Question

Describe the path of housing values leading up to, and after, the financial crisis. In this context, you should talk about NINJA/subprime loans, adjustable

mortgage rates, then in detail describe at least one real economic impact that was a result of

the housing bubble

Answer 1

There were many causes, but none of them individually was enough to cause a crisis of the magnitude we got.

The initial blame was put on subprime mortgages, but this was always silly. There weren’t enough of them to matter that much, and losing an average of 20% on loans you expected to lose 5% is not a terrible shock.

People also pointed to complex securities, but most of these crashed in the Fall of 2007, causing large problems through Spring of 2008, but not in October 2008 when things really fell apart. Corporate supersenior CDS and commercial MBS worried a lot of people, but there was no massive wave of defaults.

It wasn’t until 2010–11 that the role of developed country fiscal problems became clear. It affected things during the crisis with the massive crises in the PIIGS countries, but less noticed at the time was fear that governments of larger and stronger economies would bankrupt themselves bailing out cronies.

Another factor that was underappreciated in 2008 but later became clear was the amount of outright fraud among prime mortgages taken out by middle class people, rather than subprime loans taken out by poor people. Although the losses were smaller than subprime, the dollar amounts were much larger and the surprise was much greater. 3% losses on a pool that expected 0.1% losses is a bigger problem than the subprime numbers.

Finally the massive uncertainty caused by daily ad hoc changes to financial rules, many retroactive, and others incomprehensible was a significant contributor.

Tracing through these and other factors to identify a single cause is hopeless. They all worked together in different ways at different times, and there were other factors at play as well.