MORTGAGE MELTDOWN DUE TO PRICE OVERESTIMATION, NOT NEGLIGENCE

Mortgage meltdown due to price overestimation, not negligence: Boston Fed

The meltdown of the U.S. housing finance system resulted from overly optimistic views on home prices as opposed to a type of gross negligence in the mortgage industry, a new Federal Reserve Bank of Boston report concluded.

The report attacks several common assumptions about the cause of the recent financial crisis, including the popular notion mortgage finance firms, and insiders in the business, are primarily to blame for the housing fallout.

Instead, a collective euphoria over the rise in home prices and the false expectation of constant price increases led to the mortgage industry and borrowers miscalculating the risks. 

“If both groups believed house prices would continue to rise rapidly for the foreseeable future, then it is not surprising to find borrowers stretching to buy the biggest houses they could and investors lining up to give them the money,” wrote the report’s authors Christopher Foote, Kristopher Gerardi and Paul Willen. “Rising house prices generate large capital gains for home purchasers. They also raise the value of the collateral backing mortgages, and thus reduce or eliminate credit losses for lenders.”

The group attacks the idea that payment shocks on adjustable-rate mortgages created an atmosphere of extreme default. The report analyzes ARMs originated in 2005 and 2006. The 2006 loans experienced a less severe payment shock than the 2005 group, but ended up with a much higher delinquency rate, killing the idea that payment hikes alone on ARMs caused the problem.

84% of foreclosed borrowers, for example, were overdue on payments equal to when the mortgage first originated.

The authors go on to claim there was little substantive change or innovation in the mortgage markets in the 2000s. Government policy toward mortgages did not change as much as theorized in reports about the market fallout. The report says investors knew the risks, but like many buyers, based their short-term and long-term calculations on overly optimistic home-price growth.

 This article was written by Kerri Panchuk, May 4, 2012.

Tell me what you think

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s