The paper Understanding the Subprime Mortgage Crisis by Yuliya S. Demyanyk and Otto Van Hemert has been previously discussed on PrefBlog, but it's about to be published on a formal basis (forthcoming in the Review of Financial Studies) and the authors are beating the drums for it on VoxEU.
In the essay Subprime mortgages: Myths and reality, they highlight the following sources of confusion about the Credit Crunch:
- Myth: Subprime mortgages went only to borrowers with impaired credit
- Myth: Subprime mortgages promoted homeownership
- Myth: Declines in mortgage underwriting standards triggered the subprime crisis
- Myth: Subprime mortgages failed because people used homes as ATMs
- Myth: Subprime mortgages failed because of mortgage rate resets
- Myth: Subprime borrowers with hybrid mortgages were offered (low) "teaser rates"
Their conclusion is in line with what I've been saying for some time:
Many of the myths presented here single out some characteristic of subprime loans, subprime borrowers, or the economic circumstances in which those loans were made as the cause of the crisis. All of these factors are certainly important for borrowers with subprime mortgages in terms of their ability to keep their homes and make regular mortgage payments. But no single factor is responsible for the subprime failure.
In hindsight, the subprime crisis fits neatly into the classic lending boom and bust story – subprime mortgage lending experienced a remarkable boom, during which the market expanded almost sevenfold over six years. In each of these years between 2001 and 2007, the quality of mortgages was deteriorating, their overall riskiness was increasing, and the pricing of this riskiness was decreasing (see Demyanyk and Van Hemert 2008). For years, rising house prices concealed the subprime mortgage market's underlying weaknesses and unsustainability. When this veil was finally pulled away by a nationwide contraction in prices, the true quality of the loans was revealed in a vast wave of delinquencies and foreclosures that continues to destabilise the US housing market even today.
Subprime is just another boom and bust story; just another example of the manner in which easy money will find an outlet. Usually, of course, easy money will express itself in terms of inflation; since there was not much inflation in the period 2001-07, the Fed missed the underlying problem. This isn't just my thesis: it has been suggested by Ken Taylor of Taylor Rule fame and researchers from the Kansas City Fed.
Unfortunately, the politicians have taken over public discussion of the issue and find it much more convenient to blame bankers and their compensation; when, in fact, these guys are in the same position as those poor suckers who get caught by customs with a suitcase-full of heroin. Yes, they did wrong; but it is more important to find out who filled the suitcase.
