Mythical Subprime - Cleveland Fed. Comments

The Cleveland Federal Reserve has a new commentary, Ten Myths about Subprime Mortgages and debunks each one.

Fed's Top 10 Subprime Myths

  1. Subprime mortgages went only to borrowers with impaired credit
  2. Subprime mortgages promoted homeownership
  3. Declines in home values caused the subprime crisis in the United States
  4. Declines in mortgage underwriting standards triggered the subprime crisis
  5. Subprime mortgages failed because people used homes as ATMs
  6. Subprime mortgages failed because of mortgage rate resets
  7. Subprime borrowers with hybrid mortgages were offered (low) “teaser rates”
  8. The subprime mortgage crisis in the United States was totally unexpected
  9. The subprime mortgage crisis in the United States is unique in its origins
  10. The subprime mortgage market was too small to cause big problems

What I find incredible is option ARM resets didn't cause a crisis, but then again, if one loses their job, can't pay the mortgage, they can't pay the mortgage. If a housing price is so high, a mortgage payment eats past a paycheck, it eats past a paycheck.

On some of these myth dispels, I mean really is 20% vs. 17% rates, esp. when we don't know the total loan amounts, really evidence of a myth? But I find the overall implication of prices being just too damn high and wages, income stability was (is) just too damn low to be one strong argument that is so often completely ignored in analysis and even in policy prescriptions for any sort of recovery.

It's the jobs man.

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I have read this twice now.

And I still don't understand it. It could be I am dense but check "Myth #2":

Subprime Mortgages Promoted Homeownership. So, the author is saying this not true. Right? Then a few sentences later she says:

These subprime loans did contribute to an increased level of homeownership in the country—at the time of mortgage origination.

What am I missing? Then her conclusion is kind of a leap:

Given that there were more defaults among all (not just first-time) homebuyers with subprime loans than there were first-time homebuyers with subprime loans, it is impossible to conclude that subprime mortgages promoted homeownership.

Something is wrong with the logic. Couldn't there be a correlation between increase in first time home-buyers and and increases in sub-prime loan origination? Why then did she look at defaults and say sorry it didn't promote homeownership.

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Looks like I am not alone.

Ten subprime mortgage myths from the Fed (some of which aren't really myths)

Is the author's bigger point that leverage and securitization were the main culprits of the crisis? I would agree with that but you can't simply dismiss the problems in the subprime mortgage market as just "myths".

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Since this is a commentary

we'd have to pour over the stats. I saw one, which was the 20% vs. 17% and also noticed the window....

i.e. the timeline vs. the issues, what is the percentage of subprime vs. all loans and so on.

I think the report is in good faith and assuredly we can all agree the wages are still completely out of alignment with home prices. i.e. one cannot afford a $200k mortgage on $9/hr.

I don't think she's saying it's all myths, just some myths she is addressing.

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I reread that blog post you linked to

and I have to agree, there is something odd about this "myth" conclusions, the more I look at it.

I guess I jumped the gun because one of my things has been a real fundamental, no stability, wage repressed, it doesn't add up that anyone can afford a $400k mortgage or even $200k, so I saw that implication and jumped the gun on the entire "list". Good find!

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But there is some truth behind what you just said.

A number of subprime and prime borrowers were given mortgages regardless of income. Lenders tried to justify this by assuming real estate prices always go up.

But this where income inequality comes in:

Real median wage in the United States has been stagnant for twenty five years, despite an almost doubling of GDP per capita. About one-half of all real income gains between 1976 and 2006 accrued to the richest 5 percent of households. The new “gilded age” was understandably not very popular among the middle classes that saw their purchasing power not budge for years. Middle class income stagnation became a recurrent theme in the American political life, and an insoluble political problem for both Democrats and Republicans. Politicians obviously had an interest to make their constituents happy for otherwise they may not vote for them. Yet they could not just raise their wages. A way to make it seem that the middle class was earning more than it did was to increase its purchasing power through broader and more accessible credit. People began to live by accumulating ever rising debts on their credit cards, taking on more car debts or higher mortgages. President George W. Bush famously promised that every American family, implicitly regardless of its income, will be able to own a home. Thus was born the great American consumption binge which saw the household debt increase from 48 percent of GDP in the early 1980s to 100 percent of GDP before the crisis.

Increased credit and debt filled the gap left by stagnant wages. In order to maintain the living standard of their middle class parents and grandparents people had to assume more debt and financial oligarchy was willing and able to supply it.

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I'm in Total Agreement with this Economist

After reading this over several times, I find myself perfectly in agreement with this excellent analyses.

She sums it up perfectly, even if somewhat on the conservative side, that the exponential increase in debt leveraging - leading to the ultra-deleveraging of the present - was the prime cause.

Really no mystery there when the most succinct number I've seen to date is $136 on hand for every $10,000 lent, considering the usage of credit default swaps to allow for the "spreading of risk" by the banks, whose majority business was made up of mortgages (over 70% nationwide).

And please remember, an unlimited number of credit default swaps can be written against one borrower.

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The myth is that subprime mortgage failure brought on the meltdn

The myth that she is disputing is that the foreclosures or subprime mortgage market brought on the economic meltdown.

Had there not been layer upon layer upon layer ..... of securitization, this economy, or what is left of it, would not now exist.

The number of actual foreclosures or defaults was relatively low, simply not the "endless well" which we are falling down now.

This is similar to what occurred in the 1920s, leading to the Great Depression.

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I agree with what you said.

But the "myth" arguments detract from that.

It was increased financialization that caused this crisis along with income inequality and globalization.

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