This paper discusses some of the key characteristics of the U.S. subprime mortgage boom and bust, contrasts them with characteristics of emerging mortgage markets, and makes recommendations for emerging market policymakers. The crisis has raised questions in the minds of many as to the wisdom of extending mortgage lending to low and moderate-income households. It is important to note, however, that prior to the growth of subprime lending in the 1990s, U.S. mortgage markets already reached low and moderate-income households without taking large risks or suffering large losses. In contrast, in most emerging markets, mortgage finance is a luxury good, restricted to upper-income families. As policymakers in emerging markets seek to move lenders down, they should adopt policies that include a variety of financing methods and should allow for rental or purchase as a function of the financial capacity of the household. Securitization remains a useful tool when developed in the context of well-aligned incentives and oversight. It is possible to extend mortgage lending down the market without repeating the mistakes of the subprime boom and bust.

Ten years of ballooning property prices led to excessive optimism by investors and lenders. In the U.S., depending on the index employed, national average house prices rose between 53 and 86 percent between the mid-1990s and 2006.2 At the same time, mortgage originations rose by five times, peaking at $3.9 trillion in 2003. Markets such as Los Angeles and New York have strongly outperformed the national average and many other cities. National indexes for real rents and house prices largely moved together until 2000, when they diverged, and real house prices moved to a level 70 percent higher than that of real rents. Later, as the property balloon deflated in 2006 and 2007, rising subprime defaults spurred a reevaluation of credit spreads and credit market conditions that reflected broader and more fundamental issues.3 Apparently, individuals viewed real estate as a foolproof investment opportunity until they decided that it was not, at which point prices began to decline (André, et al., 2006, Shiller, 2007).