This chapter examines the subprime mortgage contract and its central design features. It shows that for many borrowers these contractual design features were not welfare maximizing. In fact, to the extent that the design of subprime mortgage contracts contributed to the subprime crisis, this welfare loss to borrowers — substantial in itself — is compounded by much broader social costs. A better understanding of the market failure that produced these inefficient contracts should inform the ongoing efforts to reform the regulations governing the subprime market.
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