Stefania Albanesi, Giacomo De Giorgi, and Jaromir Nosal write,
A broadly accepted view contends that the 2007-09 financial crisis in the U.S. was caused by an expansion in the supply of credit to subprime borrowers during the 2001- 2006 credit boom, leading to the spike in defaults and foreclosures that sparked the crisis. We use a large administrative panel of credit file data to examine the evolution of household debt and defaults between 1999 and 2013. Our findings suggest an alternative narrative that challenges the large role of subprime credit in the crisis. We show that credit growth between 2001 and 2007 was concentrated in the prime segment, and debt to high risk borrowers was virtually constant for all debt categories during this period. The rise in mortgage defaults during the crisis was concentrated in the middle of the credit score distribution, and mostly attributable to real estate investors.
“Real estate investors” means buyers of houses who did not intend to occupy them but were instead buying them for speculation. The non-owner-occupied phenomenon (also known as investor loans) was noted by Andrew Houghwout and others in 2011, and it was something that I suspected back in October 2008. Kevin Erdmann also has pointed out that it was not low-income borrowers who drove the boom and bust.
Let’s say the boom-bust crisis is attributable to the wave of defaults concentrated among investor loans. What we’ve seen is that underwriting standards dropped like a rock before the crisis, and have re-tightened significantly afterwards.
if this study tells an accurate story (I’m somewhat skeptical at this point), then are the credit-expansion boosters correct, and this tightening unnecessary and irrational?
On the other hand, how does debt to high risk borrowers stay constant while everyone knows that underwriting standards dropped a lot? Why wouldn’t a drop in standards have scooped up a lot of marginal borrowers and expanded the debt in that category?
In terms of the housing bust, I rather think of the housing boom as a long Bull market that started in ~1948 and ended in 2007/2008. (I believe housing prices only fell in the early 1990s although ‘real’ not ‘nominal’ prices might have fallen in the early 1980s.) That was extended Bull market that was grew way too big because of Sub-Prime and Investor buying in 2003 – 2007. If sub-prime was 10 – 20% loans but that still has a huge impact because sub-primes was the earliest wave of foreclosures. Also, name a long time developing nation that has not a Housing Bust….Germany? And their economy had a huge change after the Berlin Wall falling.
And it is not like the US did not have the Japanese example boom and bust only a decade before. In terms of the economy were there better new economies than 1980s Japan and then 1990s United States. (Or 1920s United States) Both 1980s Japan and 90s US had the economy working on all cylinders, having amazing productivity growth, seemed like a new era in capitalism and both workers & capitalism were thriving. And Both economies overheated stock markets that led to overheated housing markets.
Sounds like they were looking at the wrong information but came to the right conclusion. Credit scores measure the quality of the repayment history of the creditor. The critical information here is not credit worthiness, but debt to equity.
During an extended period of price increases, the creditor is losing rising equity by not paying, and secondary creditors will step forward. If prices hold for a decade or more, credit scores will not reflect much risk. There is no rational reason to default.
If prices go down for any reason, the incentives all change quickly, and with momentum. A handful of sales can form a new comp profile that resets the value of all the homes nearby that match it. Once there is no significant equity to protect, the firewall is breached and the slide becomes severe. Creditors without equity are a completely new ballgame, whether they have good credit scores or not.
Neighborhoods with large numbers of owners who have 5% equity or less are very vulnerable, and that describes neighborhoods with lots of speculator owned homes.
That is one of the oddities of the period. From the mid 1990s to 2003, about 2% of households each year purchased their first home. During that time, the homeownership rate was rising by about 1/2% per year, so that was a somewhat high number, but as Arnold says, this did not involve a decline in ability to pay. The new owners tended to be households in the top two income quintiles.
Then, when the subprime boom hit from 2004 to 2007, homeownership began to decline. First time homebuyers each year were: 2.1%, 1.7%, 1.7%, 1.6%. And, it looks like more existing home owners were selling and exiting the market, which also pushed ownership rates down.
This is an odd thing to see during a period frequently described as a time when they were handing out mortgages to “anyone with a pulse”. On the other hand, if the stories of amateur investors buying 3 or 4 properties in bubble cities is true, then this kind of has to be the case. Every home has one owner, and the housing stock is pretty stable, so if there are suddenly a bunch of multi-unit investors, somebody, somewhere isn’t an owner that used to be.
Also, the initial drop in homeownership in 2005-2008 appears to be concentrated at the top of the income distribution. Middle income ownership rates really only started to drop after the crisis, when most of the defaults happened, in 2009 and after.
It’s kind of like one of those scenes where they ask for volunteers and everyone else takes a step back. It may turn out that the reason average borrower quality looks so bad in 2006-2007 is not because of excessive lending, but because the qualified borrowers were tactically shorting the housing market, either by selling out and renting or by selling a house in the high priced cities, pocketing the capital gains, and buying a house in the more affordable cities. Net domestic migration of homeowners out of the 5 expensive MSAs was nearly 2% a year at the height of the boom. That’s a lot of disinvestment.
I think this is a core factor in the crisis, which I hope we can eventually come to terms with. By the time FOMC members, Wall Street Journal editors, etc. were suggesting in late 2007 that a housing bust might induce some market discipline and teach those optimistic speculators a lesson, actual owners in the market had been fleeing a sinking ship for a good two years.
Of course this is true, investors drove the bubble. That is well known despite the fact that many, many so called “homeowners” were investors that received the mortgage on a principal residence were no such thing. They simply lied to receive better terms than an investor would receive, and the banks allowed them to do so. All a bank needed was a map and a credit report to find that fraud. They chose to ignore it.
We will never be able to determine exactly how much investors were responsible for the bubble, but even with all of these hidden investors, the numbers do not lie. My favorite here in Phoenix was the guy who had 15 mortgages, all principal residences.
The federal reaction to spend the subsequent decade tightly regulating entry level mortgages to owner-occupiers must be really frustrating to you.
I do not know what that means.