Abstract
We present 12 facts about the mortgage crisis. We argue that the facts refute the popular story that the crisis resulted from finance industry insiders deceiving uninformed mortgage borrowers and investors. Instead, we argue that borrowers and investors made decisions that were rational and logical given their ex post overly optimistic beliefs about house prices. We then show that neither institutional features of the mortgage market nor financial innovations are any more likely to explain those distorted beliefs than they are to explain the Dutch tulip bubble 400 years ago. Economists should acknowledge the limits of our understanding of asset price bubbles and design policies accordingly.
Highlights
More than four years after defaults and foreclosures began to rise, economists are still debating the ultimate origins of the U.S mortgage crisis
According to this story, depicted graphically in the top panel of Figure 1, deceit starts with a mortgage broker, who convinces a borrower to take out a mortgage that initally appears affordable
Why did borrowers and investors make so many bad decisions? We argue that any story consistent with the 12 facts must have overly optimistic beliefs about house prices at its center
Summary
More than four years after defaults and foreclosures began to rise, economists are still debating the ultimate origins of the U.S mortgage crisis. Higher house price expectations rationalize the decisions of borrowers, investors, and intermediaries—their embrace of high leverage when purchasing homes or funding mortgage investments, their failure to require rigorous documentation of income or assets before making loans, and their extension of credit to borrowers with histories of not repaying debt. If this alternative theory is true, securitization was not a cause of the crisis.
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