Your Tuesday Subprime Mortgage Fix

The websites for the various Federal Reserve banks are a fascinating source of information. For instance, the Atlanta Fed is breaking new ground with “macroblog” started in October 2008, largely the work of research director/guru David Altig. Also, I recently came across a fascinating piece on subprime mortgage myths from the Cleveland Fed’s Yuliya Demyanyk. I take issue with some of her comments, particularly her Myth 6 about mortgage rate resets, but overall its a very informative document and I found this argument to be the most interesting:

Myth 3: Declines in home values caused the subprime crisis in the United States
Researchers, policymakers, and the general public have noticed that a large number of mortgage defaults and foreclosures followed the decline in house prices. This observation resulted in a general belief that the crisis occurred because of declining home values.

The decline in home values only revealed the problems with subprime mortgages; it did not cause the defaults. Research shows that the quality of newly originated mortgages was worsening every year between 2001 and 2007; the crisis was brewing for many years before house prices even started slowing down. But because the housing boom allowed homeowners to refinance even the worst mortgages, we did not see this negative trend in loan quality for years preceding the crisis.