Sunday, August 16, 2009

The Subprime Mortgage Crisis: Debunking Myth and Reality?

Recently, Yuliya Demyanyk, a Senior Research Economist, at the Cleveland Federal Reserve Bank issued a very interesting Economic Commentary entitled “Ten Myths about Subprime Mortgages.” Demyanyk contends that many of the popular explanations for the subprime crisis were in reality myths. Further, Demyanyk takes the position that empirical research proves that the causes of the subprime crisis are multifaceted and complicated; going far beyond mortgage rate resets, declining underwriting standards, or declining home values that we typically are quick to point a finger towards.

In addressing and debunking the ten myths she perceives about the subprime mortgage crisis, Demyanyk makes the following observations:

* Subprime mortgages went to all kinds of borrowers, not just borrowers with damaged or impaired credit.

* Subprime mortgages did not promote homeownership.

* Declining home prices and values did not cause the crisis. Declining home prices served to reveal the quality of subprime mortgages that had been deteriorating for years.

* Declining underwriting standards did not trigger the subprime crisis. Yes, standards were declining, but not to a level to account for the enormous rise in mortgage defaults.

* Borrowers did not use their homes as ATM’s to extract cash from home equity loans and lines of credit. Data shows that mortgages originated for refinance performed better than mortgages originated solely to buy a home.

* Mortgage rate resets did not solely cause the subprime crisis. Fixed rate mortgages showed all the signs of distress that adjustable-rate mortgages showed.

* Subprime borrowers with hybrid mortgages were not offered low “teaser rates.”

* The subprime mortgage crisis was not totally unexpected.

* The subprime crisis in the United States is not totally unique; it follows a classic cycle of boom-and-bust that has been observed historically in many countries.

Demyanyk’s Economic Commentary makes for an interesting read to better understand the complicated causes of the subprime mortgage crisis. I tend to agree with some of Demyanyk’s assertions. On the other hand, I tend to disagree with some of Demyanyk’s assertions. Again, Demyanyk’s Economic Commentary is an insightful and thoughtful piece. Do you agree or disagree with Demyanyk’s perspective? I look forward to hearing what you think about the causes of the subprime mortgage crisis.

5 comments:

  1. I find her reasoning to be circular: because many subprime borrowers were not subprime borrowers, they were not steered into subprime loans.

    If they were not subprime borrowers, then why did they not get cheaper loan products?

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  2. Professor Ramirez,

    I agree with your observation. Further, I think that the analysis Demyanyk puts forward ignores the race and class issues integrally implicated in the subprime mortgage crisis. These important facets should not be ignored.

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  4. I think that the blame needs to be shared amongst all. First mortgage brokers lack proper training when the only requirement is a 24 hour class. Second no one holds the actual brokers accountable for their actions when they can give people lemons. Third consumers aren't educated to know what to ask and what to look for, nor do they shop around to find out what's available to them. Fourth, where was the review of the applications by those originating these loans to say hey wait a minute you are in the wrong bracket.

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  5. Subprimes are/were certainly a main element as to why the mortgage market fell apart. Regardless of the type of mortgage, however, it would be difficult to argue that fraud in the mortgage market was not the driving force behind bad loans across the spectrum of borrowers. When banks open up their wallets to borrowers without taking the simple measure of verifying basic income and net worth, rather relying on “fly by night” mortgage brokerage firms to screen applicants, the bad loans will follow fraudulent documents, whether subprime or not. Making laws stricter against mortgage fraud, and extending the statute of limitations in many states to prosecute such fraud, may go a long way towards preventing future problems in the mortgage market.

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