Insufficient regulatory oversight leading to excessive risk taking and
homebuyers biting off more than they could chew, combined to doom the
housing market, according to a Harvard University study from the school's
Joint Center for Housing Studies.
"Understanding The Boom And Bust In Nonprime Mortgage
Lending" says originating risky mortgages was "inextricably linked to
demand on the secondary capital markets for mortgages with higher yields
than prime mortgages, as well as the multiplication and magnification of
this risk through actions taken in the capital markets."
"Capital markets supplied credit through Wall Street in large volumes for
risky loans to risky borrowers and then multiplied these risks by issuing
derivatives that exposed investors to risks in amounts much larger than the
face amount of all the loans," he added.
Focusing on the monthly mortgage payment rather than the true value of
the home, homebuyers used low mortgage rates to bid high in tight
housing markets, the report said.
Once house price appreciation took off, the report suggests, backward
looking price expectations led both equity grabbing homebuyers and
salivating mortgage investors to bank on rapidly rising prices, further
fueling the bubble.
Risky loans, the sheer volume of them and the large market share of them
made to speculators and those who couldn't really afford a home, followed by
bundling the mortgages into securities, crippled the U.S. economy and global
financial markets.
Regulatory lapses hurt too, including the failure to closely supervise
nonbank financial intermediaries, the failure to prevent unprecedented risk layering in mortgage underwriting, the failure to
adequately supervise the credit ratings agencies, the failure to impose
greater transparency in the capital markets and the failure to require
higher reserves against risks, the report said.
"One of the biggest problems was that the whole system created the
illusion that risks were being adequately managed. This is because rating
agencies assigned AAA-ratings to large portions of securities backed by
subprime and Alt-A loan pools and synthetic derivatives based on them," said
report co-author Nela Richardson.
Securities were over collateralized - the process of issuing a smaller
face amount of securities than the total face value of loans in the pools -
to hold aside reserves against losses.
"The fundamental underpinnings of the models used to rate these
securities were deeply flawed and the capacity of third-party insurers and
credit default swaps to make good on claims was inadequate," the report
said.
The report also discovered that while high priced loans were
disproportionately concentrated in low-income, predominantly minority census
tracts, the vast majority of high-priced loans were issued to homeowners
outside these communities.
The study also found that loans made by financial institutions regulated
under the Community Reinvestment Act, in areas where they were assessed for
meeting the credit needs of low and moderate income communities, constituted
less than five percent of all high-price loans at the peak in 2005.
"Looking forward, it is encouraging that actions have been taken within
the past two years intended to address many of the regulatory problems we found," commented Belsky.
Said Belsky "But many of the details are left for regulators to work out
and how they do so will determine the balance achieved between consumer
protection and management of systemic risk on the one hand and financial
innovation, efficiencies, and consumer access on the other."
The report says the bust could have been worse.
"The housing market would have struggled even more to recover, absent
federal guarantees of mortgages and mortgage-backed securities, and both the
cost and availability of mortgage credit moving forward would be negatively
affected by any curtailment in the scope of the guarantees," the report
says.
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