by Jan K. Brueckner, Paul S. Calem, and Leonard I. Nakamura

This paper explores the link between the house-price expectations of mortgage lenders and
the extent of subprime lending. It argues that bubble conditions in the housing market are
likely to spur subprime lending, with favorable price expectations easing the default concerns
of lenders and thus increasing their willingness to extend loans to risky borrowers. Since the
demand created by subprime lending feeds back onto house prices, such lending also helps to
fuel an emerging housing bubble. The paper, however, focuses on the reverse causal linkage,
where subprime lending is a consequence rather than a cause of bubble conditions. These ideas
are illustrated in a theoretical model, and empirical work tests for a connection between price
expectations and the extent of subprime lending.