Complex mortgages became a popular borrowing instrument during the bullish housing market of the early 2000s but vanished rapidly during the subsequent downturn. These non-traditional loans, including interest-only and negative-amortization mortgages, enable households to postpone loan repayment in contrast to fully amortizing traditional mortgages. Contrary to common perception, complex mortgages are used by households with high-income levels and prime credit scores, quite unlike the low-income population targeted by subprime mortgages. Nonetheless, we find that complex-mortgage borrowers become delinquent on their mortgages at rates twice as high as borrowers with plain-vanilla fixed-rate contracts even after controlling for household and loan characteristics. Our findings suggest a link between innovations in mortgage markets focused on prime borrowers and the financial crisis.

We document a novel channel through which coordinated trading exerts externalities on financial markets. We study the impact of a financial advisory firm that recommends frequent reallocations between equity and bond funds to Chilean pension investors. The recommendations generate large and coordinated fund flows that are exacerbated by the strategic complementarity arising from fund trading restrictions. The recommendations generate significant price pressure and increased volatility in the stock market. In response to these large trade flows, pension funds shift their allocations to more liquid securities. Our findings suggest that giving retirement savers unconstrained reallocation opportunities can destabilize financial markets. Received March 11, 2016; editorial decision July 8, 2017 by Editor Itay Goldstein.