Subprime lending not main trigger of real estate bubble

July 30, 2008

( -- Critics often point to subprime mortgage lending – the funding of home loans to borrowers with less-than-perfect credit – as the culprit in the unsustainable boom in U.S. home prices that eventually derailed the real estate and mortgage markets.

But new research led by UC Irvine’s Paul Merage School of Business Center for Real Estate suggests subprime loan products themselves may not be the primary cause of U.S. home prices’ rise and fall.

Instead, the considerable 2003 pullback of government-sponsored financial service corporations Fannie Mae and Freddie Mac from the credit market and their replacement by aggressive, private mortgage securities issuers in late 2003 had a significant impact on home prices and was more responsible than subprime lending for the drastic price runup that peaked in early 2006.

“We were quite surprised to find the intensity of subprime lending was insignificant after controlling for all the other factors influencing the market, but we were really blown away when Fannie’s and Freddie’s continuing presence in the market was shown to be so important,” said Kerry Vandell, UCI finance professor and Center for Real Estate director.

Vandell along with Major Coleman IV, finance doctoral student, and Michael LaCour-Little, Cal State Fullerton finance professor, used 1998-2006 housing and mortgage data from a variety of sources – including First American LoanPerformance, the S&P/Case-Shiller Home Price Indices and the Federal Housing Finance Board – to analyze 20 U.S. metropolitan areas.

The researchers found that rising home prices up to 2003 could be explained by economic fundamentals, such as low unemployment rates, expanding household incomes and population growth. These factors fueled housing demand and, in turn, increased U.S. home prices. During this time, Fannie Mae and Freddie Mac actively issued and purchased conventional, conforming mortgage-backed securities.

But in 2003, political, regulatory and economic factors – including accounting irregularities that led to their senior officers’ resignations and the capping of their retained loan portfolios – forced the two entities to significantly slow their lending volume. Private funding in the form of asset-backed securities and residential mortgage-backed securities replaced conventional, conforming mortgage-backed securities as the prevalent source of mortgage capital.

The new credit environment allowed looser underwriting standards and increased tolerance for riskier, high-yield loan products. Such products included adjustable-rate mortgages with low initial “teaser” rates, Alt-A loans that did not require income verification and nonowner-occupied investor products. This borrowing climate provided previously marginal borrowers with additional access to credit. The credit market shift led to a record increase in total mortgage volume and pushed up home prices with momentum characteristic of a bubble.

The researchers also determined that interest rates did not significantly affect house prices. The finding defied conventional wisdom that ties interest rates directly to the monthly cost of housing and assumes an effect on purchase prices.

“These findings help us understand that the government can have a major role in affecting the mortgage and housing markets,” Vandell said. “It’s important policymakers consider this influence when they attempt to shape the markets in the future.”

The research was partly funded by the Homer Hoyt Institute, Freddie Mac, the Mortgage Bankers Association and the National Association of Realtors’ Subprime Crisis Research Consortium. An earlier version of the research was first presented at the 2008 meeting of the Allied Social Science Associations.

Provided by University of California, Irvine

Explore further: Media plays role in igniting price wars

Related Stories

Media plays role in igniting price wars

September 17, 2015

Before Reserve Bank Governor Graeme Wheeler even announced last week's cut to the Official Cash Rate, there were media reports of fixed mortgage rates heading towards record lows. Massey University's Professor Harald van ...

Why are young Australians turning their back on the car?

January 6, 2015

Australians have long had a love affair with the car. Car ownership and use has increased every decade since its introduction to Australia. The car has fundamentally shaped the urban form of Australian cities – not just ...

Promoting homeownership is not entirely risk free

September 10, 2014

For twenty years, Switzerland has been promoting homeownership by letting residents draw on their pension fund assets to buy a home. In a recent study, Philippe Thalmann, EPFL professor in economics and architecture, dispels ...

Recommended for you

The dark side of Nobel prizewinning research

October 4, 2015

Think of the Nobel prizes and you think of groundbreaking research bettering mankind, but the awards have also honoured some quite unhumanitarian inventions such as chemical weapons, DDT and lobotomies.

How much for that Nobel prize in the window?

October 3, 2015

No need to make peace in the Middle East, resolve one of science's great mysteries or pen a masterpiece: the easiest way to get yourself a Nobel prize may be to buy one.

Search for Egypt's Nefertiti gains new momentum (Update)

September 29, 2015

The search for ancient Egypt's Queen Nefertiti in an alleged hidden chamber in King Tut's tomb gained new momentum as Egypt's Antiquities Minister said Tuesday he is now more convinced a queen's tomb may lay hidden behind ...


Adjust slider to filter visible comments by rank

Display comments: newest first

4 / 5 (5) Jul 30, 2008
Hmmm, Freddie Mac funded research finds Freddie Mac are soooo important.
Any bias here?
You have to look at the timing of it too, when tax payers are going to have to bail them out to the tune of $bns.
What an egregious example of patting your own back.
4.7 / 5 (3) Jul 30, 2008
You can save a lot of time by just reading who funded this "study"
3.7 / 5 (3) Jul 31, 2008
4 / 5 (1) Jul 31, 2008
"The new credit environment [a drop in the availability of loans] allowed looser underwriting standards and increased tolerance for riskier, high-yield loan products."

That sounds logical. Oh wait. No it doesn't.

As the other commenters are saying, just look at who funded the study and move on. Hey, and for what the heck is physorg publishing such drivel, anyway?

4 / 5 (2) Jul 31, 2008
It actually wasn't sub-prime lending, it was mortgage-backed securities. When a bank can loan you the money for a mortgage, then turn around and sell a mortgage-backed security near instantly to some sucker foreign investors, home sales become a game of VOLUME with practically no risk to the bank. They make you buy mortgage insurance and can always foreclose on you if you don't pay, and the government has gaurenteed that they get paid by screwing up the bankruptcy laws. How can you charge interest based on the lenders probability of paying you back when the government establishes laws that make the lender pay, no matter what?
4 / 5 (1) Jul 31, 2008
No one mentions the political & social pressure to increase loans to minorities and poor who were previously unable to get loans. This led to confusion between illegal (and immoral) discrimination based on race, neighborhood, life style, culture, etc. and appropriate income based discrimination. The result was, well you know...
not rated yet Jul 31, 2008
Yeah yeah.. who paid for this study?
5 / 5 (1) Aug 04, 2008
"...government-sponsored financial service corporations Fannie Mae and Freddie Mac..."

"....replacement by aggressive, private mortgage securities issuers in late 2003...."

Does this mean that the government started the sub-prime loans in the first place and that the government pulled the pin in the second place?

And who came up with those names anyway. They should have been censored!

Please sign in to add a comment. Registration is free, and takes less than a minute. Read more

Click here to reset your password.
Sign in to get notified via email when new comments are made.