Thoma: "Here's what really caused the housing crisis"
An excellent overview from Professor Mark Thoma: Here's what really caused the housing crisis. Excerpt:
As the author of the research, Antoinette Schoar, explained in an interview:When analysts were calling it a "subprime crisis", my former co-blogger Tanta wrote "We are all subprime now!" Subprime was just the first area of stress - this was a widespread crisis.
“A lot of the narrative of the financial crisis has been that this [loan] origination process was broken, and therefore a lot of marginal and unsustainable borrowers got access to funding. In our opinion, the facts don’t line up with this narrative. … Calling this crisis a subprime crisis is a misnomer. In fact, it was a prime crisis.”
As noted in a study by McClatchy from 2008, “Federal Reserve Board data show that more than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions;” “private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year;” and “only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that’s being lambasted by conservative critics.”Those who blame the CRA or Fannie and Freddie don't understand what happened.
There were many causes to the crisis, but I believe the three keys were:
1) the change in lending practices and standards for private sector lending. As an example, the lenders used to use the three Cs: Credit, Capacity, and Collateral. At Tanta explained:
Does the borrower’s history establish creditworthiness, or the willingness to repay debt? Does the borrower’s current income and expense situation (and likely future prospects) establish the capacity or ability to repay the debt? Does the house itself, the collateral for the loan, have sufficient value and marketability to protect the lender in the event that the debt is not repaid?Instead of using the three Cs, the private lenders innovated and just used FICO scores, and then eventually little or nothing to underwrite the loan. There were other innovative changes in lending practices that didn't work out very well.
2) The rating agencies models were based on prior lending methods, and weren't adjusted sufficiently to account for the new (non-existent) underwriting standards. This meant the private label MBS was rated to highly.
3) The regulators turned a blind eye to the loose lending and excessive concentrations. I was talking with field regulators in 2005 and 2006, and they were all terrified. I was told the appointees at the top of the agencies were blocking any effort to tighten standards.
There were many causes to the crisis, and Mark Thoma does a good job of debunking a few false narratives.