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The authors would like to thank Richard Baldwin, Tam Bayoumi, Stijn Claessens, Enrica Detragiache, Gianni De Nicolo, David Gussmann, Robert Hauswald, Patrick Honohan, Simon Johnson, Pete Kyle, Robert Marquez, Rebecca McCaughrin, Donald Morgan, Marcelo Pinheiro, Calvin Schnure, and seminar participants at the International Monetary Fund, Fannie Mae, George Washington University, American University, Federal Reserve Bank of New York, University of Kansas, Federal Reserve Bank of Philadelphia, and University of Virginia for helpful discussions and/or comments on an earlier version of this paper. We would also like to thank Chris Crowe for sharing his data. Mattia Landoni provided outstanding research assistance.
We estimate regression equation 1 using ordinary least squares as well as using truncated regression methods. The results remain the same.
This is also consistent with the idea of a negative relationship between bank risk-taking and the monetary policy rate. This hypothesis is explored at length, though in a different context, in Jimenez et al. (2007).
One explanation for this result relies on the fact that prime mortgages are mostly fixed-rate and are by definition underwritten for the fully-indexed cost while subprime mortgages are mostly adjustable-rate loans with low teaser rates. It is possible that lending standards in the subprime market were already flawed in the sense that the denial decision was based on initial debt-to-income ratios calculated using the teaser rate instead of considering payment shocks that would occur with the reset of the loan rate. In that case, denial rates would not respond to higher short-term interest rates, concealing the potential impact of monetary policy on lending standards.