The American housing bubble of the 2000s caused the worst global financial crisis since the Great Depression. In this definitive account, Adam Levitin and Susan Wachter pinpoint its source: the shift in mortgage financing from securitization by Fannie Mae and Freddie Mac to “private-label securitization” by Wall Street banks. This change set off a race to the bottom in mortgage underwriting standards, as banks competed in laxity to gain market share.
The Great American Housing Bubble tells the story of the transformation of mortgage lending from a dysfunctional, local affair, featuring short-term, interest-only “bullet” loans, to a robust, national market based around the thirty-year fixed-rate mortgage, a uniquely American innovation that served as the foundation for the middle class.
Levitin and Wachter show how Fannie and Freddie’s market power kept risk in check until 2003, when mortgage financing shifted sharply to private-label securitization, as lenders looked for a way to sustain lending volume following an unprecedented refinancing wave. Private-label securitization brought a return of bullet loans, which had lower initial paymentsenabling borrowers to borrow morebut much greater back-loaded risks. These loans produced a vast oversupply of underpriced mortgage finance that drove up home prices unsustainably. When the bubble burst, it set off a destructive downward spiral of home prices and foreclosures.
Levitin and Wachter propose a rebuild of the housing finance system that ensures the widespread availability of the thirty-year fixed-rate mortgage, while preventing underwriting competition and shifting risk away from the public to private investors.
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About the Author
Susan M. Wachter is Albert Sussman Professor of Real Estate and Professor of Finance at The Wharton School of the University of Pennsylvania. She is codirector of the Penn Institute for Urban Research and was an assistant secretary of HUD.
Table of Contents
Introduction: In Praise of Homeownership 1
1 Housing Finance before the New Deal 16
2 The New Deal Mortgage 38
3 The Rise of Securitization 65
4 The Boom and the Bubble 81
5 The Bubble Bursts 110
6 Timing the Bubble 131
7 Demand or Supply? 135
8 Theories of the Bubble 148
9 The Wall Street Securitization Bubble 163
10 The Key Market Failure 181
11 Postcrisis Reforms and Developments 204
12 Principles for Reform 232
13 Meet Franny Meg 255
Appendix A The Pre-New Deal Farm Finance System 265
Appendix B The Levitin-Wachter Subprime PLS Dataset 271
Appendix C CDO Manager Compensation 273