The housing bubble and speculators, once again

Commenter Handle is skeptical of the revisionist view that investor loans rather than subprime lending fueled the housing bubble and bust.

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?

Many possibilities.

1. The loosening in underwriting standards may not have been as deep and widespread as people have come to believe.

2. Perhaps looser standards did not draw in many borrowers, because people self-rationed. Most people fear taking on a lot of debt, even if lenders are offering it to them.

3. Perhaps the authors of the revisionist papers are deceiving themselves by the way that they look at trends in debt among homeowners. If debt was going up for some borrowers and down for others, then on average you might not see a debt increase. But the debt might have increased among borrowers less able to carry it. Note that the ability to carry debt depends on many factors, including factors that are not observable to economists researching the issue.

4. An increase in house purchases by affluent speculators and an increase in house purchases by sub-prime borrowers are not mutually exclusive explanations of the boom and bust. It could be that both phenomena together were important. The cycle would have been much less extreme if either of those phenomena had not taken place.

5. Perhaps the biggest shock was not the loosening of standards prior to 2008 but the tightening of standards subsequently. As the “subprime crisis” unfolded, politicians hit lenders with new rules and, more important, harsh rhetoric about “predatory lending” that discouraged lenders from offering a mortgage loan to anyone who actually needed one (lending to people with plenty of assets was still ok). Perhaps if underwriting standards had merely reverted to those of 2002, home prices would have stabilized at a higher level.

I lean toward (3) and (4). Maybe someone (Kevin Erdmann?) can talk me into (5).

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22 Responses to The housing bubble and speculators, once again

  1. EMichael says:

    Good luck with 5.

    Yeah, lots and lots of investors were willing to buy into bank’s MBSs during that time period. Not a problem with banks’ portfolios containing mortgages to “people with plenty of assets”), but anything they tried to sell was a no go. More lawsuits by investors back then, than mortgage securities being sold to investors.

    I am a big fan of 2. Lot of people are very conservative in their debt obligations and their limits.

  2. baconbacon says:

    The prime/subprime distinction is awkward.

    A person with $100,000 in income and $1,000 in unsecured debt and good credit history is a prime borrower. If that person took out $X0,000 in unsecured debt they would eventually move from prime to sub prime, as it is fairly obvious to all that a person holding lots of debt has inherent risk that a person holding little debt does not have.

    The question about prime or subprime is not “is the borrower credit worthy at the time of the loan”, it is “is the borrower credit worth AFTER they receive the loan”. Banks looked at home loans and said “yes, the security of the home’s value makes them still credit worthy”.

    The last line above means that the prime or sub prime nature depends heavily on the expectations of home prices. The fall in home prices effectively flipped those loans from prime to sub prime, and flipped sub prime to beyond junk.

    • EMichael says:

      True. Another huge problem in the prime/subprime distinction was the sophistry of Ed Pinto under the direction of Wallison. Pinto created a totally false set of “subprime” in order to attempt to blame the crisis on government policies. Unfortunately for him, people more honest and knowledgeable actually had access to facts that showed his fictions.

      But we still have this zombie definition floating around.

  3. collin says:

    Go along with Point 4. I have not seen a better argument than The Big Short done by Ryan Gosling to Steve Carrell. That the lending standards for all borrowers declined, both sub-prime & investors, and once foreclosures hit 4 – 5 % the system started collapsing. And we have to remember that the housing peak was in 2005 and the collapse was 2008 so the players understood the collapse at different points. (Case in point, why did the Democrats do so well in 2006 midterms? Because a number of buyers understood they were in a bad situation.)

    1) The basic reality that the US mortgage debt more than doubled from 2000 to 2006 which was an incredible Bull Market that attracted a lot of investment and players. And when interest rates increased 2004 -2006 the mortgage debt STILL increased which should have a HUGE warning signal. So it took all buyers, sub-prime and investors with a banks ignoring their risk departments, to make this happen. S
    2) Almost the same thing cycle happened to Japan 10 – 20 years before so we should not be that surprised.
    3) Aren’t most of the failed investors of housing 2003 – 2005 mostly upper middle class making bad decisions?
    4) The total stagnation of real wages had an impact here after the best wage environment in the late 1990s.

    Big economic bust don’t come from bad economies as we expect Valenzuela and Argentina to fail, but from the strong economies to where the growth and income going up for an extended period where everybody feels this time it is different.

    Anyway, I think it was Megan Mcardle that noted to capitalism at its ‘Finest’ was 1929 – 1932 when Andrew Mellon ‘supposedly’ stated “”liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system.” The problem society can’t function with a 25% unemployment and huge drops in real wages. (We should note few people are argue the 1930 US population was not hard working and immoral but they did at the time.)

  4. All 5 points are great points. The counterevidence on point 4 is that in 2006 and 2007, housing starts, homeownership rates, and buying from first time homebuyers were all collapsing pretty sharply. If there was an increase in speculative investor buying at the time, and it does appear that there was, then those trends are especially striking as evidence against marginal lending to owner-occupiers.

    But, more importantly, I think, going forward, researchers really will need to stop looking at data on the “US” housing and credit markets, and instead focus on the differences between markets. There is a lot of focus on how credit standards affect borrowing, consumption, and price appreciation. But, probably the factor that played a dominant role in the shape of the market at the time was the massive migration shifts that were occurring within the high priced cities, both by owners tactically selling to pocket capital gains and renters escaping rising costs. So, there were at least three US housing markets – the coastal urban cores, the bubble cities in Florida and inland West, and the rest of the country.

    In the urban coast, there basically aren’t any home buyers with median or below median incomes. But, at the height of the bubble, about 2% of homeowners (mostly with very high incomes) were moving away. They were replaced by younger aspirational households with high incomes, but with less pristine credit because of their age. I think this is basically the group that the recent Albanesi, et. al. paper and other recent research have noticed. In the most expensive cities, there is always a rotation of young aspirational in-migrants replacing older out-migrants. The mortgage boom, more than anything, accelerated that rotation, and since those out-migrants tend to have a kid or two while the in-migrants don’t, this actually led to depopulation of those cities.

    The bubble cities basically were taking on the massive migration from the high cost cities, and eventually the inflow of people outpaced their rate of housing starts, even though locals thought, correctly, that they were building a lot of houses. Even by 2005, in the gross flows, you can see households moving away from these cities. A lot of those in-migrants came with a million dollars of real estate capital gains burning a hole in their pocket. That led to a classic bubble-like situation, so in those cities there is speculation, investor buying, etc., etc. What popped the bubble in those cities was that net migration went from about 1.5% of the local population in 2005 to zero in 2007. The locals all looked at the rows of unsold houses in 2007, and blamed it on the builders, who clearly had been building at a hot pace in 2005. But, with a shock to migration flows that severe, there is absolutely no need for a supply explanation. No rational market could have faced that shift without being stuck with massive inventory.

    In 2/3 of the country, in places like Texas, nothing happened that anyone would have thought to call a bubble, even though those were the places where we probably do see an increase at the extensive margin of homebuyers with moderate incomes. Defaults in Texas were high throughout the boom, but they didn’t spike during the bust, because marginal credit expansion doesn’t cause market volatility if there are no supply constraints. In those places, marginal buyers should be buying homes. That is the one of the draws of those places – middle and lower middle class households can potentially be homeowners there.

    So, in the highest priced cities, middle class buyers were an insignificant part of the market, but when prices in those cities shot up and then collapsed, our main policy response was to prevent middle and lower-middle class households from being homeowners in places like Texas, where they never posed a problem.

    And, while the price collapse in high tier neighborhoods stabilized after late 2008, low tier neighborhoods actually lost most of their value after that. Whatever anyone wants to argue about 2006, that second phase of the collapse after 2008 clearly was the result of public policy against mortgage lending to those neighborhoods. That is when the bulk of the low tier foreclosures happened. There is no question that the tightening of credit came first in those neighborhoods. And, I would argue that that policy shift was built on misconceptions and was wholly unnecessary.

    • Geez. Sorry that was so long.

    • EMichael says:

      I agree with almost everything, but for this second mention of ” the result of public policy against mortgage lending to those neighborhoods”. Not that I disagree with it, I just have no info on what those policies were and when they were enacted.

      • Well, obviously the collapse of the private securitization market in 2007 had a large effect on lending. After years of sharply declining market share, FHA stepped into that void to provide some lending. The GSES were trying to also, but the government kept the clamps on them pretty tightly and then took them over in Sept. 2008. After that, the GSEs basically shut down lending to FICO scores under 740. The Obama administration put out a paper in late 2016 explaining how tight lending standards were hurting the entry level market. (Gee. Thanks for pointing that out, administration in control of 3/4 of the lending market for the past 8 years. :-p ) Avg. FICO scores at the GSEs went up by 40-50 points after 2008. During the bubble they didn’t change by more than a few points. This was a huge shift.

        Here is a motion chart where you can see the late phase collapse in those markets after they were cut off from credit.

      • EMichael says:

        “Well, obviously the collapse of the private securitization market in 2007 had a large effect on lending.”

        Yeah, thinking F&F had the same type of problem selling their paper as the private labels did after the crisis, despite performances far, far superior to the private label MBS.

        Couldn’t care less about a letter from Obama.

        I see no public policy whatsoever.

        • The chart on pg. 14 of your link is a good measure of the shift. During the boom, it was product risk, not borrower risk, that rose. After 2007, both fell to below previous norms.

          Page 14 shows the shift in FICO scores. The shift within the agencies was stronger than this broad market measure, but even here, we can see that average FICO scores were level during the boom and then rose after 2007.

          They show first time homebuyers on page 17. It is unfortunate that first time buyers are usually expressed as a % of buyers. This brings in unnecessary data. According to the AHS, first time homebuyers began to decline in 2005 and continued to decline throughout the bust, if measured as a % of all households.

          • EMichael says:

            Product risk and borrower risk on a loan are at, the very least, equally important.

            I agree about the % of first time buyers being almost a total waste of time.

            I know it is beyond frustrating for people with a libertarian viewpoint to have witnessed a housing bubble and financial crisis that was caused by private interests not subject to decent government regulation. They tried to blame it on government policies(some still do, but their hearts aren’t in it anymore). Now they are trying to blame the current mortgage market on government policies.

            Let’s face facts here. If the government had not nationalized(to all extent) Fannie and Freddie(plus the VA and FHA), there would be no mortgage market at all except for jumbos to millionaires in New York, SF, etc. Cannot count the damage to the economy if that had occurred.

            Actually, the contortions of these people is amazing. Wallison claiming in the beginning that the GSEs were not doing enough on low income lending; then after the bust blaming the GSEs for too much affordable housing loans that caused the bubble. Then you got the bad credit loans forced on banks by the government as the cause of the bubble, now you got them claiming that higher credit standards imposed by government policies are killing the mortgage recovery.

            Must be nice to pick an ideology and stay there despite all evidence to the contrary.

          • It sounds like you would rather talk this through with Wallison than with me. I haven’t made any of the claims you are now bringing up.

          • EMichael says:

            “now you got them claiming that higher credit standards imposed by government policies are killing the mortgage recovery.”

            “but the government kept the clamps on them pretty tightly and then took them over in Sept. 2008. After that, the GSEs basically shut down lending to FICO scores under 740.”

            Besides the number being high, your “policy” is clear.

          • Octavian says:

            EMichael: implicit in all of this is that the GSEs only exist because regulation of the credit market (and later higher interest rates) artificially stifle the supply of credit. The justification for there existence from progressives is self-co tradictory: if there’s a credit shortage requiring government underwriting, why are they talking about increasing rather than decreasing the regulatory burden on lenders?

            “Ideology despite evidence” cuts both ways. Some people actually believe banking was unregulated before the crisis.

          • EMichael says:

            Fannie and Freddie are simply a clearinghouse to enable people holding long term debt to exchange it.

            If they did not exist, we would need to create them.

            The market determines the need for the GSEs. If you do not understand that simple fact, you should not talk about the subject.

          • The GSEs only have a small effect on mortgage rates, and so they have a small effect on home prices and housing consumption. It seems to me that they might have done a pretty good job of creating access to ownership for marginalized populations in the 1990s. But I think their main benefit is the one thing everyone complains about – the implicit guarantee. I think they should only provide the guarantee, stop holding mortgages in portfolio, and just be considered an arm of monetary policy. Charge a fee for the guarantee and print money to cover it when necessary. The semi-private setup led to all sorts of public kvetching that prevented the government from committing to stabilizing policies. The GSEs look pretty good. Even the accounting scandals in 2003 and 2004 make them look pretty good in hindsight, since part of the complaints at the time we’re that they had been overstating loss reserves. I find it a bit humorous that the former CEOs agreed to pay fines for those charges in 2007, just as folks were lining up to claim the GSEs were understating loss reserves. I’d be curious to hear Arnold ‘ s reaction to that, though. I suspect he disagrees.

          • Octavian says:

            “If they did not exist, we would need to create them.

            The market determines the need for the GSEs. If you do not understand that simple fact, you should not talk about the subject.”
            Do explain how the market determines the need for a government created clearinghouse? Why is it that only a state-created enterprise can fulfill this purpose?

            Are you seriously arguing that the exchange of long-term debt can only occur when mediated by a government agency?

          • EMichael says:

            Yes, I am.

            That is what long term markets do. Let me know when you find an investor willing to ride the same horse for 30 years. Of course, in a mortgage.

    • collin says:

      If the investors were filling in the market for 2006 and 2007, that is actually after the market highpoints in 2005. What I see that these investors/suckers made the Housing Bust in September 2008 instead of a slightly smaller one in March 2008.

  5. MS says:

    This may be stating the obvious, but the willingness to lend was based partly on the assumption that home prices (the lender’s real security interest, not the borrower) would continue to rise . . . which of course depended on the continued willingness to lend.

    The “bubble” popped when Wile-e-Coyote looked down. The dynamic was even more powerful in the structured credit markets. Highly levered vehicles were using short-term funding to buy long-term debt — if they couldn’t roll their short-term paper, then they would have to sell their long-term assets (all at once). Forced-selling caused asset prices to plunge, which triggered more forced selling.

    Actual creditworthiness wasn’t nearly as bad as the fear of an ongoing bank run. Funds that were able to do technical analysis of the underlying securities (and bought them pennies on the dollar) made a killing because cashflow from the mortgages was more than enough for lenders higher up in the waterfall (i.e. the higher rated securities). Funds that were forced to mark-to-market, or maintain ratings thresholds — e.g. highly regulated 2a7 money market funds — were crushed.

    • EMichael says:

      Especially trying to cross sell long term insturments with large delinquency rates.

      A payment stream has a value, while its attractiveness and price is affected by the value of the underlying asset, it is much more effected by its performance.

      Delinquencies on these mortgages led the reduction in housing values.

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