Causes for the subprime crisis, revisited

Aug 13, 2011 20:00

...the bubble explanation is at best a proximate explanation of the subprime crisis. But while the bubble explanation is incomplete, it is also parsimonious. The only deviation from rationality it requires is the belief that house prices will continue to rise rapidly for the foreseeable future. If this belief was widespread, then millions of decisions by borrowers and investors make sense. By contrast, the insider/outsider theory requires that borrowers and sophisticated institutional investors independently, repeatedly, and systematically misunderstood the choices before them, even though they had been dealing with similar choices for decades without any problems.http://www.dictionaryofeconomics.com/article?id=pde2011_S000547

The paper argues that (now publicly available) loan-level data contradict the popular theory that insiders in the securitization process (mortgage brokers, mortgage bankers and investment bankers) took unfair advantage of the outsiders at the opposite ends of the chain (borrowers and investors). Their behavior suggests that all sides were equally deluded. It is more-or-less consistent with the classical asset bouble.

economics

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