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Mizen

Figure 2

Debt to Income Ratios

Liabilities in Percent of Disposable Income

180

160

Canada

United Kingdom

United States

Euro Area

140

120

100

80

60

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

SOURCE: OECD Economic Outlook and ECB/Haver Analytics.

each other. Borrowers continued to seek funds to

gain a foothold on the housing ladder, reassured

by the fact that the values of the properties they

were buying were rising and were expected to continue

to rise. Lenders assumed that house prices

would continue to rise in the face of strong

demand. In some cases, lenders offered in excess

of 100 percent of the value of the property. Conditions

in housing markets were favorable to

increased lending with what appeared to be limited

risk; lenders were prepared to extend the

scope of lending to include lower-quality mortgages,

known as subprime mortgages.

Growth in the Subprime Mortgage Market.

In the United States mortgages comprise four

categories, defined as follows:

(i)

prime conforming mortgages are made to

good-quality borrowers and meet requirements

that enable originators to sell them

to government-sponsored enterprises (GSEs,

such as Fannie Mae and Freddie Mac);

(ii) jumbo mortgages exceed the limits set by

Fannie Mae and Freddie Mac (the 2008

limit set by Congress is a maximum of

$729,750 in the continental United States,

but a loan cannot be more than 125 percent

of the county average house value; the limit

is higher in Alaska, Hawaii, and the U.S.

Virgin Islands), but are otherwise standard;

(iii) Alt-A mortgages do not conform to the

Fannie Mae and Freddie Mac definitions,

perhaps because a mortgagee has a higher

loan-to-income ratio, higher loan-to-value

ratio, or some other characteristic that

increases the risk of default; and

(iv) subprime mortgages lie below Alt-A mortgages

and typically, but not always, represent

mortgages to individuals with poor

credit histories.

Subprime mortgages are nevertheless difficult

to define (see Sengupta and Emmons, 2007). One

approach is to consider the originators of mort-

FEDERAL RESERVE BANK OF ST. LOUIS REVIEW SEPTEMBER/OCTOBER 2008 535

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