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The Great American Housing Bubble

posted by Adam Levitin

My new book, The Great American Housing Bubble:  What Went Wrong and How We Can Protect Ourselves in the Future was just released by Harvard University Press. The book is co-authored with my long-time collaborator, Wharton real estate economist Susan Wachter. It's the culmination of over a decade's worth of work on housing finance that began in the scramble of fall 2008 to come up with ways of assisting hard-pressed homeowners.

In the book we present a full-throated argument in favor of homeownership. Since the 2008 crisis, the policy goal of promoting homeownership has been subjected to much criticism, often misguided. While homeownership isn't for everyone, homeownership has numerous individual and societal benefits, including some that are not generally appreciated, particularly that it serves as a hedge against being priced out of a community because of gentrification. Homeownership is key to community stability, which produces all sorts of social benefits. 

The book is also a whodunnit regarding the housing bubble. It marshals a wealth of existing evidence plus some original hand-collected data to show definitively that this was a supply-driven bubble, and that the surfeit of underpriced mortgage finance was the product of the shift in financing from Fannie Mae and Freddie Mac to Wall Street securitization. The book explains why this shift happened and why the market wasn't able to detect and move against the deterioration in mortgage underwriting until it was already too late. In Clue parlance words, it was Mr. Moneybags, on the bond desk, with the CDO.  

The whodunnit story is also the story of the rise, fall, and rebirth of the American mortgage. We cover the waterfront on the history of housing finance and its regulation in America from WWI to present. Unlike most financial crisis books, our book does not feature the typical cast of archetypal characters: the wiley home flipper; the scurrilous mortgage banker; the savant investor; the rube money manager. Instead, its hero is a financial instrument, the 30-year fixed-rate mortgage or the "American mortgage".

The 30-year fixed is a product we take for granted in America, but it is a uniquely American product. Long-term, fixed-rate, fully-prepayable mortgages are simply not standard products anywhere else in the world (except Denmark). The American mortgage is the product of substantial government interventions in the mortgage market, and it has been a bedrock of systemic stability and of financial security for the American middle class. The housing bubble was marked by the abandonment of the American mortgage for a set of products that resembled the high-risk bullet loans that characterized the pre-New Deal market.

Ensuring the widespread availability of the American mortgage and the systemic stability benefits that flow from it require a certain set of institutions, and that sets the stage for our vision of a reformed housing finance system. You'll have to read our page-turner to find out just what we think should be done with Fannie and Freddie.

Highly recommended for summer quarantine or beach reading! 

 

Comments

Adam,looking forward to buying and reading your book! In the meantime, though, I can't help but tweak you about Mr. Moneybags - he's from Monopoly, not Clue. Burn!

Jim Hayes

And actually, it's not Mr. Moneybags, its Uncle Pennybags.

JAH

I am a regular reader of your blog and find it very helpful, especially when trying to understand the many complicated issues involved in the interplay of sovereign debt and vulture funds. Referenced the index of your eagerly anticipated book on the Housing Bubble on Amazon's website. Did not find the word "fraud" in the index. Wasn't fraud, at all levels of the mortgage industry, a very big part of "what went wrong"?

Hi Christopher,

There was certainly fraud during the bubble, and while it’s not in the index, it is referenced from time to time in the text. There’s also a footnote (p.321, n.92) that discusses the fraud literature. But it’s not in the index because fraud was more a symptom than a cause of the bubble. Mortgage fraud wasn't invented during the housing bubble. The bubble’s conditions certainly encouraged fraud, and I have no doubt that fraud was fuel to the fire for the bubble, but I do not think that fraud was the cause of the bubble; we would have had a bubble without any fraud. Perhaps not quite as bad, but still a bubble.

Also, when we talk about fraud in the bubble, there’s the question of where in the financing chain the fraud took place. Was it the borrower deceiving the lender? The mortgage broker inflating the borrower’s income, etc. to get the deal done and get a cut? The lender deceiving the securitization investors? All of the above? Compounding that, what is “fraud” in the context of stated income loans, where there is no verification of the income? Is anyone truly relying on the borrower’s income in such a context?

Ultimately, the question is whether the buyers have still purchased the loans at the same price regardless? I suspect so because they weren’t doing any meaningful diligence on the underlying loans in the securitizations, nor could they. The way shelf offerings worked before Reg AB II, investors had to buy before they saw the prospectus supplement (and I’m not sure that anyone except plaintiffs’ lawyers reads prospectus supplements), much less loan level data. That’s an informational problem—and that’s what we see as the core problem driving the bubble. It’s one that certainly encourages fraud, but the story of the bubble isn’t a fraud story. Indeed, anyone who looked at even the stated data about the quality of loans in private-label securitization would have witnessed a remarkable drop in underwriting quality. Yet even as stated measures of credit risk rose (and things like FICO scores weren't likely faked), the cost of financing still declined. Ultimately, the story we tell is one of a shift in the financing system that resulted in underprice mortgage credit risk and would have done so even without fraud.

Why should we read a book to find out “what should be done with Fannie Mae and Freddie Mac” if all is well post 2008?

Larry--you'll just have to buy the book to find out!

And who said that "all is well post 2008"? There are plenty of problems in the housing market today and, if the Trump administration is successful at releasing Fannie and Freddie from conservatorship, there are going to be a lot more serious ones in the near future.

Really looking forward to reading it.

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