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Remember The Global Financial Crisis?! – The Housing Crisis

What Caused the Housing Crisis?

Bad Behavior, Moral Hazard, “Inside Job”

  • Mortgage demand from confused/misled buyers, taking out mortgages that self-destructed.
  • Mortgage supply from conflict-ridden financial intermediaries with no skin in the game.
  • Facilitated by revolving door of go vernment/industry/academia.

 

Government Failure

  • Mortgage demand from explicit and implicit government subsidies trying to expand homeownership.
  • Mortgage supply from “government sponsored enterprises” (GSEs), eager to comply with affordablehousing goals and to exploit government guarantees.
  • Facilitated by ineffectual regulators and by regulatory arbitrage.

 

Bubble Thinking

  • Mortgage demand from consumers, who view houses as a great investment that never goes down in value.
  • Mortgage supply from cash pools and intermediaries, who view mortgage-backed securities as “safe assets” (because housing prices could never fall by very much!) that satisfy their increasing demand for such assets for investment and collateral.
  • This “bubble thinking” made possible by the long quiet period since the last financial crisis in the United States, and the stability of housing prices during this time.

 

Why did the bubble take hold in 2003-2007?

Housing bubbles are always lurking.

The precipitating force this time was the demand for safe assets coming from macroeconomic forces.

 

 

Special thanks to Timothy F. Geithner (Lecturer in Management, Yale SOM, Former U.S. Secretary of the Treasury, Yale School of Management) and Andrew Metrick (Michael H. Jordan Professor of Finance and Management, Yale School of Management)

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