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Explaining the Housing Bubble

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Listed:
  • Levitin, Adam
  • Wachter, Susan

Abstract

There is little consensus as to the cause of the housing bubble that precipitated the financial crisis of 2008. Numerous explanations exist: misguided monetary policy; a global savings surplus; government policies encouraging affordable homeownership; irrational consumer expectations of rising housing prices; inelastic housing supply. None of these explanations, however, is capable of fully explaining the housing bubble. This Article posits a new explanation for the housing bubble. First, it demonstrates that the bubble was a supply-side phenomenon attributable to an excess of mispriced mortgage finance: mortgage-finance spreads declined and volume increased, even as risk increased—a confluence attributable only to an oversupply of mortgage finance. Second, it explains the mortgage-finance supply glut as resulting from the failure of markets to price risk correctly due to the complexity, opacity, and heterogeneity of the unregulated private-label mortgage-backed securities (PLS) that began to dominate the market in 2004. The rise of PLS exacerbated informational asymmetries between the financial institutions that intermediate mortgage finance and PLS investors. These intermediation agents exploited informational asymmetries to encourage overinvestment in PLS that boosted the financial intermediaries’ volume-based profits and enabled borrowers to bid up housing prices. This Article proposes the standardization of PLS as an information-forcing device. Reducing the complexity and heterogeneity of PLS would facilitate accurate risk pricing, which is necessary to rebuild a sustainable, stable housing-finance market.

Suggested Citation

  • Levitin, Adam & Wachter, Susan, 2012. "Explaining the Housing Bubble," MPRA Paper 41920, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:41920
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    File URL: https://mpra.ub.uni-muenchen.de/41920/1/MPRA_paper_41920.pdf
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    Cited by:

    1. Justiniano, Alejandro & Primiceri, Giorgio E. & Tambalotti, Andrea, 2014. "Credit Supply and the Housing Boom," Working Paper Series WP-2014-21, Federal Reserve Bank of Chicago, revised 01 Mar 2014.
    2. Barakova, Irina & Calem, Paul S. & Wachter, Susan M., 2014. "Borrowing constraints during the housing bubble," Journal of Housing Economics, Elsevier, vol. 24(C), pages 4-20.
    3. James R. Barth & Donald McCarthy, 2013. "What Is the Likely Impact of the Volcker Rule on Markets, Businesses, Investors, and Job Creation?," Journal of Private Enterprise, The Association of Private Enterprise Education, vol. 28(Spring 20), pages 63-74.
    4. Pedro Linhares Rossi & Guilherme Santos Mello, 2014. "The Fourth Dimension: Derivatives As A Form Of Capital," Anais do XLI Encontro Nacional de Economia [Proceedings of the 41th Brazilian Economics Meeting] 025, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
    5. Alvarez-Cuadrado, Francisco & Japaridze, Irakli, 2017. "Trickle-down consumption, financial deregulation, inequality, and indebtedness," Journal of Economic Behavior & Organization, Elsevier, vol. 134(C), pages 1-26.
    6. Davidson, Andrew & Levin, Alex & Pavlov, Andrey D. & Wachter, Susan M., 2016. "Why are aggressive mortgage products bad for the housing market?," Journal of Economics and Business, Elsevier, vol. 84(C), pages 148-161.
    7. Dumitriu, Ramona & Stefanescu, Razvan, 2014. "Perspective ale ţintirii inflaţiei
      [Perspectives of the Inflation Targeting]
      ," MPRA Paper 52943, University Library of Munich, Germany, revised 14 Jan 2014.
    8. Broer, Tobias, 2016. "Securitisation Bubbles: Structured finance with disagreement about default correlations," CEPR Discussion Papers 11145, C.E.P.R. Discussion Papers.
    9. Buchanan, Bonnie G., 2017. "The way we live now: Financialization and securitization," Research in International Business and Finance, Elsevier, vol. 39(PB), pages 663-677.
    10. Raymond, Elora, 2016. "Negative equity in the Sixth Federal Reserve District," FRB Atlanta Community and Economic Development Discussion Paper 2016-1, Federal Reserve Bank of Atlanta.
    11. Carlos J. Perez & Manuel Santos, 2017. "On the Dynamics of Speculation in a Model of Bubbles and Manias," Working Papers 2017-02, University of Miami, Department of Economics.
    12. Atif R. Mian & Amir Sufi, 2018. "Finance and Business Cycles: The Credit-Driven Household Demand Channel," NBER Working Papers 24322, National Bureau of Economic Research, Inc.
    13. John V. Duca & Lilit Popoyan & Susan M. Wachter, 2016. "Real Estate and the Great Crisis: Lessons for Macro-Prudential Policy," LEM Papers Series 2016/30, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    14. Michael Kumhof & Romain Ranciere & Pablo Winant, 2013. "Inequality, Leverage and Crises; The Case of Endogenous Default," IMF Working Papers 13/249, International Monetary Fund.

    More about this item

    Keywords

    housing bubble; securitization; mortgage; MBS; RMBS; CMBS; PLS; Fannie Mae; Freddie Mac; GSE; informational asymmetries; community reinvestment act; affordable housing goals; irrational exuberance; standardization; housing finance; real estate;

    JEL classification:

    • L32 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Public Enterprises; Public-Private Enterprises
    • K23 - Law and Economics - - Regulation and Business Law - - - Regulated Industries and Administrative Law
    • L50 - Industrial Organization - - Regulation and Industrial Policy - - - General
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets

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