Publication DateJanuary 2008
Author(s)Janneke Ratcliffe, Roberto G. Quercia
As of this writing, some 5 million households are in default or some stage of foreclosure and the U.S. financial system, once the envy of the world, seems to be falling apart. Center researchers examine what went wrong.
As of this writing, some 5 million households are in default or some stage of foreclosure, and the U.S. financial system, once the envy of the world, seems to be falling apart. What went wrong?
Everyone seems to have a favorite suspect. Some blame borrowers who bet that house prices would always go up and overextended themselves. Others blame lenders or other participants in the home sale and origination process (brokers, real estate agents, appraisers, builders) for focusing on short-term profits without considering borrowers’ ability to pay.
Some blame Wall Street for recklessly going about the business of securitization. Others blame investors for lack of due diligence when purchasing private securities and derivatives or the credit rating agencies that evaluated investments backed by risky mortgages or the companies that insured these investments. Still others blame the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.
Finally, some have accused former Federal Reserve Chairman Alan Greenspan of being the chief enabler of the crisis. Concerned with the risk of deflation in 2003, the Federal Reserve reduced a key interest rate to 1 percent and kept it there for a year, thus encouraging overleveraging in all aspects of the market.
To some extent, we think that everyone is right: In the context of an extended period of low rates and plenty of cheap credit feeding irrational exuberance in the housing markets, many parties from borrowers to Wall Street got carried away in pursuing their own short-term interests.