The myth of the subprime crisis

A decade after its onset, the Great Recession is now generally blamed on a subprime mortgage crisis – with banks granting too many loans to low-income borrowers at high risk of default.

But Professor Manuel Adelino discovered that the account did not correspond to the facts.

Adelino, professor of finance at Duke University’s Fuqua School of Business, with co-authors Antoinette Schoar of MIT and Felipe Severino of Dartmouth, reviewed national data on income, home sales and loans mortgages years before and during the financial crisis. They found that the bank meltdowns that triggered the recession were the result of increased defaults among higher-income buyers.

The resulting research The role of the real estate and mortgage markets in the financial crisis, was recently published in the Annual Review of Financial Economics.

Adelino discusses the results in this Fuqua Q&A.

You discovered that low-income buyers were not responsible for the financial meltdown that led to the recession. How did you conclude that?

The argument for the subprime mortgage crisis is that the supply of credit to low-income households fueled the rise in house prices and was the cause of the crash. We looked at data on all mortgages issued in the United States between 2002 and 2006. We were able to see the size of the mortgage and the income reported by buyers. We also had zip code level data from the IRS, and we had access to a sample of mortgages that we could see if they were still up to date with their payments or had defaulted.

We found that there was no credit boom available to low-income borrowers. In fact, homeownership rates among the poorest 20% of Americans fell during the boom because these buyers were shut out of the market. Instead, we found that credit was extended across the board. Everyone was playing the same game. But credit expanded most dramatically in areas where house prices were rising the most, and these were markets beyond the reach of low-income borrowers.

The overwhelming majority of mortgages went to middle-income and relatively high-income households during the boom, as they always have.

Even though low-income households weren’t getting more credit, defaults caused the recession. Don’t low-income borrowers default more often?

This is usually the case. You become a subprime borrower by having a low credit score, and you get a low credit score by not meeting your debts. It’s no surprise that mortgages given to subprime borrowers have higher default rates, because that’s how they became subprime in the first place.

But what caused the financial crisis was that middle- and upper-income borrowers – including speculators who bought homes to resell them for a profit – began to default at unprecedented rates. We had a crisis because non-subprime borrowers defaulted, which they rarely did before.

In 2003, 71% of delinquent mortgages were held by subprime borrowers. But in 2006, subprime borrowers held only 39% of delinquent mortgages. Not only that, there simply aren’t enough low-income borrowers to bring down the financial system, it’s too robust for that.

Why is it important that people are wrong about the recession?

Because regulators responded based on the belief that there had been a boom in credit to low-income borrowers. They limited mortgage credit to subprime borrowers based on the belief that these loans had put the banking system at risk. This made it harder for low-income people to get credit for several years, just as house prices were lower, when first-time buyers and those with less money might otherwise have entered the market. market and help it recover. Homeownership rates among low-income borrowers have plummeted since the crisis due to the active limitation of credit to these borrowers. This did not add stability to the banking system as expected.

The financial crisis has changed the way we do research in economics and finance. We now believe there is a link between the massive increase in defaults and foreclosures and long-term economic growth losses. A better understanding of the boom and bust of the housing market can lead to better understanding for regulators and businesses when a similar situation occurs in the future.