By Kirk HaverkampProvided by
The most popular beliefs as to what caused the U.S. mortgage crisis and subsequent economic collapse are wrong, according to a new study by the Federal Reserve Bank of Boston.
The report rejects the popular explanation that industry insiders misled borrowers and investors by pushing mortgages that they knew were likely to default. Instead, they argue that both borrowers and lenders had overly optimistic views of home prices, which led to bad decisions in purchasing and lending.
The authors, who include senior economists at the Boston Fed, list what they call 12 "facts" about the mortgage market that support their view of the causes of the foreclosure crisis, including rejecting the notions that adjustable rate mortgages (ARMs), the emergence of "nontraditional" mortgages or government policies played significant roles in the growth of the housing bubble and its eventual collapse.
Similar to other bubbles
Instead, the authors conclude that the expansion of easy mortgage credit that led to the foreclosure crisis was simply the result of an asset bubble -- the same as occurred with Dutch tulip prices in the 1600s, with U.S. equities and Florida land in the 1920s, and even with Beanie Babies in the 1990s. Prices went up, the authors say, because people believed they would.
"No one doubts that the availability of mortgage credit expanded during the housing boom," the report reads. "In particular, no one doubts that many borrowers received mortgages for which they would have never qualified before. The only question is why the credit expansion took place."
Popular explanations rejected
In a section called "12 Facts About the Mortgage Market" the authors take aim at many of the claims that have been made about the causes of the foreclosure crisis. Among them:
That the housing bubble burst because homeowners could not afford to make payments on adjustable rate mortgages when the rates reset to a higher level.
The authors found that borrowers whose ARMs reset in 2008 saw smaller payment increases than those whose ARMs reset the year before, but suffered higher delinquency rates. In addition, they found only a small difference in delinquency rates between subprime ARMs and fixed-rate mortgages, a difference they found was due more to the former being less creditworthy, rather than to any payment increases when the ARMs reset.
That the growth of nontraditional, high-risk mortgages fed the housing bubble.
The study found that nontraditional mortgages such as payment-option ARMs (where a borrower can pay less than the interest due) and reduced-documentation loans (with little proof of income) were actually fairly common in the 1980s and 1990s, rather than exploding onto the scene around the turn of the century. The authors found little innovation in mortgage lending in the early 2000s.
That affordable housing and minority lending programs played a role.
The authors determined there was little change in government policy toward the mortgage markets from 1990 to 2005. They note that although the federal government did play a significant role in reducing the size of down payments needed to obtain a mortgage, which boosted home ownership, that occurred in the wake of WWII. Although the years 2002-06 saw an increase in zero-down payment financing, the authors report that minimal down payments had been common long before then.
Other findings rejected claims that lenders knew that certain types of mortgages were likely to fail, that investors had little information about the mortgage securities they were buying, that investors did not understand the risk involved in those securities and that top-rated mortgage bonds were "toxic."
They also note that the "originate-to-distribute" model, where lenders originate loans only to sell them to investors, is a longstanding practice in the mortgage industry, rather than a recent development that led to market instability, and that "complex financial products" such as mortgage-backed securities and collateralized debt obligations have been around for decades.
The study is titled "Why Did So Many People Make So Many Ex Post Bad Decisions The Cause of the Foreclosure Crisis?" and is available on the Boston Fed web site. Authors are Christopher Foote, Kristopher Gerardi and Paul Willen.
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