In House of Debt, Atif Mian, an economist at Princeton University, and Amir Sufi, a finance professor at the University of Chicago, make the case that household debt was the 2008 recession’s main culprit. This is a nuanced view that differs slightly from the view that it was the 2007 home price decline.
Mian and Sufi point out that the poorest homeowners suffered the most from the crash in home prices. They relied the most on home equity for net worth. Richer homeowners had other non-real estate assets that were less directly affected by the decline in home prices.
You can compare the dramatically different effects on the economy between the 2003 crash in internet stocks and the 2007 crash in home prices. The 2003 crash mostly hurt those with enough wealth to be invested in the stock market. The housing price decline hid a broader section of the population. By losing their net worth, the poorest homeowners lost their spending power, which lead to a drop in sales, which lead to a loss in production, which lead to a dramatic increase in unemployment. The 2003 crash was followed by a very shallow and brief recession, with little job loss.
The mortgage default rate from the 2008 recession was unprecedented. Since 1979 the mortgage default rate had never been above 6.5%. In 2009 the rate spiked above 10%. Loans were originated that went into default a few months later. The models for the securitized loans failed to address the widespread defaults.
There is no denying that some consumers were manipulated by lenders into taking out a lot of terrible home loans. There was a lot fraud and looking the other way on all sides of the mortgage loan closing table. But there was money to be made. Lenders flooded low-credit quality neighborhoods with credit despite the lack of indications that these loans could be repaid by the borrower.
The authors’ solution is a “shared-responsibility mortgage.” The lender takes some risk additional risk on the decline in value of the home and also gets a slice of the appreciation in value of the home. The monthly mortgage payment and amortization schedule gets reduced proportionally if housing prices fall. If prices increase, the lender gets a share of the appreciation. I think it’s an interesting idea, but not one that would work practically.
Regardless, the book is interesting look back at 2008 using empirical data.