THE GREAT AMERICAN HOUSING BUBBLE

Rickety Wall Street innovations and systemic market failure caused the rise in housing prices and mortgage debt that precipitated the Great Recession of 2008, according to this study.

Georgetown law professor Levitin and Wharton economist Wachter reject prominent explanations of the housing bubble of the 2000s. It was not, they contend, primarily caused by the Community Reinvestment Act’s requirement that lenders make loans to poor borrowers or by loose monetary policy or by a global savings glut. The authors advance their own complex, systematic theory of financial markets gone awry. The problem started, they argue, when the traditional 30-year fixed-rate mortgage—“the hero of our story”—was supplanted with exotic, adjustable-rate mortgages or no-amortization loans that lured borrowers with low initial payments. These mortgages were pooled and sold to investors as “private-label securities” by unregulated lenders who grabbed a market share from the staid, federally regulated corporations Fannie Mae and Freddie Mac. Demand for more mortgages to sell to investors drove lenders to make loans to bad credit risks. These iffy mortgages were packaged in complicated, opaque collateralized debt obligations and sold to still more investors with no serious accounting of their risks. That expansion of cheap credit caused borrowers to bid up housing prices to unsustainable levels on mortgage-backed securities whose risks were not reflected in their prices—with no short-selling mechanism to let the market correct itself. Dysfunctions like these are intrinsic to housing markets, the authors contend, and can only be solved by a sweeping reregulation of housing finance that would entrench traditional fixed-rate mortgages under a more powerful, federally chartered corporation that they dub “Franny Meg.” Levitin and Wachter base their intricate, incisive argument on a close reading of the scholarly literature backed up by careful attention to economic evidence and price data, which they present in illuminating charts. The book is aimed at academics and policymakers, but interested lay readers can also tackle it thanks to the authors’ thorough explanations and prose that’s always lucid and even stylish. (“It took only a very small amount of dumb or conflicted money in CDOs to build an enormous pyramid of leverage in the housing market.”) The result is an indispensable analysis of the crisis and the far-reaching measures needed to prevent a recurrence.

A trenchant analysis of the berserk market dynamics that laid low the American economy.