Anatomy of a Train Wreck

WHY did the mortgage market melt down so badly? Why were there so many defaults when the economy was not particularly weak? Why were the securities based upon these mortgages not considered anywhere near as risky as they actually turned out to be? Although there are many factors involved, the key and fundamental answer is that, in an attempt to increase homeownership-particularly among minorities and the less affluent-an attack on underwriting standards has been undertaken by virtually every branch of the government since the early 1990s. This weakening of underwriting standards had the intended impact of increasing home ownership and the unintended impact of increasing the price of housing, helping lead to a housing-price bubble that masked for many years the crucial (and predictable) problem of increased defaults.

After the government succeeded in weakening the underwriting standards, mortgages seemed to require virtually no down payment-which is the main key to the problem. There were also few restrictions on the size of monthly payments relative to income, little examination of credit scores, and little examination of employment history. This was the government’s goal and, as homeownership rates increased, there was self-congratulation all around. The community of regulators, academic specialists, and housing activists all reveled in the increase in homeownership and the increase in wealth that ensued. The decline in underwriting standards was universally praised as an “innovation” in mortgage lending.

SL

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Stan Liebowitz

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WHY did the mortgage market melt down so badly? Why were there so many defaults when the economy was not particularly weak? Why were the securities based upon these mortgages not considered anywhere near as risky as they actually turned out to be? Although there are many factors involved, the key and fundamental answer is that, in an attempt to increase homeownership-particularly among minorities and the less affluent-an attack on underwriting standards has been undertaken by virtually every branch of the government since the early 1990s. This weakening of underwriting standards had the intended impact of increasing home ownership and the unintended impact of increasing the price of housing, helping lead to a housing-price bubble that masked for many years the crucial (and predictable) problem of increased defaults.

After the government succeeded in weakening the underwriting standards, mortgages seemed to require virtually no down payment-which is the main key to the problem. There were also few restrictions on the size of monthly payments relative to income, little examination of credit scores, and little examination of employment history. This was the government’s goal and, as homeownership rates increased, there was self-congratulation all around. The community of regulators, academic specialists, and housing activists all reveled in the increase in homeownership and the increase in wealth that ensued. The decline in underwriting standards was universally praised as an “innovation” in mortgage lending.