Staff Reports
A Simple Model of Subprime Borrowers and Credit Growth
February 2016 Number 766
JEL classification: E21, E44, G21

Authors: Alejandro Justiniano, Giorgio E. Primiceri,
and Andrea Tambalotti

The surge in credit and house prices that preceded the Great Recession was particularly pronounced in ZIP codes with a higher fraction of subprime borrowers (Mian and Sufi 2009). We present a simple model of prime and subprime borrowers distributed across geographic locations, which can reproduce this stylized fact as a result of an expansion in the supply of credit. Owing to their low incomes, subprime households are constrained in their ability to meet interest payments and hence sustain debt. As a result, when the supply of credit increases and interest rates fall, they take on disproportionately more debt than their prime counterparts, who are not subject to that constraint.

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