As the U.S. economy continues to emerge from the Great Recession, there is no shortage of theories and opinions about what caused it.
Some observers and commentators have argued that affordable housing policies in the U.S. were to blame for the subprime mortgage boom, which was at the heart of the financial crisis that began in 2007. The crisis was preceded by dramatic growth in the volume of subprime mortgages originated, a boom that turned into a bust.
My research, “Did Affordable Housing Legislation Contribute to the Subprime Securities Boom?” published in Real Estate Economics, seeks to answer the question of whether affordable housing policies influenced the market for securitized subprime mortgages. And the answer is no.
The research, conducted with Rubén Hernández-Murillo of the Federal Reserve Bank of Cleveland, and Michael T. Owyang of the research division of the Federal Reserve Bank of St. Louis, found no evidence that affordable housing goals specified in federal legislation had an effect on the volume, pricing, or performance of securitized subprime mortgages.
Our research further shows that while the government-sponsored entities (GSEs) held substantial amounts of subprime private-label mortgage-backed securities (PLMBS), which were contributing factors in the financial crisis, there is no evidence that affordable housing mandates were responsible for the subprime boom.
Beyond statistical evidence, other factors gleaned from data support the conclusion that affordable housing legislation did not contribute to the subprime mortgage crisis. Our data are subprime, securitized, first-lien mortgages on one-unit properties originated in metropolitan areas of California and Florida in 2004 through 2006. The sample period coincided with the height of the subprime mortgage boom. California and Florida had large shares of subprime mortgage originations and experienced a large share of defaults during the housing bust in the following years.
First, of the 722,157 loans in our data set, the average loan went to someone with a stated income of more than $100,000. On paper, these were high-income, not low-income, households. Even if borrowers and loan originators misstated income in order to get loans originated, they would have understated rather than overstated income if they wanted the loans to qualify for affordable housing goals.
Second, the majority of the loans in our data set were originated by non-depository institutions, despite the fact that one of the affordable housing programs, the Community Reinvestment Act (CRA), only applies to depository institutions.
Those who blame affordable housing mandates for the subprime boom are often not specific about what program caused the crisis. However, the two main affordable housing programs for owner-occupied housing goals in the U.S. are the CRA, and Fannie Mae and Freddie Mac’s affordable housing goals. The affordable housing mandates target low-income neighborhoods and individuals.
We looked at loans just under the income threshold for the various affordable housing programs. For example, a qualifying loan through the CRA requires the borrower to have less than 80 percent of the median area income. So if the average income in a Census Tract is $50,000, the loan will qualify if the borrower has an income of $40,000 or less. There’s not much difference between someone with an income of $39,500 and someone with an income of $40,500, but the first loan would qualify for the CRA while the latter would not.
We thus looked to see if there were more loans made just under that threshold, which would indicate the affordable housing goal was a factor in originating the loan. We looked for a similar jump in interest and default rates. The data showed no discontinuities around the thresholds.
While we find no evidence that the affordable housing laws directly affected the subprime PLMBS market, the market may have been affected indirectly by the GSEs’ purchase of substantial quantities of PLMBS which added demand for those securities.
Our research does not indicate what caused the subprime mortgage boom but the evidence does not support claims the affordable housing mandates were responsible. It’s important to understand the true causes of the subprime mortgage crisis, and we hope our findings inspire researchers to seek other explanations for the subprime securities boom.
Read the full paper “Did Affordable Housing Legislation Contribute to the Subprime Securities Boom?” published in Real Estate Economics.
Andra Ghent is associate professor of real estate and land economics and Lorin and Marjorie Tiefenthaler Professor of Real Estate at the Wisconsin School of Business