Robert Samuelson reports on a new study that contradicts what many people believe about the late financial crisis:
Now comes a study that rejects or qualifies much of this received wisdom. Conducted by economists Manuel Adelino of Duke University, Antoinette Schoar of the Massachusetts Institute of Technology and Felipe Severino of Dartmouth College, the study — recently published by the National Bureau of Economic Research — reached three central conclusions.
What were the conclusions?
First, mortgage lending wasn’t aimed mainly at the poor. Earlier research studied lending by Zip codes and found sharp growth in poorer neighborhoods. Borrowers were assumed to reflect the average characteristics of residents in these neighborhoods. But the new study examined the actual borrowers and found this wasn’t true. They were much richer than average residents. In 2002, home buyers in these poor neighborhoods had average incomes of $63,000, double the neighborhoods’ average of $31,000.
Second, borrowers were not saddled with progressively larger mortgage debt burdens. One way of measuring this is the debt-to-income ratio: Someone with a $100,000 mortgage and $50,000 of income has a debt-to-income ratio of 2. In 2002, the mortgage-debt-to-income ratio of the poorest borrowers was 2; in 2006, it was still 2. Ratios for wealthier borrowers also remained stable during the housing boom. The essence of the boom was not that typical debt burdens shot through the roof; it was that more and more people were borrowing.
Third, the bulk of mortgage lending and losses — measured by dollar volume — occurred among middle-class and high-income borrowers. In 2006, the wealthiest 40 percent of borrowers represented 55 percent of new loans and nearly 60 percent of delinquencies (defined as payments at least 90 days overdue) in the next three years.
That dovetails nicely with observations I made early on in the crisis. It wasn’t wrongdoing that made the crisis. It was bad policy. Everyone was acting consistently with the incentives they had. Lenders were protected from the adverse effects of loans defaulting both by the apparently monotonic increases in the prices of houses and the certainty based on experience they’d be protected from the consequences of their folly. Borrowers were similarly protected. Consequently, lenders lent and borrowers borrowed until the who house of cards collapsed.
Not a lot has changed since then.
The third player is being left out–the financial institutions that craved new mortgages so they could continue to offer CDOs. If it was just buyers and lenders, would the bubble have happened? Would it have been as bad as it was?
Also focusing on incomes of the buyers may be misleading. There were many people pulling in six figure salaries that came directly from some component of the bubble. Consider their money to be like company scrip.
Debt-to-Income (DTI) ratio is not based upon dividing the mortgage by yearly income. It is the percentage of monthly mortgage payment. DTI and Loan-to-Value (LTV) are two of the factors used to determine a borrower’s ability to repay a loan and the interest rate.
There were bad actors, but what percentage, I do not know. Sub-prime and Alt-A have standards, but they are lower than prime. These lower standards cost money, and that is in the form of higher interest rates.
The housing bust and financial collapse was not supposed to occur. The best mathematicians created the best computer models, and these models predicted there would be no problems. Everybody built the future around these computer models. There is a lesson in there somewhere.
All money is like company scrip and has been for forty years.
“The best mathematicians created the best computer models, and these models predicted there would be no problems.”
Not sure about that last bit, about predicting there would be no problems. See, Recipe for Disaster: The Formula That Killed Wall Street. It wasn’t that the model said there would be no problems — it was that the finance boys understood, or rather, “understood” it that way.
Given the way that trading was/is structured, with traders rewarded for gains and not exactly punished for losses, it’s hard to see how any formula would ever work. From what I understand, nobody wanted to touch Madoff because they thought he was just like everybody else, but worse–ripping his clients off but tied up in actual trades, the unwinding of which would be too much of a hazard for the system. Only a few perceived that it was a total scam.
There was a nice two part article in the Wash Post recently anecdotally making much the same points, if you could look past their obvious attempt to make this a racial thing.
Especially interesting to me are two points I’ve been making for years.
So called liars loans as the cause is a myth. If your mortgage resets upward by a couple hundred bucks a month you don’t lose your house. If you are that tight you shouldn’t have borrowed in the fist place. But if your $300,000 home declines in value by 15%, or $45k, then your loan to value is shot to hell with most people unable to afford a make whole payment to realign the ratio. Default. That was govt policy through and through, and is exactly what the current Administration is advocating yet again. 3% down, anyone?
Subprime lending, some of which was CRA, isn’t targeted by income. It’s targeted by geography. That’s one reason why homes in certain neighborhoods suffered above average defaults but income analyses masked it. The other is that it is precisely those marginal neighborhoods where home values are most volatile and dropped the most. Boom. Default.
This whole thing has at it’s root cause bad policy. In the name of supposedly unassailable “home ownership for all” occurred a train wreck. Thank you Mr Frank, Mr Dodd, ms Walters, Mr Raines, Mr Greenspan……
And what do we have occurring right now, in an attempt to prime a laggard economy? Same as it ever was.
The craziest thing occurs with this bad policy mindset. I have two homes and a condo. We just calculated that we made an estimated $240k in the past two years just letting paperwork sit in the lock box. We make a half mil a year just from stock market increases. And yet Pres Obama will screech about income inequality and continue one boneheaded policy after another. The majority of progressives will delight in yelling kill the rich. But their hero,is antithetical to what they claim they want. You just couldnt make this shit up if you tried.
And I’m a relative pauper. The really rich can add a zero,or two after the figures I cited. Careful what you wish for Obamaphiles. I mean, really, what next, raid the 529 plans?
I do find this interesting in a way that things that support my prior views are extremely fascinating.
Tastybits, I’m skeptical of these models. A model built upon prior housing prices where price is increasingly sharply is at risk of feeding a bubble. I’m not sure what the answer is other than a certain level of downpayment.
@Drew
Subprime lending, some of which was CRA, isn’t targeted by income. It’s targeted by geography. …
Subprime is a result of credit score/rating, but you should know that. It looks like you should reword this to better fit the remainder of the paragraph.
Something like: The CRA targeted certain neighborhoods much of which was subprime, and the incomes in these neighborhoods was low.
This sounds like a more plausible scenario, but I have never thought about it in this context. I do not believe that it caused the crisis, but as you posit, it did contribute to the problem cited by these articles. Here is a baseball bat you can use.
Who woulda thunk it? A government program to help the poor did not help the poor. Instead, it hurt the poor, and it further ensured they would be entrapped in poverty. As foreseeable as this was, it was not the intention, and the fact that the do-gooders benefit while those they are helping are worse off is an unfortunate consequence of their do-gooding.
Doing good means never having to say you’re sorry.
@sam
Part of the problem with using models are the caveats or parameters. Any risk model will ultimately be used by a human, and that human will determine the amount of risk they are willing to accept.
To eliminate the human, you would need to factor in a human feedback mechanism into the model. The problem is that humans tend to be irrational, and any irrationality in your model will require rational rules to function properly.
With unlimited growth potential of the credit supply, the financial guys made the rational choices. The problem is that they were functioning within an irrational system. Create a rational system, and they will make rational choices.
1) Most of the loans which went under were not affected by CRA. It was, as this study and others have shown, the higher priced loans that were the large majority. (IIRC, Fed studies showed that only about 7% of subprime loans were connected to the CRA in any form.)
2) You think like a finance guy Drew. First, with the liars loans most people weren’t planning on keeping those homes. They were going to resell them at a profit. Next, people really do make plans based upon the size of their payments, not so much the value of the home. When payments went up, and they couldn’t sell the home w/o losing money, everything went under. If you were planning on keeping your home and payments didn’t change, the market value of the house going up and down didn’t matter much. Not being able to make payments was the problem that started everything. Almost half of subprime mortgages at the peak were liars loans. There was no govt policy promoting that. How you could ever expect to have a loan repaid w/o knowing if the borrower even had income is bizarre. Well, actually it was fraud that paid very well.
3( They shouldn’t have taken on those loans? LOL. Everyone believed housing prices were going to keep going up. The experts told them so. Guys in your profession. There was no risk. If you couldn’t meet payments you just sell and make a profit.
4) Models? Built into the models was the assumption that homes would not all drop in value at the same time. The basic assumptions were all wrong. Some old, gray haired guys should have been telling the young guys building the models they were wrong. They didn’t. The fact that they made a ton of money by not telling them that probably mattered a lot.
5) You need zero govt intervention to get to the same bad place. Like all forensic accounting you follow the money trail. Who made the money? It’s pretty clear. The same thing happened in California on a smaller scale, but it was stopped by govt intervention.
6) You are aware that low down payment loans with PMI default at about the same rate as 20% down loans?
Steve
Subprime mortgages are required to produce income documentation. Anybody who states otherwise is lying or is ignorant. The difference between a prime mortgage and a subprime mortgage is credit score/rating.
The housing crisis began with subprime ARM mortgages with a substantially lower teaser rate during the initial two year adjustment period. By 2005/2006, the standards for these mortgages were being pushed to the lower limits. The LTV and DTI were stretched as thin as possible.
People who were knowledgeable knew that many of these people would never be able to afford the resets. Many of these people had been told to refinance at prime rates during the reset, and this was usually an option in a booming market with a 2 year cleaned-up credit history.
Starting in 2007 and running through 2008, these mortgages would begin defaulting, and they would begin to pile up. The problems would accumulate faster than they could be dealt with, and the accumulating effects would overwhelm the system built using the models.
These would further begin to spread, and the entire housing boom would be slowed down. This slowdown would be a disaster for a bubble which requires abnormal growth.
Anybody who followed the people who were knowledgeable knew what was coming. I was one of those people.
Alt-A loans are for people who do not work traditional 9 to 5 jobs. These people may work as independent contractors or seasonal workers. Even after making a few movies, a movie actor might not have a very large income stream, but they may make lot of money per movie. This person would apply for an Alt-A mortgage (liar’s loan).
Just anybody does not just walk in off the street and get an Alt-A mortgage. The income documentation is for future income, and the applicant provides past income as a predictor of future income. There are standards also. You have asset and credit score/rating requirements.
Are people really this gullible?
Anyway. By late 2007, some people were forecasting a coming recession, and this recession would impact the low end people the worst. Those who could have held on during good times would be toast. In addition, there would be the usual recession increased defaults. These may or may not have been able to be absorbed, but on top of the teaser rate resets, it would be a disaster.
A lot of other mortgages types got dragged into the mess, but if the bubble had not burst, they would have been fine. Actually, there was little reason to believe that the Alt-A mortgages would have burst the bubble at that time.
The connection to the financial industry was not realized until late 2007 by the people I was following, and then, they were realizing it was going to collapse the financial industry. The rest is history.
I really get tired of this. If the Twin Towers were weakened by the loss of fireproofing insulation on their structural beams, this would have caused the steel to eventually to weaken allowing the floors to collapse. The reason they fell was the fireproof insulation came off, but this is the after the fact reason.
The housing market pancaked because the structural beams of one floor gave way. This caused the other floors to collapse on top of them. In the rubble, there are a lot of destroyed floors, but there is only one that started the cascade.
@PD Shaw
Condolences on your grandmother. I did not forget, but there are a lot of things going on.
The problem is the amount of money available without any feedback mechanism. Basically, there is an unlimited credit supply, and there is no way to limit the problem. It does not matter whether it is mortgages or student loans. The product is the loan not the thing being purchased.
Presently, the housing markets are constrained. There may be asset inflation, but there is no bubble because there is no unlimited financing possibilities. Lending institutions are too constrained in their lending. This is what the Obama Administration wants to change, and @Drew keeps noting.
What I find amazing is the idea that lenders have no responsibility when lending their hard earned money. If the lender chooses to lend their money to somebody who will never repay the money, why should the US government be used to reinforce foolish choices?
TB
Yes, your wording is better, and that is exactly the way it works. And as I have noted a number of times, I witnessed it with my very own eyes and ears in a business loan context. Over on the housing side, more than any other provision, the high loan to value standard set the stage for trouble. Think of it like margin calls in public equities. And once the asset values cracked there was no hope of retrieving LTV. Some borrowers and lenders mutually agreed to hold on and service the loan. Other times the keys were tossed.
Too many keys got tossed.
Oh, and alpha to gamma phase transitions in the iron/carbon system can suck, can’t they. It used to be mildly amusing to listen to left leaning conspiracy types lecturing about “melting” I-beams.
@Modulo Myself
The bubble was the result of available credit. This credit is created through financial instruments, and everybody gets a piece of the action. If the instrument is not created, nobody gets paid.
When a MBS is created, it is empty. Mortgages are made to fill the MBS. It is usually reported that they are bundled into a MBS, but once you understand how it actually works, you should see that the MBS needs to locate borrowers for it to function correctly.
As fewer and fewer quality borrowers can be found, there is a problem. You have an empty MBS that is supposed to be producing a profit, but there are no borrowers paying interest. The solution is lowering credit standards, and this works to everybody’s benefit – lenders, home builders, buyers, politicians, activists, etc.
In this case, the financial instruments were being used for houses, but they could have been used for college degrees, tulip bulbs, or the stock market. The housing boom was a result of runaway asset inflation due to unlimited available credit.
This is a long winded answer, but yes. The financial institutions with a large amount of the blame are the GSE’s. They could not buy MBS’s fast enough.
This problem was what caused the Great Depression. The solution was Glass-Steagall. It was designed to prevent this exact scenario. They learned what had caused the banking collapses, and apparently, it was good enough for over 50 years. (The S&L was a foreshadowing of 2008.)
For the record, this has been a bipartisan effort all the way. The repeal was done with overwhelming bipartisan support, and it was signed by President Clinton. President Obama appointed Timothy Geithner, Wall Street’s toadie, as Secretary of the Treasury, and then, there is my favorite Jon Corzine.
“Subprime mortgages are required to produce income documentation. ”
Maybe now, but not in the past.
“A stated income loan is a mortgage where the lender does not verify the borrower’s income by looking at their pay stubs, W-2 (employee income) forms, income tax returns, or other records. Instead, borrowers are simply asked to state their income, and taken at their word. These loans are sometimes called liar loans or liar’s loans.[1] Stated income loans were originated by Ameriquest.[2]”
Credit availability, policy, poor people, CRA, none of that matters if banks are handing out half of their loans without knowing if people actually have income. The mortgage market, any credit market, will fail if you are unable or unwilling, to verify that the borrowers have the means to repay the loans.
Steve
@Drew
I do not come into this with a political agenda. There is enough blame to go around. By this time, you should know that I know my ass from a hole in the ground. I defend the financial industry against political attacks, but I am not going to let anybody pretend that they are saints.
The financial industry is what it is. It is no better or worse than the healthcare industry or the education industry.
I examine this like an engineer. In order to fix the problem, you need to properly understand the cause of the problem. This is how you increase the reliability and safety of things.
If an airplane crash is caused by defective rivet installation, the correct solution is to focus on the rivet installation. The political solution would be to focus on the workers. One side would argue that the public education system was underfunded, and the other side would argue that they were lazy.
There will be no solution, and airplanes will continue to crash. Each side will claim that this has proven they were right. It seems pointless to me, but that is how the game is played. I give you all tools to beat up the other side hoping that there may be some breakthrough.
What I can assure you is that Dodd-Frank is never going away, and it is not going to get better for you. As the years pass, you will fondly recall 2015 as a wonderful year forgetting how much you disliked it. The financial industry will never be allowed to interact with the public financial institutions like they did between each other.
The tigers will be de-clawed, de-fanged, tied down, penned up, and fed a vegetarian diet. This will include any tiger to tiger interactions. You are outnumbered by the sheep. The smart tigers have turned white (to match the sheep) and are protecting the flock.
@steve
I have no idea of what planet you live on. I will not state that every single subprime loan had proper documentation, but subprime loans are simply loans where the borrower gets charged a higher interest rate because they do not meet the credit rating/score for a prime loan.
My information is about 10 years old at this point. I was researching before the event, and I had no political agenda. I wanted to make money, and I wanted to learn everything I could to avoid getting hustled – intentionally or unintentionally.
My information was from people in the mortgage industry. Later it included people who understood how mortgages and MBS’s interacted, and that brought out the CDS connection. This is where I learned about shadow banking which is just private banking.
You are coming after the fact, and you are reading political operatives who have come after the fact. Where were all you geniuses before the fact. If you all are so f’ing smart, why could none of you find out what an idiot like myself could before the collapse?
The financial industry is what it is. It is no better or worse than the healthcare industry or the education industry.
On this I agree, with the caveat that the financial industry is an industry devoted to managing the risks of electronic wealth, rather than investing money in actual industries. I don’t think the healthcare/education industries are exactly there yet, though education really wants to be.
@Modulo Myself
As the snake said after biting the person who nursed it back to health, “You knew I was a snake when you took me in.” The US has been bitten, and if it still chooses to take in the snake, I do not blame the snake.
Snakes belong outside eating the rats. If you invite them inside your house, do not complain when they bite you, your children, or your dog.
Speaking of narratives, I have to wonder if the author of this is channeling one of your commenters Dave.
The best man at my wedding was a loan officer with a small bank during the bubble and now works at Freddie Mac. From talking about this many times with him, I think there were a lot of factors at play, but two major ones was the decline in loan standards until the bubble burst, which was necessary to keep feeding the bubble beast. Secondly is that most loans were sold off after they were made. Small firms like my friend’s felt compelled to make loans they likely wouldn’t make if their own firms money was at risk over the long term. But there were buyers for these loans, the loans they made met the industry standards (ie., they weren’t fraudulent), and there was money to be made in loan origination. It was viewed as stupid leave that origination money to other firms by enforcing higher standards for loans that the firm would only hold for a couple of months anyway.
That’s only a part of the whole, but I think it’s a big part.
Andy, thanks for mentioning that so I didn’t have to. I’m assuming he’s being denounced in social media as I type this, though I haven’t checked.
Employment is really one of those issues where the more you drill down, or even just scratch the surface, you realize that the narrative is tremendously misleading.
@Icepick
Mish went through the link, but he added in a few other groups. I am not sure if he added the people hiding by going back to school, but I think you have mentioned those. He estimates the number over 9%.
Apparently Obama Motors is making liars loans……..
http://www.zerohedge.com/news/2015-02-04/2008-deja-vu-gmac-confirms-sec-probe-subprime-loans-will-investigate-itself
In a few years, the same people who thought ZIRP was great and wonderful will suddenly discover that companies were borrowing ZIRP money to boost earnings and stock prices. These same people will proclaim this to be the new lowest evil, and these CEO’s to be the newest evil doers. They will also claim that nobody could have known.
This will require a new set of regulations, and the CEO’s will need new hair shirts to atone for their sins. Of course, we are all supposed to forget all the people stating this was happening. No, they were racists who hated having an elegant black man as president.
People will make rational decisions even within an irrational system. The problem with acting outside of one’s own interests is which standard to use. If a company is not operating for itself, who or what is it operating for.
Environmental, wealth inequality, poverty, minority, etc. issues have different goals that are not necessarily aligned. When conflicts arise, how are they resolved? Somebody is not going to be happy. How many unhappy somebodies does it take to make one evil company? One, two, three, …