By 2008, before the financial crisis, there were 55 million mortgages in the US. Of these, 31 million were subprime or otherwise risky. And of this 31 million, 76 % were on the books of government agencies, primarily Fannie and Freddie. This shows where the demand for these mortgages actually came from, and it wasn’t the private sector. When the great housing bubble (also created by the government policies) began to deflate in 2007 and 2008, these weak mortgages defaulted in unprecedented numbers, causing the insolvency of Fannie and Freddie, the weakening of banks and other financial institutions, and ultimately the financial crisis.
Remember what the Washington Post Style section proclaimed on January 1st. Narrative is out. Facts are in.
Of course, in addition to the Freddie and Fannie securities, there were lots of private-sector securities backed by risky mortgages. My contention is that this boom was fueled by risk-based capital rules, which stated that once these loans were packaged into securities, divided into tranches, and blessed by rating agencies as AAA, banks could earn three times the return on such mortgages as could be earned by originating and holding an old-fashioned, low-risk mortgage.
How much did the slicing and dicing and tranching them increase their risk by doing things like making ownership paper trails uncertain? And what was the impact of this on net risk. It would be ironic if taking low quality loans and packaging them into AAA actually made them net riskier.
That 31 million number might actually be understated, depending on the rate of fraud in the origination process. Falsified income/asset documentation, down payments funded with an unsecured loan in someone else’s name, etc.
Misleading to call a secondary market demand but yes, Wall Street had run out of other places to put it. They still took on greater risk as demonstrated by their severer losses but we can call this their business until they need bailouts. Capital rules aren’t drawn out of the ether though, they are embodiment of market desires and practices.
“we can call this their business until they need bailouts”
Expectations and implicit potential bailouts work a little differently I’d suggest.
” demand for these mortgages actually came from, and it wasn’t the private sector. ”
If the private sector has no demand for loose mortgage standards it would be easy for the GOP Congress to pass a bill getting the government out of the mortgage markets as Wallison prefers. If they can’t pass a bill that shows he is wrong about where the demand comes from. The GOP House has not managed to pass a bill in fours years so I think he is wrong.
Wait a second, because bankruptcy did what half the House didn’t, you assume we have a perfect voter to legislator to rulemaker to GSE “market.”?
That is what you are doing.
‘Capitalism is a profit and loss system. Profits encourage risk taking. Losses encourage prudence.’ -Was that Friedman?
This is completely outside my bailiwick, but I have always wondered why Moodys didn’t seem to experience anything like, oh, consequences for giving all those bonds AAA ratings. Is that something that normal people with only a passing interest in finance are allowed to know?
Wallison’s interpretation seems narrative heavy, and light on facts. For example, how did he conclude that causality ran from declining GSE standards to lower private market standards, despite the private issuance crowding out of GSE securities? If he is looking at GSE owned portfolios, then why does his fact analysis suddenly refer to “subprime or otherwise risky”? Such sloppy labeling avoids the difference in performance between private label MBS acquired by GSEs and those acquired by entities not subject to OFHEO constraints, which once again highlights Wallison’s lack of analysis on rates of change in below-660 FICO GSE and non-GSE demand.
Ignoring differentials in issuance and purchase trends, and divergent charge-off rates in “subprime” securities, accomodates a narrative where people like Wallison can say, “It was GSE demand”. It’s retrospective just so analysis, rather than fact based forensics. Something happened to mortgage demand between 2004 and 2006. Wallison thinks that the GSEs that lost market share in the time period somehow reduced real required returns in the rest of the market. Fine, but where are the facts?