Subprime lending gets a break from being the villain

Remember a few weeks ago when Justin spent some time playing with Fed data on home mortgage lending and made us this nice chart?

And he wrote:

The basic picture is pretty clear: Fannie and Freddie [i.e., GSEs, or government-sponsored enterprises] have dominated U.S. mortgage lending since the early 1980s—except from 2004 through 2006, when the asset-backed securities [ABS] issuers, a.k.a. Wall Street, took over. And that's when the craziest excesses of the mortgage boom happened.

He was onto something there. In this (PDF!) paper (which was presented at a meeting of the Allied Social Science Associations and is under review for publication in the Journal of Housing Economics), three finance academics sort through a whole bunch of loan, home price and broader economic data and conclude that a lot of the house-price run-up we saw after 2003 was because of the pullback of Fan and Fred. Subprime lending itself, not so much to blame.

Kerry Vandell and Major Coleman IV of University of California, Irvine, and Michael LaCour-Little of California State University at Fullerton write:

Our primary conclusion to be drawn from the dominant GSE- vs. dominant private-ABS-regimes is that the primary driver of house price returns during the GSE-dominant years tended to be economic fundamentals, with some indication of short-term, largely offsetting effects from jumbos, subprime, and non-owner occupied investor loans. However, in the ABS-dominant years, with one exception, the loan-density related effects largely disappeared, as did the effects of economic fundamentals. Non-owner occupied loans and the hunger for yields by private ABS issuers exploiting the dynamics of the yield curve (while ex post found to be underpricing risk) drove house price returns to new highs, which did not abate until 2006. Subprime lending activity per se was not the primary culprit in driving house prices higher. Rather both were the products of an economic environment and permissive regulatory environment that allowed the house price market dynamic to play out.

They put it a little more simply in the paper's abstract:

Most significantly, we find evidence that the changing credit regime that took place in late 2003, as the GSE's pulled back from the market for political, regulatory, and market-based reasons [Curious Capitalist notes: they're talking about accounting scandals, caps on retained loans, etc.], is suggested to be a primary factor reducing the dominance of market fundamentals in affecting house price returns and creating the price-momentum conditions characteristic of a “bubble”. Rather than causing the run-up in house prices, the subprime market may well have been a joint product, along with house price increases, (i.e., the “tail”) of the economic, political, and regulatory environment characteristic of the early- to mid-2000's (the “dog”).

Though none of their charts are as attractive as Justin's.

Barbara!