Explaining the Housing Bubble

Levitin, Adam and Wachter, Susan (2012): Explaining the Housing Bubble. Published in:

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.

• Item Type: MPRA Paper
• Language: English
• 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
• Subjects: L - Industrial Organization > L3 - Nonprofit Organizations and Public Enterprise > L32 - Public Enterprises ; Public-Private Enterprises; K - Law and Economics > K2 - Regulation and Business Law > K23 - Regulated Industries and Administrative Law; L - Industrial Organization > L5 - Regulation and Industrial Policy > L50 - General; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L15 - Information and Product Quality ; Standardization and Compatibility; R - Urban, Rural, Regional, Real Estate, and Transportation Economics > R3 - Real Estate Markets, Spatial Production Analysis, and Firm Location > R31 - Housing Supply and Markets

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