgage market and the effect has a relatively low threshold: when the number of mortgage purchases is five or fewer in the previous year, the odds of denial increase 32 percent. More than 30 percent of the neighborhoods in the Detroit metropolitan area have been adversely affected by the lack of accurate information on neighborhood home sales prices. Results from this case study shed light on the systematic process of property valuation and mortgage underwriting during the recent housing crisis.