
Why Sub-Prime Lenders Didn’t Cause the Housing Crash (2015) - colinprince
http://knowledge.wharton.upenn.edu/article/why-sub-prime-lenders-didnt-cause-the-housing-crash/
======
joeax
This article is little more than an argument about semantics. Whether prime or
subprime, the real culprit was mortgage-backed securities. At the height of
the bubble, banks were merely underwriting loans and they couldn't sell them
fast enough as MBSs/CDOs, a market of which was experiencing its own shadow
bubble. Banks were basically shifting risk off of themselves.

When housing crashed (and subsequently the MBS bubble pop), banks like WaMu
and Wachovia were left holding too many loans (prime and subprime) and no
market to offload them, which quickly lead to their insolvency.

~~~
skookumchuck
> Banks were basically shifting risk off of themselves.

FDIC means that banks are not held responsible for losing depositor money, and
depositors no longer pay attention to how risky the bank's financial practices
are.

~~~
grzm
The FDIC provides insurance which is paid by the member banks. They're held
responsible in the same sense that individuals who pay car insurance are held
responsible in car accidents. It's in their best interest not to lose
deposits, at least as far as the FDIC is concerned.

[https://en.wikipedia.org/wiki/Federal_Deposit_Insurance_Corp...](https://en.wikipedia.org/wiki/Federal_Deposit_Insurance_Corporation)

~~~
skookumchuck
When was the last time you or anyone you know checked the solvency or the
soundness of the financial practices of the bank your checking account it in?

I'm betting on "never". I haven't either.

This wasn't true before the FDIC. Banks tried to project an image of
conservative solidarity. They don't bother with that anymore.

~~~
grzm
Can you point to where the FDIC as an institution is responsible for this? The
primary banking crises of my lifetime were the S&L in 1980 and the 2008
bailouts, neither of involved the FDIC. In the S&L crises, the
responsibilities of the FSLIC (which were responsible for insuring the S&Ls)
were transferred to the FDIC, and FDIC banks ended up contributing into the
bailout, but I would have a hard time seeing the FDIC (as opposed to the
FSLIC) as a direct cause of the S&L crises.

As for "solvency", I frankly _do_ take into account bank reputation
(admittedly as a proxy for solvency or soundness) when opening an account. I
also know the difference between a credit union, a bank, and a savings and
loan company, and other financial services companies. I know the regulations
between these differ. I also know that the regulations of accredited banks (as
opposed to other financial institutions) are pretty stringent and don't allow
them to hand out loans of the type that played a role in the 2008 crisis. One
of the reasons these crises happened in the S&L and mortgage industries was
because the regulations that covered those particular instruments and
institutions weren't as stringent as the banks.

It's easy and understandable to conflate banks and other financial
institutions because often they're inter-related, but they are separate, and
to really understand what happened requires taking these differences into
account.

Please don't read this as some sort of apologia for the financial industry:
it's not. In my opinion there are systemic problems. I do take issue with
landing this at the feet of the FDIC.

~~~
skookumchuck
> Can you point to where the FDIC as an institution is responsible for this?

The most obvious is to look at bank buildings built before the FDIC and after.
Before they were massive stone edifices with spectacular vault doors inside
very visible to the customers.

[https://upload.wikimedia.org/wikipedia/commons/f/f8/U.S._Nat...](https://upload.wikimedia.org/wikipedia/commons/f/f8/U.S._National_Bank_Building_-
_Portland%2C_Oregon.jpg)

[https://upload.wikimedia.org/wikipedia/commons/thumb/8/87/Wi...](https://upload.wikimedia.org/wikipedia/commons/thumb/8/87/WinonaSavingsBankVault.JPG/300px-
WinonaSavingsBankVault.JPG)

After, they were cheap insubstantial buildings in strip malls. The corner
Radio Shack here has morphed into a Wells Fargo branch :-)

This one looks like a gas station:

[http://www.jeffarchitect.com/images/projects/exp-
websterbank...](http://www.jeffarchitect.com/images/projects/exp-
websterbank.jpg)

~~~
grzm
Churches have undergone similar changes in architecture. The local roller rink
is now a church. I included a lot more in my comments which is more
substantial. If this is what you're going to continue with, it's hard to
imagine the conversation is likely to improve. Best wishes and I hope you
enjoy the rest of your day.

~~~
skookumchuck
Very few monumental churches were built in the US. The monumental ones in
Europe date from eras where the church was able to forcibly extract funds to
build them - not volunteer donations.

It's a very different dynamic.

------
ChuckMcM
I think the article is junk but that first comment by Dodson is solid gold.

~~~
blincoln
I agree - especially this part of Dodson's comment:

"When sub-prime borrowers began to default in droves and the value of the
private label MBS tumbled, investors also pulled away from the conventional
MBS market as well, even though these borrowers continued to make their
payments. However, with a short period the domino effect of defaulting
mortgagors spread and then began the recession."

I've always viewed the housing crash as the result of the bottom falling out
of the housing market. I don't know how common it is now, but in the early
2000s, it was very common for people to view homeownership as some sort of
magic escalator to riches - one would buy a home, then basically be guaranteed
to resell it for significantly more later, and the gains would be used to buy
a more expensive home.

I went to a free "how to buy your first home" presentation around 2002, and
this was exactly the model recommended by the people giving the presentation -
people who worked in the home loan and real-estate field. Basically "buy the
most expensive house you can possibly afford now, because you'll be making
more money in a few years and what you think is an expensive monthly payment
now will seem like nothing. Then you can resell your home and buy something
even fancier."

Obviously, this depends upon a constant influx at the bottom of the
"escalator", which is unsustainable because it's a pyramid scheme. The
collapse of that pyramid is exactly what happened, IMO, and it wouldn't have
been possible without the sub-prime lending.

~~~
jpmattia
> _The collapse of that pyramid is exactly what happened, IMO, and it wouldn
> 't have been possible without the sub-prime lending._

imho, housing prices would have declined sooner. The valuation of houses was
already wacky in 2001 by many measures. For example, look at the price-to-
rent:

[https://3.bp.blogspot.com/-GVhHsBNhPfE/WP-6gJXNhTI/AAAAAAAAq...](https://3.bp.blogspot.com/-GVhHsBNhPfE/WP-6gJXNhTI/AAAAAAAAq6g/KfHIu3Mj86suoDIK-
uM_EFCq3wEgVbZfgCLcB/s1600/PriceRentFeb2017.PNG)

In 2001, prices were already at the level of the 1989 real-estate bubble:
Older folks will remember the savings and loan scandal, which was the result
of the 1989 bubble collapsing. The Fed thought it needed to compensate for the
internet bubble collapsing, which was a large contributor to the ensuing mess
in housing.

It has to make us wonder: If compensating for the internet bubble lead to the
housing bubble (and collapse), what will the result of compensating for the
housing bubble be?

~~~
dood
It's bubble-compensation all the way down.

------
notyourday
Reading HN version of the events is live stepping into alternative reality.
Just for the fun of it I did Ctrl-F for a word "conforming" and it was nowhere
to be found in the comments.

Subprime is _irrelevant_. Prime is _irrelevant_. The only thing that was
relevant was _conforming_ vs. non-conforming loans. Non-conforming loans
started the fall ( oh, and nearly all subprime loans were non-conforming but
that's not that relevant as the total amount of money in subprime non-
conforming was just not that high compared to the amount of money in prime
non-conforming ) because conforming loans were sold to F&F and removed from
the books. Originating conforming just did not may that much which is why it
was difficult to get them while a barely walking corpse could get NINJA 3/1
loan with a payment _lower_ than the APR and a balloon at 5 years.

And it was not the CDOs that mattered. It was _CDS_ that did not trigger when
the underlying collapsed. That was fraud. Fraud that the treasury secretary at
the time oversaw.

It was _fraud_ that Goldman became a _bank_ to get the protection of US
Government and was allowed not to behave like a bank, etc, etc, etc.

------
ktRolster
In retrospect (as the housing prices have mostly recovered:
[http://www.doctorhousingbubble.com/wp-
content/uploads/2013/0...](http://www.doctorhousingbubble.com/wp-
content/uploads/2013/01/united_states.png) ), the hosing crisis can be seen as
an irrational bubble, with the major problem being that the banks were under-
capitalized for the risk they were taking on. After several years of injecting
capital into the banks for several years, they are fine. Arguably the banks
didn't worry about the risk because they trusted the government would help
them out.

~~~
norikki
> the banks didn't worry about the risk because they trusted the government
> would help them out

This is euphemistic for the banks stealing money from taxpayers through crony
capitalism.

~~~
Godel_unicode
You're aware that those taxpayers actually got a very good deal, right?
Roughly 10% return on investment, we effectively just invested public funds in
good companies at cheap prices.

[https://projects.propublica.org/bailout/](https://projects.propublica.org/bailout/)

~~~
paulddraper
If it was such a fantastic deal, why wasn't someone else willing to step in
and take it?

~~~
Godel_unicode
I did, and my portfolio is super happy about it. I cheerfully 'bailed out'
Ford too.

~~~
thinkcontext
No, you bought after the crash. The relevant question is would you have sold
an insurance policy before the crisis and been able to stay solvent through
it.

~~~
Godel_unicode
I'm not saying that I bought before the crash, neither did the government. I
literally did exactly what the government did; bought shares of banks and
automotive companies after the crash, at severely reduced prices, and held for
a substantial gain.

The government absolutely did not sell an insurance policy before the crash.
Even if you're arguing that there was a guarantee that the banks would be
bailed out, which argument has merit, the banks didn't pay for that guarantee.

We did it for different reasons (I won't pretend I was either magnanimous or
delusional enough to think my investment by itself would buoy the stock price
enough to keep the companies alive) but the actual actions are the same.

Edit: technically both the government and I bought during the crash rather
than after; my ROI wishes I'd been better at calling the bottom, but that's
life.

~~~
thinkcontext
Buying stock was only a small part of what the government did for the finance
industry. Guaranteeing money market funds, opening up the discount window,
bailing out AIG and paying off counterparties at 100%, sinking $100B+ into
Fannie and Freddie, etc.

The government had essentially given the finance industry an insurance policy
before the crash that paid off during the crash. And you are right, they
didn't have to pay for it in money, perhaps its possible to argue that they
paid for it in regulation. If the firms had had to buy such a policy on the
open market what would the price have been?

------
cm2187
A lesser known but major contributor to the financial crisis is the commercial
real estate market. As far as I know, Lehman went bust because of their
massive commercial morgage position, that Fuld accumulated in 2007, trying to
catch a falling knife. And commercial real estate blew major holes in balance
sheets all over the place.

------
dogruck
This article is horribly biased against lenders.

We all can agree that lenders did loosen their criterion -- but why? They did
so because legislator and judges were criticizing them for refusing sub-prime
loans. The government said, hey, you're not giving enough loans to minorities
who dominate the sub-prime population.

So, the lenders complied.

------
chiefalchemist
Knowledge@Wharton: Because of the way the economy was going back then, people
were feeling much better, there was more money, jobs were better, salaries
were better. So people had that money to basically throw around.

Ferreira: It’s like today. If you ask me today who is getting more loans,
riskier borrowers or the middle class, [it’s] the middle class that sees a
market that’s stable, that had jobs for the past five, six years, people that
were able to save for their down payment — they are the ones getting earlier
into this market.

\---

So we're on the cusp of repeating 2008? So soon?

~~~
quuquuquu
It's been almost 10 years already. That is decently long compared to bubbles
of years passed. We average about one per decade.

I think it makes sense. Lenders have a never ending impetus from Wall St to
grow revenue and profit.

When all of the rich and moneyed people (13.5m people in the USA are
millionaires) have already taken on loans, who do you go to next?

It becomes a cycle of just digging deeper and deeper into the question of "how
do we sell this large capital asset to someone who barely has the ability to
pay it back in the next 30 years".

Eventually, small economic cracks (sub prime defaults) lead to medium economic
cracks (minor layoffs) which eventually, if the hysteria is massive enough,
lead to massive economic cracks (major layoffs, shutting down business arms,
pull backs in investment)

Eventually the govt is expected by market actors to become a lender of last
resort, the dust settles, assets are repo'd, and over time...

... the cycle begins anew.

So, keep an eye out for the cracks that may be forming right now. Soon there
will be another Lehman, another Enron, another Oil Crisis, another speculative
bubble bursting due to credit on credit on credit on credit.

~~~
chiefalchemist
Yes. But must we immediately repeat the same series of bad moves? Have we not
learned anything?

~~~
quuquuquu
Oh, I completely agree with you! I hate bubbles, I hate predatory lending,
etc.

However I am very sad to say that my observation is that this is happening
again, either from ignorance or deliberate action.

I would love to be wrong :(

------
CryptoPunk
Another good reevaluation of the causes of the financial crisis that similarly
argues against sub-prime mortgages being the main culprit:

[http://econlog.econlib.org/archives/2016/05/dont_solve_prob....](http://econlog.econlib.org/archives/2016/05/dont_solve_prob.html)

The explanation is much simpler than others offered, but often simple problems
are the ones most overlooked.

~~~
eru
Indeed. The economy could have easily dealt with a few banks failing---if the
central banks would have kept nGDP up.

Australia, and even more Israel, barely noticed the Great Depression. Britain
also did much better than American and the Euro area, thanks to a competent
reaction by the Bank of England.

~~~
CryptoPunk
The article points to the FDIC and the misalignment of incentives it creates
when it is combined with small undiversified banks, as the primary cause of
the crisis. The note on the central bank's monetary policy relates to the
Great Depression, not the 2008 crash.

~~~
eru
You are right. I was interpreting things a bit more liberally: the housing
crisis and banking crash would have stayed relatively small, if the Great
Recession wouldn't have started:

At some point nGDP started to fall, giving the housing market and banks more
trouble.

------
ChicagoDave
This article has to be founded by some pro-banking group. The article
completely misses the part where the ratings agencies were incapable of
reviewing capitalized mortgage pools to rate them appropriately. Regardless of
the balance of prime to sub-prime, the inherent falsehoods within the ratings
returned from Moody's, Standard & Poor, and Fitch are what made our financial
system "untrustworthy" and that's what led to the financial crisis.

~~~
CryptoPunk
Maybe ratings agencies would do their job and refuse to rate things they can't
see into if they were actually competition in the ratings sector, instead of a
monopoly by the three ratings agencies, enshrined into law with regulations.

Much of the ratings sector is for all intents and purposes impossible for any
outside firm to compete in, because of government regulations that are
supposed to ensure high quality ratings. As it happens, the ratings agencies
have some of the highest profit margins in the market, which is a classic sign
of lack of competition, and rent-seeking.

~~~
klenwell
Funny you suggest market competition. In The Big Short movie, it's competition
that the ratings agency rep played Melissa Leo cites to explain their corrupt
ratings:

Georgia: If we don't give them the rating, they go to Moody's. Right down the
street. If we don't work with them, they will go to our competitors. Not our
fault. Simply the way the world works.

Vinnie: Holy shit.

Georgia: Yes, now you see. And I never said that.

[https://www.youtube.com/watch?v=mwdo17GT6sg&feature=youtu.be...](https://www.youtube.com/watch?v=mwdo17GT6sg&feature=youtu.be&t=3m18s)

~~~
CryptoPunk
At the micro level, that could very well be, but at the macro level,
competition for reputation should create a business interest in not giving out
inaccurate ratings.

When the entire market is dominated by three agencies (two alone have 80% of
the market), with the US government considering ratings given by them alone as
sufficient for approval for certain listings, then regulatory management of
the industry has effectively replaced reputational competition as the primary
driver of quality.

~~~
ChicagoDave
I don't think you understand how this works in real life. I worked in the
treasury department of a large bank 12 years ago and saw first hand...

1\. mortgages are pooled, usually around 10,000 per pool.

2\. the pool is divided up into tranches by the bank. This means that out of
10k loans, x% are supposedly AAA, y% are AA, and so on down to junk ratings
(usually a small portion of the pool).

3\. the bank has their treasury department "validate" the tranches, but this
is really just "spot checking" and not fully investigating the details of
every single mortgage and its associated paperwork

4\. the bank sends the pool to the ratings agency

5\. the ratings agency sends it back approved, never even spot checking
whether the bank's review was accurate or not

6\. the bank creates "securities" or "paper" based on the tranches

7\. investment entities purchase the paper...this is usually municipal bonds
and other organizations expecting the AAA rating to be a "guarantee" (though
it's really a gamble)

So ... in 2008 when the financial industry figured out that years of
securities with false AAA ratings had been sold throughout the world, well, we
know what happened...

None of this has changed except they expect the banks to maintain enough cash
to handle any wobbliness in the financial markets....but the core problems
still exist and has nothing to do with prime or sub-prime mortgages....

It's about accurate and clear information and an industry that literally banks
on the lack thereof...

------
olivermarks
One of an endless stream of academia forensics after the fact.

Another argument is that it was wealthy house flippers who capsized the market
and not poor people being given large loans they couldn't repay.

[https://qz.com/1064061/house-flippers-triggered-the-us-
housi...](https://qz.com/1064061/house-flippers-triggered-the-us-housing-
market-crash-not-poor-subprime-borrowers-a-new-study-shows/)

~~~
wmil
At the end of the day most of the theories aren't exclusive. It takes a lot of
people to create a global economic disaster.

~~~
mannykannot
True, but this article is trying to narrow the range of causes.

------
Dowwie
Another recent study confirms this narrative as well. No citation to the 2015
study: [https://hceconomics.uchicago.edu/research/working-
paper/cred...](https://hceconomics.uchicago.edu/research/working-paper/credit-
growth-and-financial-crisis-new-narrative)

------
jamesblonde
The Toronto housing market is starting to crash now. That leaves just 3
housing markets that kept walking on water after the crash - Australia,
Sweden, and Norway. Tick tock.

~~~
randomdata
Not likely. The Toronto housing market saw its laws changed at the end of
April. The market has lost some confidence because of that, but it is likely
to only be temporary. Once buyer confidence is restored, it will be business
as usual.

Vancouver's market also "crashed" in mid-2016[1] after their new – similar to
Ontario's – laws came into effect. Six months later, after buyer confidence
came back, an all-time record high was set.

[1] [http://creastats.crea.ca/vanc/images/vanc_chart05_xhi-
res.pn...](http://creastats.crea.ca/vanc/images/vanc_chart05_xhi-res.png)

------
mcguire
" _It was a new type of lending focusing on riskier borrowers who didn’t have
money for the standard 20% down payment, who didn’t have a history of stable
employment, or who didn’t have a high enough credit score to apply for
conventional standard loans, so-called “prime” loans. Lenders became quite
creative in terms of finding ways to provide loans to those individuals, to
those families._ "

We bought a house in late 2006/early 2007. We had money for 20% down; a
history of stable, highly paid employment; and a pair of high credit scores.
_We had to twist the goddamn lender 's arm to get a standard, non-whacked-ass
"creative" loan._

It was _obvious_ in mid-2005 that they were writing unsustainable loans. It
was obvious that as soon as the business cycle had any kind of hiccup, the
wheels were going to start coming off.

" _Ferreira: Yes. Let’s split the housing market into four major components.
There’s the prime sector. That’s always around 60% of the market. That’s the
bulk of the mortgage market. There are the governmental loans — HUD, FHA and
VA — which are about 10% to 15% of the market. Then there’s sub-prime. Sub-
prime started in the mid-1990s with about 5% to 10% of the market. And that
increased to 20% — big, but a third the size of the prime sector. And then you
have all-cash transactions: investors or wealthy people. And that’s about 10%
of the market. So during the whole time period, even at the height of the
housing boom, sub-prime was never more than 20% of the market. And the prime
sector was 60% or more and increasing._ "

The sub-prime market was, as expected, the first up against the wall when the
wheels started coming off. And the result was that 20% of the market, rather
than 5-10%, were forced to sell quickly or be foreclosed. 20% of the market is
going to have a bigger effect on overall prices than 5-10%.

On the other hand, that doesn't let prime lenders off the hook, since everyone
was pushing bigger loans that overextended more borrowers, as in, "[T]he
phenomenon was widespread. It was not concentrated solely on the sub-prime
sector."

But this is where Ferriera starts going off the rails.

" _More equity helps. Having a higher down payment helps._ "

No, having lower payments helps. It doesn't matter whether you've got 20% or
0% if you physically cannot make the payments. _Lenders were writing loans
that overextended borrowers._

" _So around 2008 and 2009, in certain markets, you had about 10% to 20% of
the stock of homes being foreclosed. Those markets were the weaker markets,
such as inland California, areas like Fresno and Modesto, or smaller markets
in Florida, for example._ "

I seem to recall it being the stronger markets, like Las Vegas. But anyway...

" _Knowledge@Wharton: [...] I guess, in some respects, then, we still don’t
have a full, true understanding about housing cycles and how they affect the
markets, or the potential of the U.S. having another bubble down the road._ "

We may not have a full understanding, but we do have, and did have, enough of
an understanding that _you cannot lend more money to people than they can be
expected to pay back._ It makes no sense to frame the issue as prime vs. sub-
prime or wealthy vs. poor. It was purely a case of lenders not doing their
jobs. So, then:

" _Ferreira: Unfortunately, I don’t think so. Let me give you an example about
lenders. Lenders got all the blame, especially sub-prime lenders, for the
crisis. So what’s happening right now in this recovery? Are we giving thank-
yous to the lenders because perhaps they’re helping with the recovery?
Absolutely not._ "

And rightfully so! Lenders deserved the blame. And then they didn't "[help]
with the recovery"; they stopped making loans _at all_.

------
TwoBit
This article is bunk.

~~~
oblib
Agreed, and not much more needs to be said about it.

