Hat tip to Wendy for sending in this article on subprime vs. prime mortgages causing the crisis. The authors probably didn’t catch the fact that prime borrowers were getting neg-am loans based on FICO scores only, and those weren’t considered subprime loans:
We can draw two conclusions from this data. One is that your chances of being foreclosed upon in the past decade was more a matter of timing than anything else. If you were a subprime borrower in, for instance 2002, who bought a bigger house than a more prudent and creditworthy borrower would have bought, chances are you would have been fine. But a prime borrower who did everything right—bought a house he could easily afford, with a large downpayment—but did so in 2006 would have had a higher chance of defaulting than the subprime borrower with better timing.
Since whether you were hurt by the crisis had more to do with luck than anything else, Ferreira argues we should rethink whether doing more to help underwater homeowners would have been a good idea.
not sure how relevant this paper is despite the hype by fortune. the crux is properly categorizing subprime borrowers, which this paper probably does no better job at it with the paper’s biggest defining trait being the originating lender (appears on HUD list). so the if the loan came from a subprime lender it must be a subprime borrower.
in a homer simpson moment, the key finding of the research is that negative equity conditions explain all of the difference in prime borrowers outcomes. so LTV matters after all.
an un-researched implication cited by the authors is that large numbers of loans from Prime lenders that did not start out with extremely high LTVs still lost their homes. Now they are on to something that truly matters but the authors fail to explore the sequence of home price declines.
and in other news, the authors conclude the problem was “much more widespread and systemic.” house prices, like all others, are set at the margin. perhaps the largest decline in home prices since the great depression happened in a sequence that we think of in a stock exchange. a small decline in price, forces the levered stock buyers out of their positions. this initial forced selling then cascades more widely into prices.
so while subprime loans were not the largest, but perhaps they were sizable enough at the margin to start the cascade down in prices when they defaulted. the price decline got so large, it eventually turned many “prime loans” upside down. obviously, an underwater borrower has a whole different set of incentives.
easy example is a less aggressive lender that only does 90% LTV, but its market competitors are doing 100% LTV. first that will likely drive up prices, so the conservative is not really 90% LTV but more like 95-100% LTV. Then when high LTV loans default, prices fall, causing the conservative loans now to be underwater. So the conservative lender gets hurts by the irrational lender. The lending practices of the “marginal” lender have a large influence in the marketplace. IMHO, the authors are downplaying the role of the marginal lenders in this crisis, which were the subprime names.
the simple take away is that leverage matters regardless if the paper is prime or subprime. too much high LTV can affect the whole market.