Anatomy of a Train Wreck

From The Independent Institute:

With the very serious problem of financial markets in turmoil and an unprecedented federal bailout of $700 billion, most people are frantically trying to understand what exactly is going on and why. In this regard, we hope that you will find the following, new, in-depth Independent Policy Report of special value:

Anatomy of a Train Wreck: Causes of the Mortgage Meltdown, by Stan J. Liebowitz

This unique and far-reaching Policy Report is included in our forthcoming book, Housing America: Building Out a Crisis, edited by Randall G. Holcombe and Benjamin W. Powell.

This report has also been excerpted for the cover story in the October 20th issue of National Review (subscription required).

In addition, you may be especially interested in the following articles on our blog, The Beacon, by our Senior Fellow Robert Higgs, whose many books include Depression, War, and Cold War, Crisis and Leviathan, and Neither Liberty Nor Safety.

• The Stock Market Proved . . . Or Did It?
• Two Unspoken Assumptions in the Credit-Crisis Debate
• Metaphors Reveal the Economic Ignorance of Politicians and Journalists
• Credit Is Flowing, Sky Is Not Falling, Don’t Panic
• Treasury Opens Vault; Gangs of Robbers Rush In
• Does Wall Street Have a Death Wish?
• The Fed’s AIG Loan/Takeover: Another New Deal Legacy
• Ticking Time Bomb Explodes, Public Is Shocked

Anatomy of a Train Wreck: Causes of the Mortgage Meltdown

October 3, 2008
by Stan J. Liebowitz

Download PDF File (29 pages)

Why did the mortgage market melt down so badly? Why were there so many defaults when the economy was not particularly weak? Why were the securities based upon these mortgages not considered anywhere as risky as they actually turned out to be?

This report concludes that, in an attempt to increase home ownership, particularly by minorities and the less affluent, virtually every branch of the government undertook an attack on underwriting standards starting in the early 1990s. Regulators, academic specialists, GSEs, and housing activists universally praised the decline in mortgage-underwriting standards as an “innovation” in mortgage lending. This weakening of underwriting standards succeeded in increasing home ownership and also the price of housing, helping to lead to a housing price bubble. The price bubble, along with relaxed lending standards, allowed speculators to purchase homes without putting their own money at risk.

The recent rise in foreclosures is not related empirically to the distinction between subprime and prime loans since both sustained the same percentage increase of foreclosures and at the same time. Nor is it consistent with the “nasty subprime lender” hypothesis currently considered to be the cause of the mortgage meltdown. Instead, the important factor is the distinction between adjustable-rate and fixed-rate mortgages. This evidence is consistent with speculators turning and running when housing prices stopped rising.

Anatomy of a Train Wreck is included in the forthcoming Independent Institute book, Housing America: Building Out of a Crisis, edited by Randall G. Holcombe and Benjamin Powell.

---

Stan J. Liebowitz is Research Fellow at The Independent Institute, Ashbel Smith Professor of Economics and Director of the Center for the Analysis of Property Rights and Innovation at the University of Texas at Dallas, and co-author with Stephen Margolis of Winners, Losers, and Microsoft: Competition and Antitrust in High Technology, published by the Independent Institute.

Comments

[Rob]

This report concludes that, in an attempt to increase home ownership, particularly by minorities and the less affluent, virtually every branch of the government undertook an attack on underwriting standards starting in the early 1990s. Regulators, academic specialists, GSEs, and housing activists universally praised the decline in mortgage-underwriting standards as an “innovation” in mortgage lending.

[GM Cassel AMH1(AW) USN RET]

At least a train wreck can be cleaned up and the system put back in working order.

[Katie]

You can blame this mess on Bill Clinton. If he and Greenspan didn't force the subprime mess onto banks to save the stock market in the 1990's from the dot.com collapse, we wouldn't be in this mess.

Or you can do what Hamas is doing and blame the Jews.

[Jennifer]

I must admit that when this economic crisis all started I was out of my element. This article is very informative though. Thanks for the link to "Anatomy of a Train Wreck: Causes of the Mortgage Meltdown." It may take me a while to read it, but hopefully I will gain a better understanding of why this happened.