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Why did so many people make so many ex post bad decisions?: the causes of the foreclosure crisis

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  • Christopher L. Foote
  • Kristopher S. Gerardi
  • Paul S. Willen

Abstract

This paper presents 12 facts about the mortgage market. The authors argue that the facts refute the popular story that the crisis resulted from financial industry insiders deceiving uninformed mortgage borrowers and investors. Instead, they argue that borrowers and investors made decisions that were rational and logical given their ex post overly optimistic beliefs about house prices. The authors 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.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Boston in its series Public Policy Discussion Paper with number 12-2.

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Date of creation: 2012
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Handle: RePEc:fip:fedbpp:12-2

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Keywords: Mortgage loans ; Global financial crisis ; Housing - Prices ; Foreclosure;

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References

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  1. Rubén Hernández-Murillo & Andra C. Ghent & Michael T. Owyang, 2012. "Did affordable housing legislation contribute to the subprime securities boom?," Working Papers 2012-005, Federal Reserve Bank of St. Louis.
  2. Manuel Adelino & Kristopher Gerardi & Paul S. Willen, 2009. "Why don't lenders renegotiate more home mortgages?: redefaults, self-cures, and securitization," Public Policy Discussion Paper 09-4, Federal Reserve Bank of Boston.
  3. Kristopher S. Gerardi & Christopher L. Foote & Paul S. Willen, 2010. "Reasonable people did disagree : optimism and pessimism about the U.S. housing market before the crash," Public Policy Discussion Paper 10-5, Federal Reserve Bank of Boston.
  4. Jianjun Miao & PENGFEI WANG, 2011. "Bubbles and Credit Constraints," Boston University - Department of Economics - Working Papers Series WP2011-031, Boston University - Department of Economics.
  5. Foote, Christopher L. & Gerardi, Kristopher & Willen, Paul S., 2008. "Negative equity and foreclosure: Theory and evidence," Journal of Urban Economics, Elsevier, vol. 64(2), pages 234-245, September.
  6. Kristopher S. Gerardi & Andreas Lehnert & Shane M. Sherlund & Paul S. Willen, 2009. "Making sense of the subprime crisis," Working Paper 2009-02, Federal Reserve Bank of Atlanta.
  7. Ing-Haw Cheng & Sahil Raina & Wei Xiong, 2013. "Wall Street and the Housing Bubble," NBER Working Papers 18904, National Bureau of Economic Research, Inc.
  8. Gorton, Gary B., 2010. "Slapped by the Invisible Hand: The Panic of 2007," OUP Catalogue, Oxford University Press, number 9780199734153, October.
  9. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
  10. Nicola Gennaioli & Andrei Shleifer, 2010. "What Comes to Mind," The Quarterly Journal of Economics, MIT Press, vol. 125(4), pages 1399-1433, November.
  11. Elul, Ronel, 1997. "Financial innovation, precautionary saving and the risk-free rate," Journal of Mathematical Economics, Elsevier, vol. 27(1), pages 113-131, February.
  12. Saul B. Klaman, 1959. "The Postwar Rise of Mortgage Companies," NBER Books, National Bureau of Economic Research, Inc, number klam59-1.
  13. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
  14. Laibson, David I. & Fuster, Andreas & Mendel, Brock, 2010. "Natural Expectations and Macroeconomic Fluctuations," Scholarly Articles 9938147, Harvard University Department of Economics.
  15. Jane Dokko & Brian Doyle & Michael T. Kiley & Jinill Kim & Shane Sherlund & Jae Sim & Skander Van den Heuvel, 2009. "Monetary policy and the housing bubble," Finance and Economics Discussion Series 2009-49, Board of Governors of the Federal Reserve System (U.S.).
  16. Nicola Gennaioli & Andrei Shleifer & Robert Vishny, 2010. "Financial Innovation and Financial Fragility," NBER Chapters, in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
  17. Edward L. Glaeser & Joshua D. Gottlieb & Joseph Gyourko, 2010. "Can Cheap Credit Explain the Housing Boom?," NBER Working Papers 16230, National Bureau of Economic Research, Inc.
  18. Simsek, Alp, 2012. "Belief Disagreements and Collateral Constraints," Scholarly Articles 9561259, Harvard University Department of Economics.
  19. Foote, Christopher L. & Gerardi, Kristopher & Goette, Lorenz & Willen, Paul S., 2008. "Just the facts: An initial analysis of subprime's role in the housing crisis," Journal of Housing Economics, Elsevier, vol. 17(4), pages 291-305, December.
  20. John P. Herzog & James S. Earley, 1970. "Home Mortgage Delinquency and Foreclosure," NBER Books, National Bureau of Economic Research, Inc, number herz70-1.
  21. Kristopher S. Gerardi & Harvey S. Rosen & Paul S. Willen, 2010. "The Impact of Deregulation and Financial Innovation on Consumers: The Case of the Mortgage Market," Journal of Finance, American Finance Association, vol. 65(1), pages 333-360, 02.
  22. Atif Mian & Amir Sufi, 2009. "The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis," The Quarterly Journal of Economics, MIT Press, vol. 124(4), pages 1449-1496, November.
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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Foreclosure crisis: it is not about irrationality and sneaky bankers
    by Economic Logician in Economic Logic on 2012-05-29 14:48:00
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
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Cited by:
  1. Steinar Holden, 2012. "Implications of insights from behavioral economics for macroeconomic models," IMK Working Paper 99-2012, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
  2. Andreas Fuster & Paul S. Willen, 2012. "Payment size, negative equity, and mortgage default," Public Policy Discussion Paper 12-10, Federal Reserve Bank of Boston.
  3. Robert Shimer, 2013. "Private Information and the Mortgage Market: Evidence and a Theory of Crises," Working Papers Central Bank of Chile 716, Central Bank of Chile.
  4. Giovanni di Iasio & Mario Quagliariello, 2013. "Incentives through the cycle: microfounded macroprudential regulation," Temi di discussione (Economic working papers) 894, Bank of Italy, Economic Research and International Relations Area.
  5. Anat Bracha & Elke U. Weber, 2012. "A psychological perspective of financial panic," Public Policy Discussion Paper 12-7, Federal Reserve Bank of Boston.

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