Here's what really caused the housing crisis

By Mark Thoma MoneyWatch January 10, 2017, 5:30 AM

One story of the housing crisis goes like this: Government programs that helped low-income households purchase houses led to widespread defaults on the subprime loans they held, sparking the entire the financial meltdown.

For example, Lawrence Kudlow and Stephen Moore, both of whom have been named as economic advisers to Donald Trump, argue that the financial crisis and recession were caused by policies Bill Clinton implemented that were designed to stop discrimination in housing loans, known as “red-lining,” in poor areas. In particular, they argue that the Community Reinvestment Act (CRA), legislated in 1977, is to blame:

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However, according to new research from the Sloan School of Management at MIT, that isn’t what happened. As the author of the research, Antoinette Schoar, explained in an interview:

“A lot of the narrative of the financial crisis has been that this [loan] origination process was broken, and therefore a lot of marginal and unsustainable borrowers got access to funding. In our opinion, the facts don’t line up with this narrative. … Calling this crisis a subprime crisis is a misnomer. In fact, it was a prime crisis.”

There are other reasons to doubt that subprime borrowers were responsible for the financial crisis. For one, a large number of subprime mortgages originated in non-CRA banks, and “none of the 300+ mortgage originators that imploded were depository banks covered by the CRA.”

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As noted in a study by McClatchy from 2008, “Federal Reserve Board data show that more than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions;” “private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year;” and “only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that’s being lambasted by conservative critics.”

A second question to ask is why, if the CRA and subprime borrowing were the problem, did a very similar housing bubble and financial crisis occur in scores of other countries that didn’t have legislation like this?

A third argument, the one Kudlow and Moore cite, is that declining lending standards by Fannie and Freddie brought about by the requirements of the CRA helped fuel subprime loans. But once again, this argument doesn’t stand up to scrutiny.

As Barry Ritholtz pointed out in 2011, “The relative market share of Fannie Mae and Freddie Mac dropped from a high of 57 percent of all new mortgage originations in 2003, down to 37 percent as the bubble was developing in 2005-06.”

The reason Fannie and Freddie were losing market share is that loan standards on mortgages issued by private lenders were falling. Fannie and Freddie eventually adjusted some of their conditions for obtaining a loan in an attempt to prevent a further loss in market share, but it’s very clear that they were followers, not leaders, in the erosion of lending standards.

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But when it comes to the financial crisis, government wasn’t the problem. It was lack of government, specifically the failure to impose the necessary regulatory structure on the shadow banking system.

I can’t put the entire blame on Republicans for the failure to regulate the financial system because Democrats also supported reduced regulation based on the idea the markets, especially ones with so much at stake, are self-regulating.

What I can say is that conservatives seem to have learned little from the experience largely because they ignore what solid evidence says and instead embrace political arguments. This isn’t the only issue where that’s true, and I can’t see how that will change with Mr. Trump as president.

For more of that solid evidence, see:

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