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Excellent Economic Research; Mortgage Experts Did Not Predict The Housing Crash, They Lost More Than Non-Mortgage Experts

This article is more than 9 years old.

This is a lovely little piece of economic research summarised for us over at EconLog. The finding is that the experts in the mortgage securitisation business were even more clueless than the rest of us about the housing bubble and the likelihood of a crash. This rather puts paid to the idea that it was all a conspiracy to make as much as possible while the sun was shining.

Here's the basic nugget:

A forthcoming AER paper examines whether professionals in the mortgage securitization industry foresaw the housing crash. If these professionals knew that they were buying and selling toxic assets, they would betray this knowledge by their personal housing decisions. For example, if you thought that the housing market was going to crash, you wouldn't rush out to buy a second home. However, the AER paper shows that securitization professionals were as aggressively invested in the housing market as comparable professionals.

So think this through for a moment. If you were some evil character intent on just making as much money as you could out of flogging dodgy mortgages to people, knowing that such mortgages were not a very good idea, then you would have sold those mortgages but stayed out of the market yourself. That is, if you were a predatory lender who knew that the whole house of cards was about to come tumbling down then you would have continued to cash the commission checks, continued to drum up business, but you would never have put your own money into something that you knew was going to fail.

On the other hand, it is actually possible that you simply made a mistake. That you were deluded if you prefer. Into thinking that the housing market was only ever going to go up and thus encouraging people to mortgage themselves to the hilt was just a great idea. And if you did believe that then you would probably go out and do that yourself as well, given the commission checks that were rolling through your bank account at the time.

So, by looking at whether these mortgage industry professionals were taking out loans for second houses and so on we can get an insight into their true beliefs. If they geared up on housing less than everyone else then perhaps we might start to think that they didn't believe in the market. If they were borrowing just as much as everyone else then perhaps they were just as deluded as the rest of us? That is, simply being wrong which isn't one of those things that is or ought to be a crime.

And our finding is that they were borrowing just as much if not more as everyone else:

Securitization professionals were less likely to divest from housing in every year from 2003-2006 -- the prime "bubble period." They were slightly more likely to divest in 2007-2009 during the bust.

Yep, during the bubble they were deeper into the market, meaning that our best guess is that they really did believe the story. And so were wrong, not duplicitous.

This is also an interesting finding:

The housing portfolios of managers from companies that cratered during the crash (like Lehman and Countrywide) did worse than the portfolios of managers from companies that did relatively well (like BB&T and Wells Fargo ).

We can even distinguish between firms in this, the managers of those who did worse believed the story even more strongly as evidenced by their personal behaviour.

This is an excellent little piece of economic research and provides us with an interesting conclusion. That bubble was about people getting things wrong rather than about anything else.