All lending involves a variety of risks that must be allocated, managed, and priced, but the 10- to 30-year maturities and the legal aspects of mortgage lending pose unique risks. Risk taking by lenders and investors should be regulated and supervised by both regulatory authorities and market participants. The principal risks associated with financial intermediation are well known: credit, market, liquidity, foreign currency, operations (or business), and political. Mortgage value depends on a host of factors, including house prices, interest rates, and the legal environment for enforcing the mortgage lien. Mortgage lenders establish risk measures and methods for mitigating risk that reflect these characteristics. In many cases, measures appropriate for mortgage lenders differ from risk measures and tolerances for shorter-term and unsecured lending. In addition to product-specific issues, real estate lending can be a source of systemic risk, as banking and real estate crises are frequently correlated. T h e fact that inappropriate lending, pricing, and risk management can create problems for the broader financial system and macro economy presents special challenges for regulators. By definition, emerging markets suffer from a lack of public, detailed financial information, and they lack liquidity in both the    financial and real estate markets. Th e lack of information and liquidity, along with the cyclical nature of the property markets, can lead lenders and regulators to restrict the flow of credit to housing, to the detriment of the market and economy in particular, to moderate- and lower-income borrowers. Yet    effective risk management techniques and enlightened regulatory policies can create a climate for safe lending.

The ability to manage and price these risks is a major determinant of the availability and cost of housing finance, as well as the provision of credit for affordable housing. Th e ability to do so in turn depends on the soundness of the economic, primary market, and regulatory infrastructure. Th e two most important prerequisites for managing risk in housing lending are macroeconomic stability and an effective legal framework for property ownership and mortgage lending. Macroeconomic stability is very important for several reasons. First, it has a major effect on the demand for mortgages. High rates of   inflation and nominal interest rates are typical features of many emerging economies. Th ese features have the effect of reducing mortgage affordability. A volatile economy also affects the supply of funds and the characteristics of mortgages offered by lenders. In a volatile environment, lenders are concerned about liquidity risk and reluctant to offer long-term loans. Th is may lead them to not offer mortgages or only offer short maturity loans that in turn are less affordable for consumers. Lenders and investors may prefer short-term assets, in part because of the difficulties of forecasting inflation and interest rates and thus the cash flows of their portfolios. FRMs create substantial cash-flow risk for lenders in volatile environments.1 Variable rate mortgages are riskier for borrowers in a volatile environment, as interest rate change causes payment shock. In turn, this increases the credit risk of mortgage lending (for example, Colombia, Mexico from the early 1990s).