This story is puzzling. Apparently a new academic study found that "subprime lending was not the main trigger of [the] real estate bubble." I think most housing market observers would agree with that—subprime mortgages didn't really take off until well after the beginning of the housing bubble. So if subprime mortgages weren't the primary factor, what was? According to the study, the primary factor was:

the considerable 2003 pullback of government-sponsored financial service corporations Fannie Mae and Freddie Mac from the credit market and their replacement by aggressive, private mortgage securities issuers. ... [I]n 2003, political, regulatory and economic factors . . . forced the two [GSEs] to significantly slow their lending volume. Private funding in the form of asset-backed securities and residential mortgage-backed securities replaced conventional, conforming mortgage-backed securities as the prevalent source of mortgage capital. The new credit environment allowed looser underwriting standards and increased tolerance for riskier, high-yield loan products. Such products included adjustable-rate mortgages with low initial “teaser” rates, Alt-A loans that did not require income verification and nonowner-occupied investor products. This borrowing climate provided previously marginal borrowers with additional access to credit. The credit market shift led to a record increase in total mortgage volume and pushed up home prices with momentum characteristic of a bubble.
Huh? "Subprime mortgages" are, by definition, mortgages that don't meet Fannie and Freddie's conforming loan guidelines. If Fannie and Freddie's pullback from the credit market, and the resulting rise of mortgages that didn't meet Fannie and Freddie's guidelines, was the primary factor, then the primary factor was subprime mortgages. Now, it's possible that the authors of the study use a different definition of "subprime" (though I doubt it, since it would be incredibly misleading not to use the widely-accepted definition of "subprime" in a paper about the housing bubble). It's also possible that the article simply mischaracterizes the study's findings. Am I missing something, or does this article just not make sense?


MidPointMan said...

This is wrong. Housing prices were tethered more or less to inflation until 1996-1997. This is really when the "bubble" started.

This also is when the subprime mortgage market got started. By 2000 there were already billions in subprime mortgages.

The Community Reinvestment Act was expanded in 1995 which forced banks to begin issuing them, they were then securitized by Bear Stearns and a few other banks.

Fannie and Freddie did indeed begin securitizing subprime mortgages in 2002, and this was the problem. Fannie subprime securities were considered safe because everyone knew that Fannie would always be bailed out.

In fact in 2003 the Bush administration wanted to begin tighter regulation. Google the NYT article on 9/11/03 on this point. The Democrats opposed it.

Subprime mortgages were not a problem as long as home prices appreciated. Distressed borrowers could always use the equity in their homes to stay up, or get out before a foreclosure.

It was when the housing market ran out of buyers when mortgages just got crazier and crazier, and fueled the last 2 years of the "bubble". Many of those were "affordable" mortgages under CRA guidelines.

When gas prices went up at the same time housing prices stalled and home equity lines gave out, you saw the collapse that was 8 years in the making.

The vast majority of loans in default are subprime loans. 50% of those subprime loans are CRA classified mortgages.

Those "affordable" mortgages issued in 2003-2005 were the first to go. The glut of foreclosures cratered home prices which caused many others to just walk away, even if they could pay the mortgage. Why pay full price for something that is only worth half what your paid for it.

The CRA was a social experiment that went awry. It took 9 years for it to implode and one more year to bring Wall Street to its knees.

Go look and see when home prices began to radically outpace inflation. It started in 1996. It started with the subprime mortgage market.

The reality is that increasing home values masked the fact that the borrowers will still not creditworthy, but that only lasts until the home quity line runs dry.

It ran dry. And here we are.

MidPointMan said...

Scratch my first sentence.

YOU ARE RIGHT! Brain fart. I hope that does no blow my credibility to shreds.

Nice observation.

Fannie and Freddie did securitize a bunch of subprime loans through some pretty nefarious measures.

Franklin Raines, interestingly enough, was the official in the Clinton Administration at HUD that pressed for CRA.

Ironically, John McCain wanted to regulate Fannie in 2005, which might have been too late anyway, but still prescient.

Also, it is ironic that Barack Obama received ungodly contributions from Fannie Mae relative to anyone else.

Fannie Mae is a big problem. It takes risks that no truly private entity would because it can borrow at Treasury Rates. It's paper was considered as sold as Treasuries with a higher interest rate.

Bad assumption.

On that loose credit fever, they got into all kinds of schemes.

I am no fan of Bush, but he was right on a few things. In 2003 he was dead on the mark.

It would have stopped this mess in it's tracks.

Now we get to hear about "Failed Bush Economic Policies" causing this, when it was a social experiment between Big Government and Wall Street that simply imploded causing all sorts of unintended consequences.

Barack Obama worked for a law firm that sued banks for not issuing enough sub-prime loans.

Mortgage Securitization, enabled by Fannie Mae created a moral hazard. Suddenly banks got rich by originating mortgages, but did not get exposed to the risk if the cut corners, and many did. Some under duress due to CRA.

I just find it the height of irony that this story will lead to the political philosophy that caused this to likely dominate politics, perhaps for a generation.

Get ready for more of the same. Ironic, eh?

I fear in 20 years we will be France. Maybe sooner.

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