The Smoking Gun; or: It Wasn't a Subprime Crisis After All

[Horseradish]

I've found a very interesting research paper from 2017 that seems to prove that (in the US market, but I imagine that the same technique would produce similar results in the UK) the housing crash in 2007/8 was caused not by irresponsible subprime borrowers, but in fact by the prime segment of the market, specifically in the "real estate investor" segment - i.e. BTL. The abstract from the paper reads:

Quote

A broadly accepted view contends that the 2007-09 financial crisis in the U.S. was caused by an expansion in the supply of credit to subprime borrowers during the 2001- 2006 credit boom, leading to the spike in defaults and foreclosures that sparked the crisis. We use a large administrative panel of credit file data to examine the evolution of household debt and defaults between 1999 and 2013. Our findings suggest an alternative narrative that challenges the large role of subprime credit in the crisis. We show that credit growth between 2001 and 2007 was concentrated in the prime segment, and debt to high risk borrowers was virtually constant for all debt categories during this period. The rise in mortgage defaults during the crisis was concentrated in the middle of the credit score distribution, and mostly attributable to real estate investors. We argue that previous analyses confounded life cycle debt demand of borrowers who were young at the start of the boom with an expansion in credit supply over that period.

The paper examines credit report data (e.g. Equifax, Callcredit). Their approach takes into account the fact that when you take out your first mortgage you usually have a bad credit score, but that over the cycle of the mortgage your score improves - and this fact is not accounted for by previous studies, grossly skewing them and the generally held perception (i.e. that it was a subprime crisis).

The key quote from the report is:

Quote

Most importantly, we find that the rise in mortgage delinquencies is virtually exclusively accounted for by real estate investors.

A pretty stunning result, I am sure you'll agree. Not for the fact that it's surprising (at least to people on here), but that it's provable. It would be amazing to see this research replicated using a UK dataset. I think that this is a bit of a smoking gun for BTL; the paper proves that it was an investor-led crisis. I think that this combined with the market distortions that BTL has caused really need to be better and more widely reported in the media.

The paper is paywalled (of course, urgh), but if you wish to read it there's a good trick with academic papers; just email an author and they'll usually be so thrilled that you're interested in their work that they'll email you a copy ?.

[Si1]

This link isn't paywalled:

 

http://www.nber.org/papers/w23740.pdf

[guest_northshore]

Recall it discussed here previously. Made sense to me. For ref -

Paper: https://econresearch.uchicago.edu/sites/econresearch.uchicago.edu/files/Albanesi_DeGiorgi_Nosal_2017_credit-growth-financial-crisis.pdf

Summary: https://voxeu.org/article/credit-growth-and-global-crisis-new-narrative

[Si1]

Also makes sense that the establishment bailed itself out with zirp - the Wilsons, landlord MPs etc.

[Horseradish]

8 minutes ago, guest_northshore said:

Recall it discussed here previously. Made sense to me. For ref -

Paper: https://econresearch.uchicago.edu/sites/econresearch.uchicago.edu/files/Albanesi_DeGiorgi_Nosal_2017_credit-growth-financial-crisis.pdf

Summary: https://voxeu.org/article/credit-growth-and-global-crisis-new-narrative

I did do a search on here but I couldn't find it linked. Perhaps one of those other links was discussed, or my searching skills were lacklustre... Have you got a link to where it was discussed on here?

Edited July 17, 2018 by Horseradish
Request for link on HPC

[Horseradish]

11 minutes ago, Si1 said:

This link isn't paywalled:

 

http://www.nber.org/papers/w23740.pdf

Seems paywalled for me. Perhaps you work somewhere that pays for it?

[Si1]

28 minutes ago, Horseradish said:

Seems paywalled for me. Perhaps you work somewhere that pays for it?

Ah, I must have a stray cookie logging me in. You're probably right.

[guest_northshore]

32 minutes ago, Horseradish said:

I did do a search on here but I couldn't find it linked. Perhaps one of those other links was discussed, or my searching skills were lacklustre... Have you got a link to where it was discussed on here?

Thought there was more discussion than that, but it's all I could find in a quick search.

 

[Horseradish]

4 minutes ago, guest_northshore said:

Thought there was more discussion than that, but it's all I could find in a quick search.

Great, thanks. Though as you say, that's not a lot of discussion for what is, I think, a pretty important paper. It's a shame that it is paywalled, which will put more than a few people off from digging a little harder for it, but it's absolutely worth the read, not least to bolster the discussion on here!

[guest_northshore]

1 minute ago, Horseradish said:

Great, thanks. Though as you say, that's not a lot of discussion for what is, I think, a pretty important paper. It's a shame that it is paywalled, which will put more than a few people off from digging a little harder for it, but it's absolutely worth the read, not least to bolster the discussion on here!

This was the one:

 

[Horseradish]

1 minute ago, guest_northshore said:

This was the one:

 

Nice, thanks. It makes sense that it was picked up here, albeit via the press on it.

[Captain Kirk]

3 hours ago, Horseradish said:

The paper examines credit report data (e.g. Equifax, Callcredit). Their approach takes into account the fact that when you take out your first mortgage you usually have a bad credit score, but that over the cycle of the mortgage your score improves - and this fact is not accounted for by previous studies, grossly skewing them and the generally held perception (i.e. that it was a subprime crisis).

So what they are saying is that they moved this set of people into the prime borrowers set and, voila, now the prime borrowers caused the subprime crisis?

Well, they certainly were subprimers after the collapse! They probably were before! Especially the ones that had no job or income!

I'm sure that speculation by real prime borrowers was a factor given the 4 years of HPI, mania and fear of losing out. Also, the CDOs and other mortgage derivatives being traded on Wall St which hid subprime were a factor. Also the FED raising rates and bursting the bubble didn't help. And the American Downpayment Dream Initiative that started the whole thing off.

Quite possibly, had it only been subprime and 1st mortgage borrowers that defaulted, we may not have had a crisis, but it doesn't really change much for me.

[Horseradish]

46 minutes ago, Captain Kirk said:

So what they are saying is that they moved this set of people into the prime borrowers set and, voila, now the prime borrowers caused the subprime crisis?

No. There are two separate pieces of evidence, and by far the most important is the other one - noting that it is people with second mortgages defaulting on those mortgages. Additionally, their method for re-appraising what constitutes subprime appears sound, and is an important addition to the literature - please do read the paper.

[Wayward]

The financial crisis in 2008 has been rewritten so many times I have lost count. Every interest group puts a different spin on it to suit their world view and end goal.

[ftb_fml]

I read an article on Wolf Street a while ago on a similar situation unfolding in Canada, which also referenced the US.

Crux was that the cause was defaulting sub-prime lending,  however the image of the typically responsible sub-prime borrower was inaccuractely portrayed by the media as the poor working-class owner occupier struggling to make ends meet; when in actual fact the majority culprits were speculators with a thirst for increasingly unsustainable levels of debt in order to chase rocketing prices.

The point being that the term sub-prime relates any party who wishes to borrow more than their credentials suggest is safe or responsible; regardless of income, background, intent etc.

EDIT: Link.

Edited July 17, 2018 by ftb_fml

[Captain Kirk]

1 hour ago, Horseradish said:

No. There are two separate pieces of evidence, and by far the most important is the other one - noting that it is people with second mortgages defaulting on those mortgages. Additionally, their method for re-appraising what constitutes subprime appears sound, and is an important addition to the literature - please do read the paper.

I will read it when I have a few spare hours. Just skimming through it though, it does come across as a bit of a reclassifying exercise. There were a lot of amateur speculators taking out second mortgages during the boom. I wouldn't class them as investors or necessarily prime borrowers. Maybe long term / professional investors are separated from those in the paper, so I won't speculate any more until I've read it and digested it.

[Captain Kirk]

14 minutes ago, ftb_fml said:

I read an article on Wolf Street a while ago on a similar situation unfolding in Canada, which also referenced the US.

Crux was that the cause was defaulting sub-prime lending,  however the image of the typically responsible sub-prime borrower was inaccuractely portrayed by the media as the poor working-class owner occupier struggling to make ends meet; when in actual fact the majority culprits were speculators with a thirst for increasingly unsustainable levels of debt in order to chase rocketing prices.

The point being that the term sub-prime relates any party who wishes to borrow more than their credentials suggest is safe or responsible; regardless of income, background, intent etc.

EDIT: Link.

+1.

And if anything, there were people considered to be prime who really should have been classified as sub-prime.

Sub-prime rose from 8% to 20% prior to the meltdown according to this paper -

Quote

Subprime mortgages rose from only 8 percent of originations in 2003 to 20 percent in 2005 and 2006, while the interest-only and payment-option share shot up from just 2 percent in 2003 to 20 percent in 2005.

http://www.jchs.harvard.edu/sites/default/files/son2008.pdf

 

 

 

[Si1]

25 minutes ago, Captain Kirk said:

I will read it when I have a few spare hours. Just skimming through it though, it does come across as a bit of a reclassifying exercise. 

Typical of 80% of published incremental academic work these days.

[zugzwang]

The idea that a cohort of America's poorest could between them generate sufficient debt to collapse the US financial system in its entirety (and thence the world) always struck me as supremely improbable. Subprime was just a convenient scape-grace, a sustained misdirection that ensured the real culprits remained scot-free and unfettered in their offshore tax avoidance hideaways. It was the treasure islanders - the Friends of Boris Johnson - and their insatiable demand for risk-free, high yielding assets which ultimately pushed the commercial banks into abandoning all lending restraint and move instead to a securitisation model dependent on overnight commerical paper, credit derivatives and the clandestine informality of the shadow banking system which proved to be their undoing.

 

 

[Si1]

10 hours ago, zugzwang said:

The idea that a cohort of America's poorest could between them generate sufficient debt to collapse the US financial system in its entirety (and thence the world) always struck me as supremely improbable. Subprime was just a convenient scape-grace, a sustained misdirection that ensured the real culprits remained scot-free and unfettered in their offshore tax avoidance hideaways. It was the treasure islanders - the Friends of Boris Johnson - and their insatiable demand for risk-free, high yielding assets which ultimately pushed the commercial banks into abandoning all lending restraint and move instead to a securitisation model dependent on overnight commerical paper, credit derivatives and the clandestine informality of the shadow banking system which proved to be their undoing.

 

 

A convenient excuse to get the poor to bail out the rich.

[bearishonhouses]

21 hours ago, Horseradish said:

Seems paywalled for me. Perhaps you work somewhere that pays for it?

earlier drafts seem to be available at::

http://gatton.uky.edu/sites/default/files/Albanesi.pdf  or 

 

http://www.jaromirnosal.net/uploads/6/0/7/5/60756213/newnarrative_august_2017.pdf

 

[ccc]

22 hours ago, Horseradish said:

Seems paywalled for me. Perhaps you work somewhere that pays for it?

 

21 hours ago, Si1 said:

Ah, I must have a stray cookie logging me in. You're probably right.

"You are eligible for a free download if you are an employee of the U.S. federal government "

Surely not. You do always seem ahead of the game.... 

 

[Si1]

1 hour ago, ccc said:

 

"You are eligible for a free download if you are an employee of the U.S. federal government "

Surely not. You do always seem ahead of the game.... 

 

I deny everything bigly!

Edited July 18, 2018 by Si1