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Increased mortgage securitization and the proliferation of new mortgage products have been widely blamed for the current financial crisis. A new paper by Princeton University’s Harvey S. Rosen, former chairman of President George W. Bush’s Council of Economic Advisers, and Federal Reserve economists Kristopher Gerardi and Paul S. Willen challenges
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these assumptions. The authors of the study note that the spread of innovative mortgage products occurred long before the lending boom that led to the current crisis. At this event, they will present their findings that these products actually had a positive effect on mortgage markets by helping good borrowers with high future incomes to buy homes.
Discussing the paper’s conclusions and its implications for financial regulation will be Karen Dynan of the Federal Reserve Board of Governors and AEI’s Alex J. Pollock. AEI director of economic policy studies Kevin A. Hassett will moderate.
| 9:45 a.m. |
Registration |
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| 10:00 |
Presenters: |
Kristopher Gerardi, Federal Reserve Bank of Atlanta |
| Harvey S. Rosen, Princeton University |
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| Paul S. Willen, Federal Reserve Bank of Boston |
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| Discussants: |
Karen Dynan, Federal Reserve Board of Governors |
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| Alex J. Pollock, AEI |
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| Moderator: |
Kevin A. Hassett, AEI |
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| 11:30 |
Adjournment |
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WASHINGTON, MAY 18, 2009--Increased mortgage securitization and the proliferation of new mortgage products over the past few decades have received much blame for causing the ongoing housing crisis. At an AEI event on May 15, Princeton University's Harvey Rosen and Federal Reserve economists Kris Gerardi and Paul Willen presented a paper that challenges these assumptions by showing that the increase in mortgage securitization predated the crisis by nearly two decades and actually enhanced efficiency in the housing market, making homebuyers better off.
According to Rosen, who served on George W. Bush's Council of Economic Advisers from 2003 to 2005, "people make their economic decisions with an eye not only to their economic circumstances today but their future economic circumstances." Therefore, even if a doctor and a plumber earn the same income today, the doctor would be expected to buy a more expensive home based on the expectation that his income will rise in the future. If the theory holds true, the authors surmise that consumers' current spending levels should forecast their future income, and the efficiency of the housing finance market can be evaluated based on whether or not consumers can borrow based on their future income.
Using data covering home purchases from 1970 to 2005, the authors find, according to Gerardi, that "people are thinking toward their future and future earning power when they are making . . . housing purchase decisions; people who buy big houses are not being reckless and myopic." He reasons further that if the ability through your home purchase to forecast your future income "has been improving over time, then we would infer that the system of housing finance has been getting better over time because it's letting people spend according to their permanent income." Again, the data support this inference, showing that home purchases over time became more sensitive to future income--corresponding with the development of the secondary mortgage market in the early to mid-1980s. The data also suggest that subgroups more constrained by income limits--such as first-time homebuyers, low-income households, and minority- and female-headed households--benefitted the most from mortgage market innovations.
Karen Dynan, an assistant director in the Division of Research and Statistics of the Federal Reserve Board of Governors, said the paper successfully persuaded her to believe "that mortgage credit availability changed in the 1980s in a way that has been welfare-enhancing." She questioned, however, whether all of the improvement could be attributed to mortgage securitization. "There were a lot of things that happened in the 1980s," she said, including the standardization of underwriting and the deregulation of state banking laws. Turning to the question of what financial innovation has done more broadly for household economic security, Dynan suggested that although it has allowed households to take bigger risks in pursuit of higher utility, households' share of income that is committed to debt service and households' exposure to asset price shocks have also increased dramatically. Looking at the current crisis, Dynan said that it "illustrates that innovations expanding credit supply may not only allow households to take on larger direct risks, but, to the extent that risk-taking is correlated across households, may lead to broader negative consequences by inducing a credit cycle."
Providing a historical perspective on the mortgage market was AEI's Alex J. Pollock, who liked the way the paper "makes us think . . . about the institutional evolution over a much longer time frame that what we're accustomed to." He highlighted changes during the 1980s that substantially altered the mortgage market, including the expansion of government-sponsored enterprises, the introduction of adjustable-rate mortgages, and "innovation around the process or mortgages" that lowered the cost of refinancing and enhanced its efficiency. Although "securitization largely succeeded in solving the problem of managing interest rate risk of long-term fixed rate mortgages," he said, a new problem needs to be resolved: how "the mortgage system deals with finance based on the expectations of rising house prices."
--AMY RODEN
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Karen Dynan is an assistant director in the Division of Research and Statistics of the Federal Reserve Board of Governors. Her research focuses on household consumption and saving decisions, household indebtedness, and the effects of financial innovation on economic volatility. She has published papers in numerous journals, including The American Economic Review, the Journal of Monetary Economics, the Journal of Political Economy, and The Journal of Economic Education. From 2003 to 2004, Ms. Dynan served as a senior economist at the President’s Council of Economic Advisers. She was also a visiting professor at Johns Hopkins University in 1998.
Kristopher Gerardi is a research economist and assistant policy adviser in the economic group in the research department of the Federal Reserve Bank of Atlanta. His major fields of study are real estate economics, applied microeconomics, and macroeconomics. Before joining the Atlanta Fed in 2008, Mr. Gerardi was a research associate at the Federal Reserve Bank of Boston. He has published in several journals, including The Journal of Finance, the Journal of Political Economy, the Brookings Papers on Economic Activity, and the NBER Macroeconomics Annual.
Kevin A. Hassett is the director of economic policy studies and a senior fellow at AEI. He is also a weekly columnist for Bloomberg. Before joining AEI, Mr. Hassett was a senior economist at the Board of Governors of the Federal Reserve System and an associate professor of economics and finance at Columbia Business School. He was an economic adviser to the George W. Bush campaign in the 2004 presidential election and was the chief economic adviser to Senator John McCain during the 2000 presidential primaries and the 2008 presidential campaign. He has also served as a policy consultant to the U.S. Department of the Treasury during both the former Bush and Clinton administrations. Mr. Hassett is a member of the Joint Committee on Taxation’s Dynamic Scoring Advisory Panel. He is the author, coauthor, or editor of six books on economics and economic policy, including Toward Fundamental Tax Reform (AEI Press, 2005). He has published scholarly articles in The American Economic Review, Economic Journal, the Quarterly Journal of Economics, the Review of Economics and Statistics, the Journal of Public Economics, and many other professional journals. Mr. Hassett’s popular writings have been published in the Wall Street Journal, The Atlantic Monthly, USA Today, the Washington Post, and numerous other outlets. His economic commentaries are regularly aired on radio and television, including recent appearances on Fox Business, Bloomberg’s Political Capital, and CNBC’s Power Lunch.
Alex J. Pollock has been a resident fellow at AEI since 2004, focusing on financial policy issues, including government-sponsored enterprises, retirement finance, housing finance, corporate governance, accounting standards, and issues raised by the Sarbanes-Oxley Act. Previously, he spent thirty-five years in banking, including twelve years as president and chief executive officer of the Federal Home Loan Bank of Chicago, while also writing numerous articles on financial systems and management. He is a director of Allied Capital Corporation, the Chicago Mercantile Exchange, the Great Lakes Higher Education Corporation, the International Union for Housing Finance, and chairman of the board of the Great Books Foundation.
Harvey S. Rosen is the John L. Weinberg Professor of Economics and Business Policy at Princeton University, where he teaches undergraduate courses in public finance, taxation, and introductory microeconomics and graduate courses in public finance. Mr. Rosen has been a member of Princeton’s department of economics since 1974. He served as chairman of the department from 1993 to 1996 and has been codirector of the Center for Economic Policy Studies since 1993. In 1986, he was elected a fellow of the Econometric Society. From 1989 to 1991, Mr. Rosen’s served in the U.S. Department of the Treasury as deputy assistant secretary for tax analysis. During a second stint in Washington from 2003 to 2005, he served on the President’s Council of Economic Advisers, first as a member and then as chairman. In this capacity, he provided advice to the White House on a wide variety of policy issues, including tax reform, social security, health care, energy, the federal budget, and financial market regulation. Mr. Rosen is widely published in the public finance literature and is the author of Public Finance (McGraw-Hill/Irwin), a textbook used widely in undergraduate public finance courses that is now in its eighth edition. He serves on the editorial boards of several journals dealing with public finance and taxation. In 2007, he received the National Tax Association’s most prestigious award, the Daniel M. Holland Medal for distinguished lifetime contributions to the study and practice of public finance.
Paul S. Willen is a senior economist and policy adviser in the research department of the Federal Reserve Bank of Boston. Mr. Willen’s research focuses on household financial management and has been published in many scholarly journals, including the Review of Economics and Statistics, Economic Theory, The Journal of Finance, the Journal of Public Economics, the Journal of Urban Economics, the NBER Macroeconomics Annual, and the Brookings Papers on Economic Activity. His recent research on the mortgage markets and the origins of the subprime crisis has appeared in scholarly journals and has been cited in virtually every major newspaper in the United States. Before joining the Boston Fed in 2004, Mr. Willen was on the faculty at Princeton University and the University of Chicago. He has also been a visiting member of the faculty at the Massachusetts Institute of Technology for the past three years.
