Cleveland Fed Researcher Debunks Popular Myths about Subprime Mortgage Crisis

As efforts to address foreclosures and resolve the current housing crisis continue, a Cleveland Fed researcher says much of what we believe about what led to the mess we're in is a myth.

In an Economic Commentary released today by the Federal Reserve Bank of Cleveland, economist Yuliya Demyanyk says the causes of the subprime mortgage crisis were more complicated than mortgage interest rate resets, declining underwriting standards, or declining home values. Feeding off the lending, securitization, leveraging and housing booms, Demyanyk says the crisis had been building for years.

Addressing a number of popular myths about the subprime mortgage crisis, Demyanyk says that:

-- Subprime mortgages went to all kinds of borrowers, not only to those with impaired credit.

-- Subprime mortgages did not promote homeownership.

-- Declining home prices did not cause the crisis. They only revealed that the quality of subprime mortgages had been deteriorating for many years.

-- A decline in underwriting standards did not trigger the crisis. Standards were declining, but not enough to explain the magnitude of the rise in defaults.

-- The subprime crisis did not occur because borrowers used mortgages to extract cash from homes. Mortgages that were originated for refinancing (and extracting cash from home equity) performed better than mortgages originated solely to buy a home.

-- The crisis was not solely caused by mortgage rate resets. Fixed-rate mortgages showed as many signs of distress as did adjustable-rate mortgages.

-- Subprime borrowers with hybrid mortgages were not offered low “teaser rates.”

-- The subprime mortgage crisis was not totally unexpected.

-- The crisis in the U.S. is not unique; it seems to have followed the classic lending boom-and-bust scenario that has been observed historically in many countries.

To read more, go to the Commentary.