Arnold Kling  

More on the Roots of the Bailout

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Stan J. Liebowitz says that the road to mortgage crisis was paved with good intentions. Concerning a Boston Fed study that purported to find mortgage discrimination, he writes,

Most politicians jumped to support the study. "This study is definitive," and "it changes the landscape" said a spokeswoman for the Office of the Comptroller of the Currency. "This comports completely with common sense" and "I don't think you need a lot more studies like this," said Richard F. Syron, president of the Boston Fed. One of the study’s authors, Alicia Munnell said, without any apparent concern for academic modesty "the study eliminates all the other possible factors that could be influencing [mortgage] decisions." When quotes like these are made by important functionaries, you know that the fix is in and that scientific enquiry is out.

Syron, you will recall, is now the CEO of Freddie Mac.
Steve Sailer takes the same view, both of the Boston Fed study and the adverse consequences of the policy of trying to increase home ownership among minorities.

As Peter Brimelow noted in Forbes on January 4, 1993, blacks had the same default rates as whites, suggesting racial fairness. After all, if current financial institutions were really discriminating irrationally against minorities, it would be highly profitable for a non-discriminator to enter the market, just as the Brooklyn Dodgers won six National League pennants in the decade after they became the first team to sign black baseball players.

The way I think of the Liebowitz story (you should read his whole paper) is as follows.

First, various regulators put pressure on lenders to loosen underwriting standards for minorities and low-income borrowers. That provided the kindling for the housing bubble.

Next, increasing numbers of borrowers started speculating in homes. These borrowers were attracted by adjustable-rate mortgages, because they expected to sell the homes for a profit before the rates adjusted. The fact that we now have such a large inventory of unoccupied homes is consistent with the view that many of the new owners were speculators, not owner-occupants.

Liebowitz is a bit weak in explaining how Wall Street was able to sell so much paper backed by these risky mortgage loans. Although I think it is important to point out the role that government policy played in forcing regulated institutions to relax underwriting standards, I do not think that the private sector is blameless here. There was some very serious mispricing of risk going on. Nassim Taleb's Risk Animal and Wall Street over-confidence were important factors.

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COMMENTS (5 to date)
Brad Hutchings writes:

Another outstanding read. It would be interesting to see a distribution of homeowner income for foreclosed homes. If the speculator theory holds, one might expect that the distribution covers unexpectedly high incomes. That is, the mortgage innovations were put in place for the poor and minorities, but taken advantage of by the fairly well-off. As prices were driven up by increasing demand, more fairly well-off people were forced to stretch their finances to afford home ownership.

eric writes:

OK, housing has gone up the past 25 years, basically since the start of the data we have on home prices. In 2002, it just went thru the recession without a hiccup. Tons of new mortgage brokers enter the field, and banks, to compete lower their standards. There is a systematic attempt to lower underwriting via targeting 'historically disadvantaged groups', putting the stamp of the Fed and its allies on these new underwriting tactics, backed by the most powerful GSEs, Fannie and Freddie.

From mad money new brokers, to ACORN-led do-gooders, to quants looking at historical worst-case-scenarios, this was a perfect storm.

Hindsight is 20-20, but

8 writes:

When I first read about the red-lining regulations, I assumed it was conservatives and libertarians finding a convenient excuse for a major financial crisis. While I still believe it doesn't explain the whole story, every piece of evidence I read suggests it is a much larger piece of the puzzle than I assumed. Especially damning is the nexus between the Democrats, the GSEs, and Mr. Syron, which suggests the GSEs were operated with the goal of social policy.

Lord writes:

Despite the media, this was not a subprime crisis. This was a stated income crisis. Relaxed lending would have not caused a crisis if lenders assured borrowers could repay their loans. Failure to do that allowed lenders to print money and printed it they did.

Lord writes:

That is, stated income, and qualification on low initial teaser rates.

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