Explaining the housing bubble

Georgetown Law Journal

Volumn 100, Issue 4, 2012, Pages 1177-1205

  Levitin, Adam J ^a   Wachter, Susan M ^a  

^a GEORGETOWN UNIVERSITY LAW CENTER   (United States)

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EID: 84860120077     PISSN: 00168092     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (213)

1. See S&P/Case-Schiller Housing Price Indices, STANDARD & POORS, http://www.standardpoors.com/indices/articles/en/us/?articleType= XLS&assetID=1245214507706 (last visited Jan. 9, 2012). When adjusted for inflation, the increase in housing prices was still an astounding 135%.
2. See Edward L. Glaeser, Joshua D. Gottlieb & Joseph Gyourko, Can Cheap Credit Explain the Housing Boom? 1 (Nat'l Bureau of Econ. Research, Working Paper No. 16230, 2010).
3. See FIN. CRISIS INQUIRY COMM N, THE FINANCIAL CRISIS INQUIRY REPORT: FINAL REPORT OF THE NATIONAL COMMISSION ON THE CAUSES OF THE FINANCIAL AND ECONOMIC CRISIS IN THE UNITED STATES 124-25 (2011) [hereinafter FIN. CRISIS INQUIRY COMM'N FINAL REPORT], available at http://www.gpo.gov/fdsys/pkg/GPO- FCIC/content-detail.html (leaving out an official view of when the bubble began but implying that it started after the Federal Reserve lowered interest rates in 2001); id. at 417-18, 424 (Keith Hennessey, Douglas Holtz-Eakin & Bill Thomas, dissenting) (arguing the bubble began in the late 1990s); id. at 445 (Peter J. Wallison, dissenting) (identifying the housing bubble as occurring between 1997 and 2007); see infra section II.B.
4. See JOHN B. TAYLOR, GETTING OFF TRACK: HOW GOVERNMENT ACTIONS AND INTERVENTIONS CAUSED, PROLONGED, AND WORSENED THE FINANCIAL CRISIS 1-6 (2009).
5. See Ricardo J. Caballero & Arvind Krishnamurthy, Global Imbalances and Financial Fragility, 99 AM. ECON. REV. 584, 584 (2009);
6. Ben S. Bernanke et al., International Capital Flows and the Returns to Safe Assets in the United States, 2003-2007, at 1-3 (Bd. of Governors of the Fed. Reserve Sys., Int'l Fin. Discussion Paper No. 1014, 2011) [hereinafter Bernanke, International Capital Flows], available at http://www.federalreserve. gov/pubs/ifdp/2011/1014/ifdp1014.htm;
7. Steven Dunaway, Global Imbalances and the Financial Crisis (Council on Foreign Relations, Council Special Report No. 44, 2009);
8. Ben S. Bernanke, Chairman, Fed. Reserve Sys., Bundesbank Lecture: Global Imbalances: Recent Developments and Prospects (Sept. 11, 2007) [hereinafter Bernanke, Global Imbalances], available at http://www.federalreserve.gov/ newsevents/speech/bernanke20070911a.htm;
9. Ben S. Bernanke, Chairman, Fed. Reserve Sys., Sandridge Lecture at the Virginia Association of Economists: The Global Saving Glut and the U.S. Current Account Deficit (Mar. 10, 2005) [hereinafter Bernanke, Global Saving Glut], available at http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/.
10. See, e.g., THOMAS SOWELL, THE HOUSING BOOM AND BUST 30-56 (2009);
11. FIN. CRISIS INQUIRY COMM'N FINAL REPORT, supra note 4, at 444 (Peter J. Wallison, dissenting) ("[T]he sine qua non of the financial crisis was U.S. government housing policy, which led to the creation of 27 million subprime and other risky loans-half of all mortgages in the United States-which were ready to default as soon as the massive 1997-2007 housing bubble began to deflate. If the U.S. government had not chosen this policy path-fostering the growth of a bubble of unprecedented size and an equally unprecedented number of weak and high risk residential mortgages-the great financial crisis of 2008 would never have occurred.");
12. Edward Pinto, Op-Ed., Acorn and the Housing Bubble, WALL ST. J., Nov. 12, 2009, http://online.wsj.com/article/ SB10001424052748703298004574459763052141456.html ("The flood of CRA and affordable-housing loans with loosened underwriting standards, combined with declining mortgage interest rates ⋯ resulted in a massive increase in borrowing capacity and fueled a house price bubble of unprecedented magnitude over the period 1997-2006.");
13. Peter J. Wallison, Cause and Effect: Government Policies and the Financial Crisis, AMER. ENTER INST. (Nov. 25, 2008), http://www.aei.org/files/ 2008/11/25/20081203-1123724NovFSOg.pdf;
14. Peter J. Wallison, The True Origins of This Financial Crisis, AM. SPECTATOR (Feb. 6, 2009, 5:37 PM), http://spectator.org/archives/2009/02/06/the- true-origins-of-this-finan.
15. See Yuliya Demyanyk & Otto Van Hemert, Understanding the Subprime Mortgage Crisis, 24 REV. FIN. STUDIES 1848, 1852 (2011);
16. Kurt Eggert, The Great Collapse: How Securitization Caused the Subprime Meltdown, 41 CONN. L. REV. 1257, 1257 (2009) (arguing that securitization encouraged market participants to weaken underwriting standards);
17. Patricia A. McCoy, Andrey D. Pavlov & Susan M. Wachter, Systemic Risk Through Securitization: The Result of Deregulation and Regulatory Failure, 41 CONN. L. REV. 1327, 1366-67 (2009) (arguing the ability to pass off risk allowed lenders who lowered standards to gain market share and crowd out competing lenders who did not weaken credit standards);
18. Giovanni Dell'Ariccia, Deniz Igan & Luc Laeven, Credit Booms and Lending Standards: Evidence from the Subprime Mortgage Market 1 (Int'l Monetary Fund, Working Paper No. WP/08/106, 2008), available at www.imf.org/external/ pubs/ft/wp/2008/wp08106.pdf (noting that "lending standards declined more in areas with higher mortgage securitization rates");
19. cf. Christopher L. Peterson, Predatory Structured Finance, 28 CARDOZO L. REV. 2185, 2188-90 (2007) (describing how securitization facilitated predatory lending).
20. See Benjamin J. Keys et al., Did Securitization Lead to Lax Screening? Evidence from Subprime Loans, 125 Q.J. ECON. 307, 307-10 (2010)
21. [hereinafter Keys et al., Did Securitization Lead to Lax Screening?];
22. Benjamin J. Keys et al., Financial Regulation and Securitization: Evidence from Subprime Loans, 56 J. MONETARY ECON. 700, 702 (2009)
23. [hereinafter Keys et al., Financial Regulation and Securitization];
24. Atif Mian & Amir Sufi, The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis, 124 Q.J. ECON. 1449, 1449-50 (2009)
25. [hereinafter Mian & Sufi, The Consequences of Mortgage Credit Expansion] (finding correlation, unassociated with income growth, between an increase in mortgage securitization and the expansion of mortgage credit in subprime ZIP codes);
26. Atif R. Mian & Amir Sufi, Household Leverage and the Recession of 2007 to 2009, at 6-7 (Nat'l Bureau of Econ. Research, Working Paper No. 15896, 2010)
27. [hereinafter Mian & Sufi, Household Leverage and the Recession of 2007 to 2009] (finding that home-equity borrowing was responsible for a large share of the rise in household leverage during the bubble, as well as for a large portion of the defaults).
28. See generally ROBERT J. SHILLER, IRRATIONAL EXUBERANCE (2d ed. 2005) (arguing this thesis). An alternative demand-side theory looks to behavioral economics and suggests that consumers' cognitive failure to disentangle real and nominal interest rates results in an overestimation of the value of real estate in times of falling inflation.
29. Markus K. Brunnermeier & Christian Julliard, Money Illusion and Housing Frenzies, 21 REV. FIN. STUD. 135, 135-36 (2008) (arguing that consumers cannot disentangle real and nominal changes in interest rates and rents, which results in their failing to recognize that, when expected inflation falls, future price and rent appreciation-and not just nominal interest rates-also fall).
30. See Edward L. Glaeser, Joseph Gyourko & Albert Saiz, Housing Supply and Housing Bubbles, 64 J. URB. ECON. 198, 198-99 (2008);
31. Thomas Davidoff, Supply Elasticity and the Housing Cycle of the 2000s, at 1-4 (Soc. Sci. Research Network, Working Paper No. 1562741, 2010), available at http://ssrn.com/abstract=1562741.
32. See FIN. CRISIS INQUIRY COMM'N FINAL REPORT, supra note 4, at 74-80. Deregulatory legislation, such as the Commodities Futures Modernization Act of 2000, Pub. L. No. 106-554, app. E, § 407, 114 Stat. 2763A-365, 2763A-461 (codified in scattered sections of 7 U.S.C.), excluding covered bank swap agreements from Commodity Futures Trading Commission jurisdiction) and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, §§ 901-07, 119 Stat. 23, 146-83 (codified in scattered sections of 11 U.S.C.) (broadening financial-contract safe harbors in bankruptcy) did contribute to the housing bubble, as did the failure of the Federal Reserve to act on its existing authority under the Home Owners Equity Protection Act (HOEPA) to rein in predatory lending. See also Donald P. Morgan, Benjamin Iverson & Matthew Botsch, Subprime Foreclosures and the 2005 Bankruptcy Reform, FRBNY ECON. POL'Y REV., forthcoming, available at http://www.newyorkfed. org/research/epr/forthcoming/1102morg.pdf (arguing that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made it more difficult for debtors to free up income to pay their mortgages by discharging unsecured debt, thereby contributing to subprime-mortgage foreclosures).
33. Cf. ZOLTAN POZSAR ET AL., FED. RESERVE BANK OF N.Y., SHADOW BANKING 1-4 (2010), available at http://www.ny.frb.org/research/staff-reports/sr458.pdf (describing shadow banking as a financing system relying on short-term debt obligations other than insured deposits).
34. Cf. Steven L. Schwarcz, Rethinking the Disclosure Paradigm in a World of Complexity, 2004 U. ILL. L. REV. 1, 19 (arguing that many securities transactions are "so complex that less than a critical mass of investors can understand them in a reasonable time period ⋯ [so that] the market will not reach a fully informed price equilibrium, and hence will not be efficient").
35. See Gillian Tett, Credit Rating Groups Under Microscope, AUSTRALIAN, (Apr. 10, 2007, 12:00 AM), http://www.theaustralian.com.au/archive/business-old/ credit-rating-groups-under-microscope/story-e6frg90x-1111113311477 ("[Structured products such as collateralised debt obligations and collateralised loan obligations are unusually opaque products and investors cannot see through to the credit quality of the underlying borrowers making interest and principal repayments on those securities ⋯. Because of the opacity and complexity of these debt instruments, investors such as pension schemes are more dependent on guidance from rating agencies.");
36. Joseph R. Mason & Joshua Rosner, Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions 3, 5, 18 (Soc. Sci. Research Network, Working Paper No. 1027475, 2007), available at http://ssrn.com/abstract=1027475 (noting that "changes in origination and servicing practices, along with the existing complexity of RMBS, results in greater opacity in the RMBS market"; "increased grading of risk induced increased complexity, and therefore increased opacity"; and "the lack of liquidity, transparency, history and available data coupled with unprecedented complexity has made it difficult for all but the most well funded, well staffed and most sophisticated to analyze the markets or assets").
37. See, e.g., Glaeser et al., supra note 3, at 1-2; Ben S. Bernanke, Chairman, Fed. Reserve Sys., Speech at the Annual Meeting of the American Economic Association: Monetary Policy and the Housing Bubble (Jan. 3, 2010), available at http://www.federalreserve.gov/newsevents/speech/bernanke20100103a. htm.
38. See, e.g., Keys et al., Did Securitization Lead to Lax Screening?, supra note 9;
39. Mian & Sufi, The Consequences of Mortgage Credit Expansion, supra note 9;
40. Atif Mian & Amir Sufi, The Great Recession: Lessons from Microeconomic Data, 100 AM. ECON. REV: PAPERS & PROCEEDINGS 1, 2 (2010).
41. For a more detailed explanation of mortgage securitization, see Anna Gelpern & Adam J. Levitin, Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage-Backed Securities, 82 S. CAL. L. REV. 1075, 1080-87 (2009).
42. See Kenneth A. Snowden, Mortgage Securitization in the United States: Twentieth Century Developments in Historical Perspective, in ANGLO-AMERICAN FINANCIAL SYSTEMS: INSTITUTIONS AND MARKETS IN THE TWENTIETH CENTURY 261, 261-64 (Michael D. Bordo & Richard Sylla eds., 1995).
43. See generally William N. Goetzmann & Frank Newman, Securitization in the 1920's (Nat'l Bureau of Econ. Research, Working Paper No. 15650, 2010) (discussing mortgage securitization in the 1920s).
44. In addition to Fannie Mae and Freddie Mac, there were twelve Federal Home Loan Banks, which comprised a smaller GSE system. See Mark J. Flannery & W. Scott Frame, The Federal Home Loan Bank System: The "Other" Housing GSE, ECON. REV., Third Quarter 2006, at 33, 33 (examining the structure, activities, and risks of the Federal Home Loan Bank system).
45. See Brent W. Ambrose & Arthur Warga, Measuring Potential GSE Funding Advantages, 25 J. REAL EST. FIN. & ECON. 129, 146 (2002) (finding the GSE-to-Treasuries spread was 25-29 basis points less than AA-rated banking-sector bonds);
46. Frank E. Nothaft, James E. Pearce & Stevan Stevanovic, Debt Spreads Between GSEs and Other Corporations, 25 J. REAL EST. FIN. & ECON. 151, 151 (2002) (finding that GSEs had a funding advantage of 22-30 basis points relative to AA-rated bonds).
47. The GSEs are now in federal conservatorship, and their obligations carry an "effective guarantee" from the federal government but do not enjoy a "full faith and credit" backing. See Dawn Kopecki, Fannie, Freddie Have 'Effective' Guarantee, FHFA Says, BLOOMBERG (Oct. 23, 2008, 14:06 EDT), http://www.bloomberg.com/apps/news?pid=20601087&sid=aO5XSFgElSZA&refer= home (referencing the director of the Federal Housing Finance Agency as saying that GSEs have an "effective" federal guarantee); see also 12 U.S.C. § 1719(e) (2006) (explicitly stating that GSE debts are not government debts). The difference, if any, between "full faith and credit" and an "effective guarantee" is unclear.
48. We use the term PLS here to refer to residential mortgage-backed securities (RMBS) that lack a guarantee from the federal government or the GSEs. Although PLS can trace their pedigree back to a 1977 deal by Bank of America, see Bank of Am. Nat'l Trust & Sav. Assoc., SEC No-Action Letter, 1977 SEC No-Act. LEXIS 1343 (May 19, 1977), they remained a niche market for years because of their unproven risk profile. Gretchen Morgenson and Joshua Rosner cite a 1993 United Companies Financial securitization as the first securitization of nonprime mortgages.
49. GRETCHEN MORGENSON & JOSHUA ROSNER, RECKLESS ENDANGERMENT: HOW OUTSIZED AMBITION, GREED, AND CORRUPTION LED TO ECONOMIC ARMAGEDDON 48-50 (2011).
50. The nonprime securitization market, however, predates this deal. See, e.g., ANTHONY LEMBKE & PETER DIMARTINO, "B" AND "C" BORROWERS: A NEW FRONTIER IN THE NONAGENCY MARKET 8 (1994).
51. See DAVID MURPHY, UNRAVELLING THE CREDIT CRUNCH 133 (2009) ("[T]he first private label MBS deals were backed by very high quality mortgages: it took some years for investors to become comfortable with lower quality pools.").
52. See NOMURA FIXED INCOME RES., MBS BASICS 22 tbl.12 (2006), available at http://www. securitization.net/pdf/Nomura/MBSBasics-31Mar06.pdf.
53. In the TBA market, a mortgage originator enters into a forward contract with a GSE or Ginnie Mae in which the originator promises to deliver, in the future, a package of loans meeting the GSE's or Ginnie Mae's requirements in exchange for GSE or Ginnie Mae MBS being identified in the future. See OFFICE OF FED. HOUS. ENTER. OVERSIGHT, MORTGAGE MARKET NOTE 08-3, A PRIMER ON THE SECONDARY MORTGAGE MARKET 9-10 (2008), available at http://www.fhfa.gov/ webfiles/1242/MMNOTE083.pdf. Because the originator is able to resell the loan to the GSE or Ginnie Mae for a guaranteed rate before the closing of the loan, the originator is not exposed to interest-rate fluctuations between the time it quotes a rate and closing. Without the TBA market, originators would have to bear the risk that the market value of the loan would change before closing due to fluctuations in market rates. The commodity nature of GSE and Ginnie Mae MBS means that they are sufficiently liquid to support a TBA market that allows originators to offer borrowers locked-in rates in advance of closing. Originators of nonconforming (non-GSE-eligible) loans, particularly prime jumbos, are able to piggyback on the TBA market to hedge their interest-rate risk by purchasing in the TBA market.
54. See Ricardo J. Caballero, The "Other" Imbalance and the Financial Crisis 13-14 (Nat'l Bureau of Econ. Research, Working Paper No. 15636, 2010), available at http://www.nber.org/papers/w1536.
55. For example, for the Wells Fargo Mortgage Backed Securities 2003-2 Trust, a jumbo deal consisting mainly of prime or near-prime (alt-A) jumbos, 98.7% of the securities, by dollar amount, were rated AAA. See Wells Fargo Asset Sec. Corp., Mortgage Pass-Through Certificates, Series 2003-2 (Form 424(b)(5)) (Feb. 27, 2003), available at http://www.secinfo.com/dsVsn.2h2.htm.
56. Manuel Adelino, Do Investors Rely Only on Ratings? The Case of Mortgage-Backed Securities 42 (Nov. 24, 2009) (unpublished manuscript), available at http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.156. 989&rep=rep1&type=pdf.
57. Overcollateralization means that the initial principal balance of the mortgages supporting the MBS is greater than the principal balance on the MBS. See Richard J. Rosen, The Role of Securitization in Mortgage Lending, CHI. FED LETTER, Nov. 2007 (noting that 61% of private-label PLS issued in 2006 were overcollateralized). The cash flows generated by a larger pool balance are available to absorb losses from mortgage defaults. Overcollateralization is an expensive form of credit enhancement because it ties up collateral that could otherwise be used for other deals, so PLS indentures sometimes provide for the periodic release of collateral if performance thresholds are met. Note that pool overcollateralization is in addition to the overcollateralization of mortgages with < 100% LTV ratio.
58. Shifting interest involves the reallocation of subordinate tranches' share of prepayments (both voluntary prepayments and the proceeds of involuntary liquidations) to senior tranches. Shifting-interest arrangements are often stepped down over time, with a decreasing percentage of prepayments shifted. See Sunil Gangwani, MBS Structuring: Concepts and Techniques, SECURITIZATION CONDUIT, Autumn 1998, at 26, 33.
59. The effect is to make senior tranches' share of a securitization larger at the beginning of the deal and smaller thereafter. See Manus J. Clancy & Michael Constantino, III, Understanding Shifting Interest Subordination, in THE HANDBOOK OF NONAGENCY MORTGAGE-BACKED SECURITIES 39, 42 tbl.4 (Frank J. Fabozzi et al. eds., 2d ed. 2000).
60. See GARY B. GORTON, SLAPPED BY THE INVISIBLE HAND: THE PANIC OF 2007, at 87 (2010).
61. See William W. Bratton & Michael L. Wachter, The Case Against Shareholder Empowerment, 158 U. PA. L. REV. 653, 719 n.198 (2010).
62. Selected Interest Rates (Daily)- H. 15, BD. OF GOVERNORS OF THE FED. RESERVE SYS., http://www. federalreserve.gov/releases/h15/data.htm (last visited Mar. 2, 2012).
63. See Whitney Tilson, Value Investing Website, T2 PARTNERS LLC, http://www.t2partnersllc.com (last visited Mar. 16, 2012). These figures reflect all mortgages, not just subprime. The LTVs are arguably understated relative to fundamentals because of the housing-price inflation of the bubble. Determining true LTVs, however, is impossible due to the endogeneity problem.
64. See Michael Tucker, Adjustable-Rate and Fixed-Rate Mortgage Choice: A Logit Analysis, 4 J. REAL EST. RES. 81, 86 (1989) ("Higher T-bill rates are associated with a decrease in the probability of borrowers selecting ARMs.").
65. See Andrey Pavlov & Susan Wachter, Mortgage Put Options and Real Estate Markets, 38 J. REAL EST. FIN. & ECON. 89, 92 (2009).
66. Although housing economists have noted that interest-rate changes do not explain the bubble, they neglect to fully explore the impact of the decline in underwriting standards. See, e.g., Glaeser et al., supra note 3, at 2-3. Glaeser et al. examine underwriting in a very cursory fashion; their finding that loan approval rates were constant during the bubble ignores the dramatic rise in loan application volume. See id. at 6, 26. This problem can also be seen in Charles Himmelberg et al., Assessing High House Prices: Bubbles, Fundamentals and Misperceptions, J. ECON. PERSP., Fall 2005, at 67, 68, which argues that, as of 2004, there was no housing bubble. Although Himmelberg et al. note that housing prices are not the same as the annual cost of owning a house, id., they neglect to consider whether the shift in mortgage-product mix was reducing the (initial) affordability of housing.
67. See Christopher Mayer et al., The Rise in Mortgage Defaults, J. ECON. PERSP., Winter 2009, at 27, 36 (noting that three nontraditional mortgage products "might be responsible for at least part of the delinquency rise").
68. This may be the reason that homeownership actually peaked early in the bubble in 2004. See Paul S. Calem et al., Implications of the Housing Market Bubble for Sustainable Homeownership, in THE AMERICAN MORTGAGE SYSTEM: CRISIS AND REFORM 87, 87 (Susan M. Wachter & Marvin M. Smith eds., 2011).
69. See Corporate Default and Recovery Rates, 1920-2008, MOODY'S GLOBAL CREDIT POL'Y (Moody's Investors Serv., New York, N.Y.), Feb. 2009, at 4-5, available at http://www.moodys.com/sites/products/DefaultResearch/ 2007400000578875.pdf.
70. See, e.g., FIN. CRISIS INQUIRY COMM'N FINAL REPORT, supra note 4, at 445 (Peter J. Wallison, dissenting); Dean Baker, East Asia's Economic Revenge, GUARDIAN (U.K.) (Mar. 9, 2009, 12:00 EDT), http://www.guardian.co.uk/ commentisfree/cifamerica/2009/mar/09/usa-useconomy; Pinto, supra note 7 ("Most agree that the housing bubble started in 1997."). Robert Shiller argues that there were regional housing bubbles as early as 1998, but how these regional bubbles would have become national bubbles is not clear.
71. See Robert J. Shiller, Understanding Recent Trends in House Prices and Homeownership, in HOUSING, HOUSING FINANCE, AND MONETARY POLICY 89, 89 (2007).
72. See, e.g., Lawrence H. White, Federal Reserve Policy and the Housing Bubble, 29 CAT O J. 115, 115-19 (2009) (describing the bubble as the result of Federal Reserve policy in 2001 and beyond);
73. James R. Hagerty, Who's To Blame for the Housing Bubble?, WALL ST. J. DEV. BLOG (Nov. 16, 2009, 1:57 PM), http://blogs.wsj.com/developments/2009/11/ 16/whos-to-blame-for-the-housing-bubble (citing Tom Lawler, a housing economist, as positing 2002 as the start of the bubble);
74. Ironman, A Better Method of Detecting Housing Bubbles, SEEKING ALPHA (Feb. 25, 2010), http://seekingalpha.com/article/190753-a-better-method-of- detecting-housing-bubbles (noting that housing prices in specific U.S. cities began to increase 2001).
75. See Joseph E. Stiglitz, Symposium on Bubbles, 4 J. ECON. PERSP. 13, 13 (1990). Stiglitz defines a bubble as follows: "[I]f the reason that the price is high today is only because investors believe that the selling price will be high tomorrow-when 'fundamental' factors do not seem to justify such a price-then a bubble exists." Id.
76. See ROBERT J. SHILLER, IRRATIONAL EXUBERANCE (2d ed. 2005), available at http://www.econ.yale.edu/shiller/data/Fig2-1.xls (online supplement with historical housing-market data). The inflation adjustment is based on the Consumer Price Index. Shiller's Housing Price Index is a combination of the S&P/Case-Schiller Housing Price Index for 1987 through the present and four other sources for historical data.
77. See Himmelberg et al., supra note 66. Himmelberg et al. compared imputed rental costs with ownership costs, which they acknowledge are not the same as housing prices. Id. With a nontraditional mortgage, ownership costs of housing could be quite low even with high housing prices. Cf. Chris Mayer & Todd Sinai, Bubble Trouble? Not Likely, WALL ST. J., Sept. 19, 2005, at A16 (noting that the ratio of the cost of owning to renting in 2004 was insignificant). Himmelberg, Mayer, and Sinai's argument assumes continuation of housing-price appreciation at historic rates. In 2004, although many market participants and economists believed that prices would continue to go up, some did not because prices were at an all-time high relative to imputed rents. Prices obviously did eventually decline.
78. See generally Kristopher S. Gerardi et al., Reasonable People Did Disagree: Optimism and Pessimism About the U.S. Housing Market Before the Crash, in THE AMERICAN MORTGAGE SYSTEM: CRISIS AND REFORM, supra note 75, at 26, 27 (noting commonly held assumptions among economists prior to the bubble).
79. See generally Andrey Pavlov & Susan Wachter, Subprime Lending and Real Estate Prices, 39 REAL EST. ECON. 1, 15 (2011) (arguing that "aggressive lending instruments magnif[y] real estate market cycles").
80. Prior to 2008, a third explanation for housing-price increases could be found, namely that the increases were reflecting fundamentals. See, e.g., The Economic Outlook: Hearing Before the Joint Econ. Comm., 109th CONG. 52 (2005) (statement of Hon. Alan Greenspan, Chairman, Board of Governors, Federal Reserve System) (justifying higher debt burdens because of productivity improvements);
81. The Economic Outlook: Hearing Before the Joint Econ. Comm., 109th Cong. (2005) (statement of Ben S. Bernanke, Chairman, President's Council of Economic Advisers) (noting that "[h]ouse prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas.").
82. See SHILLER, supra note 10; see also Ernan Haruvy et al., Traders' Expectations in Asset Markets: Experimental Evidence, 97 AM. ECON. REV. 1901, 1901 (2007) ("We find that individuals' beliefs about prices are adaptive, and primarily based on past trends in the current and previous markets in which they have participated. Most traders do not anticipate market downturns the first time they participate in a market, and, when experienced, they typically overestimate the time remaining before market peaks and downturns occur."); Glaeser et al., supra note 3, at 39 (concluding that Shiller's explanation has merit).
83. See Randal O'Toole, How Urban Planners Caused the Housing Bubble, POL'Y ANALYSIS at 1 (2009).
84. See Edward L. Glaeser & Joseph Gyourko, Arbitrage in Housing Markets, in HOUSING MARKETS AND THE ECONOMY: RISK, REGULATION, AND POLICY 113, 124 (Edward L. Glaeser & John M. Quigley eds., 2009) (noting that home mortgage-interest tax deduction pushes up housing prices in supply-constrained markets). It is notable, though, that the bubble was more extreme in highly supply-elastic markets like Phoenix and Las Vegas.
85. See Richard K. Green et al., Metropolitan-Specific Estimates of the Price Elasticity of Supply of Housing, and Their Sources, 95 AM. ECON. REV. 334, 336-37 (2005); Davidoff, supra note 11, at 2.
86. See FIN. CRISIS INQUIRY COMM N, PRELIMINARY STAFF REPORT: THE COMMUNITY REINVESTMENT ACT AND THE MORTGAGE CRISIS 6 (2010);
87. Elizabeth Laderman & Carolina Reid, CRA Lending During the Subprime Meltdown, in REVISITING THE CRA: PERSPECTIVES ON THE FUTURE OF THE COMMUNITY REINVESTMENT ACT 115, 124 (Prabal Chakrabarti et al. eds., 2009) (finding that CRA-subject institutions were less likely to make subprime loans in California, and that subprime loans made by CRA-subject institutions in CRA assessment areas outperformed these institutions' subprime loans made outside CRA-assessment areas);
88. Neil Bhutta & Glenn B. Canner, Did the CRA Cause the Mortgage Market Meltdown?, COMMUNITY DIVIDEND, Mar. 1, 2009, http://www.minneapolisfed.org/ publications-papers/pub-display.cfm?id=4136;
89. Memorandum from Glenn Canner & Neil Bhutta to Sandra Braunstein, Dir., Consumer & Cmty. Affairs Div., Bd. of Governors of the Fed. Reserve Sys. 3 (Nov. 21, 2008) [hereinafter Memorandum from Canner & Bhutta], available at http://www.federalreserve.gov/newsevents/speech/20081203-analysis. pdf;
90. Ellen Seidman, No, Larry, CRA Didn't Cause the Sub-Prime Mess, LADDER BLOG (Apr. 15, 2008, 9:55 AM), http://www.newamerica.net/blog/asset-building/ 2008/no-larry-cra-didn-t-cause-sub-prime-mess-3210.
91. Michael S. Barr, Credit Where It Counts: The Community Reinvestment Act and Its Critics, 80 N.Y.U. L. REV. 513, 517 (2005).
92. See Robert B. Avery et al., The 2007 HMDA Data, FED. RES. BULL., Dec. 2008, at A107, A124 tbl.11. Critically, not all financial institutions are subject to the CRA; only federally insured banks and thrifts fall within its ambit. Depositories' uninsured subsidiaries and affiliates are not subject to the CRA, but insured institutions are permitted to count their subsidiaries' and affiliates' activities toward their own CRA credit. Independent mortgage companies are not covered by CRA whatsoever. The variation in CRA coverage enables a comparison of the mortgage lending of CRA-subject institutions with that of other institutions. Bank regulators do not specifically track subprime lending, but, under the Home Mortgage Disclosure Act of 1975 (HMDA), they track so-called HOEPA loans, which are high-interest-rate loans, as defined by the Home Owners Equity Protection Act of 1994, and which provide a good proxy for subprime lending. See 12 U.S.C. §§ 2801-2811 (2006), amended by Dodd-Frank Wall Street Reform and Consumer Protection Act, § 1094, 124 Stat. 1376 (2010) (identifying the HMDA reporting requirements for depositories and other lenders); 12 C.F.R. § 203.4(a)(12)-(13) (2011) (specifying HMDA and other high-price loan reporting requirements). A HOEPA loan is a closed-end, nonpurchase money mortgage (excluding reverse mortgages) secured by a consumer's principal residence, which has an APR of more than 800 basis points above comparable-maturity Treasury securities (for first liens) or 1,000 basis points above comparable-maturity Treasury securities (for junior liens), or that has total points and fees payable by the consumer, at or before closing, that exceed the greater of 8% of the total loan amount or an annually adjusted dollar amount. See 15 U.S.C. § 1602(aa) (2006), amended by Dodd-Frank Wall Street Reform and Consumer Protection Act, § 1094, 124 Stat. 1376 (2010) (defining HOEPA loans); 12 C.F.R. § 226.32(a) (identifying the requirements for closed-end mortgages). CRA-subject institutions made only a small percentage of HOEPA loans between 2004 and 2007. See Avery et al., supra. Although depositories made over 40% of loans, they made less than 30% of HOEPA loans. Id. When their subsidiaries and affiliates are included, the market share of all loans was around 70%, though HOEPA loan share was only around 50%. Id. In comparison, independent mortgage companies made up about 30% of the mortgage lending market and around 50% of the HOEPA market. Id. HOEPA lending was concentrated in institutions not subject to the CRA. Id.
93. See Robert B. Avery & Kenneth P. Brevoort, The Subprime Crisis: Is Government Housing Policy To Blame? 15-76 (Div. of Research and Statistics, Bd. of Governors at Fed. Reserve Sys., Working Paper No. 1726192, 2011), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=1726192.
94. See Joseph Gyourko, Understanding Commercial Real Estate: Just How Different from Housing Is It? (Nat'l Bureau of Econ. Research, Working Paper No. 14708, 2009), available at http://www.nber.org/papers/w14708 (finding a 40% price correlation between residential and commercial real estate between 1978 and 2008);
95. Adam J. Levitin & Susan M. Wachter, The Commercial Real Estate Bubble (Soc. Sci. Research Network, Working Paper No. 1978264, 2012), available at http://ssrn.com/abstract=1978264 (finding a 13% historical correlation between residential and commercial real-estate prices between 1987 and 2002 but 83% correlation between 2003 and 2011);
96. see also Jennifer Roback, Wages, Rents, and the Quality of Life, 90 J. POL. ECON. 1257 (1982) (positing a long-term correlation in commercial and residential real-estate prices because of shared fundamentals);
97. Sherwin Rosen, Wage-Based Indexes of Urban Quality of Life, in CURRENT ISSUES IN URBAN ECONOMICS 74, 74-102 (Peter Mieszkowski & Mahlon Straszheim eds., 1979) (exploring "some possibilities for imputing an index of the 'quality of life' among metropolitan areas from wage data").
98. See S&P/Case-Schiller Housing Price Indices, supra note 1; Moody's/REAL Commercial Property Price Index (CPPI), MIT CTR. FOR REAL EST., http://web.mit.edu/cre/research/credl/rca.html (browse to the "Downloads" subheading; select "Click here to download returns data for all indexes"; open downloaded file; select "National Indices" folder and open "Quarterly Returns National-Property Types.csv") (last visited Jan. 12, 2012) (identifying the national quarterly returns since 2001).
99. See, e.g., Pinto, supra note 7; Peter J. Wallison, Op-Ed., The Price for Fannie and Freddie Keeps Going Up, WALL ST. J., Dec. 29, 2009, http://online.wsj.com/article/SB10001424052748703278604574624681873427574.html; Wallison, supra note 7.
100. Xudong An & Raphael W. Bostic, GSE Activity, FHA Feedback, and Implications for the Efficacy of the Affordable Housing Goals, 36 J. REAL EST. FIN. & ECON. 207, 207-08 (2008).
101. See Interim Housing Goals, 58 Fed. Reg. 53,048 (Oct. 13, 1993) (establishing interim GSE affordable-housing goals for 1993 and 1994); Continuation of Federal Home Loan Mortgage Corporation and Federal National Mortgage Association Housing Goals, 59 Fed. Reg. 61,504 (proposed Nov. 30, 1994) (to be codified at 24 C.F.R. pt. 81) (temporarily extending the 1994 GSE affordable-housing goals into 1995); The Secretary of HUD's Regulation of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), 60 Fed. Reg. 61,846 (proposed Dec. 1, 1995) (to be codified at 24 C.F.R. pt. 81) (setting GSE affordable-housing goals for 1996 through 1999); HUD's Regulation of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), 65 Fed. Reg. 65,044 (proposed Oct. 31, 2000) (to be codified at 24 C.F.R. pt. 81) (setting affordable-housing goals for 2001 through 2003 and a default goal for 2004); HUD's Housing Goals for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) for the Years 2005-2008 and Amendments to HUD's Regulation of Fannie Mae and Freddie Mac, 69 Fed. Reg. 63,580 (proposed Nov. 2, 2004) (to be codified at 24 C.F.R. pt. 81) (establishing GSE affordable-housing goals for 2005 through 2008). 130. See U.S. DEP'T OF HOUS. & URBAN DEV., OVERVIEW OF THE GSES' HOUSING GOAL PERFORMANCE, 1996-2003 (2005), available at http://www.huduser.org/ Datasets/GSE/gse2003.pdf.
102. See Harold L. Bunce & Randall M. Scheessele, The GSEs' Funding of Affordable Loans 4 (U.S. Dep't of Hous. & Urban Dev., Working Paper No. HF-001, 1996), available at http://www.huduser.org/Publications/pdf/gsewp.pdf;
103. Harold L. Bunce, The GSEs' Funding of Affordable Loans: A 2000 Update 30 (U.S. Dep't of Hous. & Urban Dev., Working Paper No. HF-013, 2002), available at http://www.huduser.org/Publications/pdf/workpapr13.pdf;
104. Paul B. Manchester, Characteristics of Mortgages Purchased by Fannie Mae and Freddie Mac: 1996-97 Update 5 (U.S. Dep't of Hous. & Urban Dev., Working Paper No. HF-006, 1998), available at http://www.huduser.org/publications/pdf/ wkp-006.pdf.
105. See Xudong An & Raphael W. Bostic, Policy Incentives and the Extension of Mortgage Credit: Increasing Market Discipline for Subprime Lending, 28 J. POL'Y ANALYSIS & MGMT. 340, 345-46 (2009);
106. David Listokin & Elvin K. Wyly, Making New Mortgage Markets: Case Studies of Institutions, Home Buyers, and Communities, 11 HOUSING POL'Y DEBATE 575, 637 (2000);
107. Kenneth Temkin et al., The Impact of Secondary Mortgage Market Guidelines on Affordable and Fair Lending: A Reconnaissance from the Front Lines, REV. BLACK POL. ECON., Fall 2000, at 29, 35.
108. See Stuart A. Gabriel & Stuart S. Rosenthal, Government-Sponsored Enterprises, the Community Reinvestment Act, and Home Ownership in Targeted Underserved Neighborhoods, in HOUSING MARKETS AND THE ECONOMY, supra note 101, at 202, 205 (finding "essentially no evidence" that GSE affordable-housing goals increased lending or homeownership);
109. Brent W. Ambrose & Thomas G. Thibodeau, Have the GSE Affordable Housing Goals Increased the Supply of Mortgage Credit?, 34 REGIONAL SCI. & URB. ECON. 263, 271 (2004); An & Bostic, supra note 124, at 208; An & Bostic, supra note 132, at 346;
110. Raphael W. Bostic & Stuart A. Gabriel, Do the GSEs Matter to Low-Income Housing Markets? An Assessment of the Effects of the GSE Loan Purchase Goals on California Housing Outcomes, 59 J. URB. ECON. 458, 474 (2006).
111. See Joshua Brockman, With Freddie's Help, Big Lenders Charge into Subprime Business, AM. BANKER, Sept. 10, 1999, 1999 WLNR 2765773 (quoting a trader who claimed that "Fannie and Freddie are 'very, very big investors' that buy AAA securities backed by B&C loans⋯. [which allows them to have] a much greater impact than their involvement as a credit provider, or wrap provider").
112. See William K. Black, Fannie and Freddie Fantasies, NEW ECON. PERSP. BLOG (Dec. 29, 2011), http://www.neweconomicperspectives.blogspot.com/2011/12/ fannie-and-freddie-fantasies.html (arguing that executive compensation drove the GSEs into nonprime mortgages).
113. See FED. HOUS. FIN. AGENCY, CONSERVATOR'S REPORT ON THE ENTERPRISES' FINANCIAL PERFORMANCE: THIRD QUARTER 2010, at 4-5 (2010), http://www.fhfa.gov/ webfiles/19585/Conservator%27s-Report112910.ppd.
114. See John B. Taylor, Discretion Versus Policy Rules in Practice, 39 CARNEGIE-ROCHESTER CONF. SERIES ON PUB. POL'Y 195, 202 (1993).
115. See TAYLOR, supra note 5, at 4; John B. Taylor, Housing and Monetary Policy 2-3 (Nat'l Bureau of Econ. Research, Working Paper No. 13682, 2007), available at http://www.nber.org/papers/w13682.
116. See Marco Del Negro & Christopher Otrok, 99 Luftballons: Monetary Policy and the House Price Boom Across U.S. States, 54 J. MONETARY ECON. 1962, 1965 (2007);
117. Marek Jarociński & Frank R. Smets, House Prices and the Stance of Monetary Policy, 90 FED. RES. BANK OF ST. LOUIS REV. 339, 362 (2008); Glaeser et al., supra note 3, at 2-4.
118. See Edward L. Glaeser, Joshua Gottlieb & Joseph Gyourko, Did Credit Market Policies Cause the Housing Bubble?, POL'Y BRIEFS, May 2010, at 1, 4, http://www.hks.harvard.edu/var/ezp-site/storage/fckeditor/file/pdfs/ centers-programs/centers/taubman/PB-housing-2010-final.pdf.
119. See DAVID MIN, CTR. FOR AM. PROGRESS, TRUE NORTH: THE FACTS ABOUT THE CANADIAN MORTGAGE BANKING SYSTEM 1 (2010), available at http://www. americanprogress.org/issues/2010/08/true-north.html.
120. See Richard Green et al., Housing Finance in Developed Countries in a Time of Turmoil (Aug. 2010) (unpublished paper) (on file with authors) (examining why some developed countries experienced housing bubbles but not others).
121. See Bernanke, International Capital Flows, supra note 6; see also Caballero & Krishnamurthy, supra note 6, at 588 (explaining that foreign demand for riskless debt raises the value of domestic, risky assets). But see Claudio Borio & Piti Disyatat, Global Imbalances and the Financial Crisis: Link or No Link? 24-2 (Bank for Int'l Settlements, BIS Working Papers No. 346, 2011) (arguing that "'excess elasticity' of the international monetary and financial system," not "excess savings," was behind the financial crisis);
122. Maurice Obstfeld & Kenneth Rogoff, Conference Report, Asia Economic Policy Conference of the Federal Reserve Bank of San Francisco's Center for Pacific Basin Studies, Global Imbalances and the Financial Crisis: Products of Common Causes, at 1 (Oct. 18-20, 2009), http://www.frbsf.org/economics/ conferences/aepc/2009/09-Obstfeld.pdf (arguing that "the global imbalances did not cause the leverage and housing bubbles, but they were a critically important codeterminant").
123. see also Gary Gorton, Conference Report, The Federal Reserve Bank of Atlanta's 2009 Financial Markets Conference: Financial Innovation and Crisis, Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007 (May 11-13, 2009), http://www.frbatlanta.org/news/Conferen/09fmc/gorton.pdf (discussing investor demand for "informationally-insensitive" financial assets).
124. Lloyd Blankfein, Do Not Destroy the Essential Catalyst of Risk, FIN. TIMES (U.K.) (Feb. 8, 2009, 16:53), http://www.ft.com/intl/cms/s/0/0a0f1132- f600-11dd-a9ed-0000779fd2ac.html#axzz1dRTrq3ev.
125. See Susan M. Wachter, The Ongoing Financial Upheaval: Understanding the Sources and Way Out 6-7 (Univ. of Pa. Law Sch. Inst. for Law & Econ., Research Paper No. 09-30, 2009), available at http://ssrn.com/abstract=1464791.
126. See Jack Favilukis, Sydney C. Ludvigson & Stijn Van Nieuwerburgh, The Macroeconomic Effects of Housing Wealth, Housing Finance, and Limited Risk-Sharing in General Equilibrium 1-2 (Soc. Sci. Research Network, Working Paper No. 1602163, 2011), available at http://ssrn.com/abstract=1602163 (arguing that the boom was in part a response to a relaxation of credit constraints and a decline in transaction costs for home purchases and refinancings);
127. Amir E. Khandani, Andrew W. Lo & Robert C. Merton, Systemic Risk and the Refinancing Ratchet Effect 1-3 (Nat'l Bureau of Econ. Research, Working Paper No. 15362, 2009) (finding that easy refinancing facilitated widespread home-equity extraction, which resulted in a leverage-and-default cycle among homeowners).
128. See Keys et al., Financial Regulation and Securitization, supra note 9, at 701;
129. Mian & Sufi, The Consequences of Mortgage Credit Expansion, supra note 9, at 1450-51;
130. Mian & Sufi, Household Leverage and the Recession of 2007 to 2009, supra note 9, at 1-3.
131. See Xavier Gabaix & David Laibson, Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets, 121 QJ. ECON. 505, 506-07 (2006)
132. [hereinafter Gabaix & Laibson, Shrouded Attributes] (arguing that firms can sometimes reveal exploitation by other companies "and win over customers");
133. Marisa J. Mazzotta & James J. Opaluch, Decision Making When Choices Are Complex: A Test of Heiner's Hypothesis, 71 LAND ECON. 500, 513 (1995) (finding that individuals resort to simplified decision-making rules when choices reach a certain level of complexity);
134. Xavier Gabaix & David Laibson, Competition and Consumer Confusion 1 (Apr. 30, 2004) (unpublished paper presented to the 2004 N. Am. Summer Meeting of the Econometric Soc'y), available at http://citeseerx.ist.psu.edu/viewdoc/ download;jsessionid=A4EED6ACBC2B733BC1 EDD15AB6CE65B8?doi=10.1.1.167. 8583&rep=rep1&type=pdf (arguing that firms with lower intrinsic quality utilize excess complexity to confuse consumers and thereby increase market share).
135. See Gabaix & Laibson, Shrouded Attributes, supra note 174, at 509.
136. See Adam B. Ashcraft & Til Schuermann, Understanding the Securitization of Subprime Mortgage Credit, 2 FOUND. & TRENDS FIN. 191, 203-05, 212-13 (2006);
137. Oren Bar-Gill, The Law, Economics and Psychology of Subprime Mortgage Contracts, 94 CORNELL L. REV. 1073, 1080-83 (2009).
138. See DEBBIE GRUENSTEIN BOCIAN ET AL., CTR. FOR RESPONSIBLE LENDING, UNFAIR LENDING: THE EFFECT OF RACE AND ETHNICITY ON THE PRICE OF SUBPRIME MORTGAGES 21 (2006), available at http://www.responsiblelending.org/mortgage-lending/ research-analysis/rr011-Unfair-Lending-0506.pdf.
139. See Howell E. Jackson & Laurie Burlingame, Kickbacks or Compensation: The Case of Yield Spread Premiums, 12 STA N. J.L. BUS. & FIN. 289, 310-11 (2007). Yield-spread premiums are now illegal. See 12 C.F.R. § 226.36(e) (2012). The servicing-release premiums paid to originators by secondary-market institutions might also incentivize the steering of borrowers to riskier loans.
140. JAMES GRANT, MR. MARKET MISCALCULATES: THE BUBBLE YEARS AND BEYOND 170 (2008).
141. The potential for a lemons problem in securitization has long been noted. See Claire A. Hill, Securitization: A Low-Cost Sweetener for Lemons, 74 WASH. U. L.Q. 1061, 1065-66 (1996).
142. The bubble and its aftermath play out George Akerlof's lemons problem exactly as predicted. See George A. Akerlof, The Market for "Lemons": Quality Uncertainty and the Market Mechanism, 84 Q.J. ECON. 488, 495 (1970) (explaining how dishonest brokers can drive out high-quality goods from the marketplace). Once a market becomes a market for lemons, it contracts, which happened in the fall of 2007 as the weakness of the mortgage market became apparent.
143. See Andrey Pavlov & Susan M. Wachter, The Inevitability of Marketwide Underpricing of Mortgage Default Risk, 34 REAL EST. ECON. 479, 494 (2006).
144. See Todd Davenport, What's Behind Wall Street Players' Mortgage Deals, AM. BANKER (Aug. 14, 2006, 1:00 AM), http://www.americanbanker.com/issues/171- 158/-286097-1.html.
145. See Kevin Donovan, The Freddie Mac T-Series Wrap: A Service or Disservice to Mortgage-Related ABS?, ASSET SECURITIZATION REPORT, June 11, 2001, http://www.highbeam.com/doc/1G1-75428784.html;
146. Patrick Sheehy, Subprime Lending Moves to More Solid Ground, ALLBUSINESS.COM, http://www.allbusiness.com/finance/3594590-1.html#ixzz1iK0yJzkR (last visited Jan. 13, 2012).
147. See THORSTEIN VEBLEN, THE THEORY OF BUSINESS ENTERPRISE 105-06, 112-13 (1904) (noting a cycle in which an increase in collateral value increases credit availability, which then further increases collateral value);
148. Nobuhiro Kiyotaki & John Moore, Credit Cycles, 105 J. POL. ECON. 211, 212-13 (1997) (theorizing a cycle in which increasing collateral value increases credit availability, which then further increases collateral value);
149. Mian & Sufi, The Consequences of Mortgage Credit Expansion, supra note 9, at 1490-92 (finding support for the Kiyotaki & Moore model in housing-price and credit growth).
150. See Stephen A. Ross, The Arbitrage Theory of Capital Asset Pricing, 13 J. ECON. THEORY 341, 341-43 (1976).
151. For background information on the credit-rating agencies, see Efraim Benmelech & Jennifer Dlugosz, The Alchemy of CDO Credit Ratings, 56 J. MONETARY ECON. 617 (2009) (documenting the credit-rating process);
152. John C. Coffee, Jr., Ratings Reform: The Good, the Bad, and the Ugly, 1 HARV. BUS. L. REV. 231, 234 (2011) (discussing the need for competition among ratings agencies);
153. Frank Partnoy, The Siskel and Ebert of Financial Markets?: Two Thumbs Down for the Credit Rating Agencies, 77 WASH. U. L.Q. 619, 711 (1999) (noting that "the reputational capital view of credit rating agencies is not supported by history or economic analysis");
154. Frank Partnoy, Overdependence on Credit Ratings Was a Primary Cause of the Crisis 11 (Univ. of San Diego Sch. of Law, Research Paper No. 09-015, 2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstractid=1430653 (arguing that market participants relied too heavily on ratings).
155. Fitch ratings measure the likelihood of default by evaluating borrowers' ability to meet their financial obligations. Ratings range from AAA, which is given to companies with the "lowest expectation of default risk," to C and D ratings, assigned to companies that have defaulted or where "[d]efault is imminent or inevitable." See FITCH RATINGS, DEFINITIONS OF RATINGS AND OTHER FORMS OF OPINION 9-10 (2011), available at http://www.fitchratings.com/web-content/ratings/fitch-ratings-definitions-and- scales.pdf.
156. In contrast, Moody's ratings reflect "expected loss," which is an assessment of the risk of default plus the severity of the loss upon default. Ratings range from Aaa, which is given to companies with "minimal credit risk," to a C rating, which is given to companies "typically in default" and from which there is "little prospect for recovery of principal or interest." See MOODY'S INVESTORS SERV., RATING SYMBOLS AND DEFINITIONS 4 (2011), available at http://www.moodys.com/ researchdocumentcontentpage.aspx?docid=PBC-79004.
157. See Adelino, supra note 43, at 31-34. Even very sophisticated AAA investors seemed to have purchased by rating rather than by risk. In 2006, Daniel Mudd, the CEO of Fannie Mae, explained that Fannie, one of the most sophisticated entities in the entire mortgage investment world, could not price the risks involved in private-label securities. Mudd noted "that the credit characteristics reflected in the layering of products-products that typically get distributed through the private-label securities market- have risks that are difficult to quantify." See Paul Muolo, Fannie's Mudd Is Wary of Exotics, NAT 'L MORTGAGE NEWS (July 24, 2006, 1:00 AM), http://www.nationalmortgagenews. com/nmn-issues/30-41/-443044-1.html (quoting Daniel Mudd). Mudd made this comment at a time when Fannie Mae held over $85 billion in PLS, almost all of which were AAA rated.
158. See Fed. Nat'l Mortg. Assoc., Annual Report (Form 10-K) 120 tbl.34 (Dec. 31, 2006), available at http://www.fanniemae.com/ir/pdf/sec/2006/form10k-120606. pdf.
159. See, e.g., Jerome S. Fons, Rating Competition and Structured Finance, J. STRUCTURED FIN., Fall 2008, at 7, 11-14;
160. Joseph R. Mason, The (Continuing) Information Problems in Structured Finance, J. STRUCTURED FIN., Spring 2008, at 7, 7-11;
161. Mason & Rosner, supra note 19, at 8-15; Matthew Richardson & Lawrence J. White, The Rating Agencies: Is Regulation the Answer?, in RESTORING FINANCIAL STABILITY: HOW TO REPAIR A FAILED SYSTEM 101, 104-15 (Viral V. Acharya & Matthew Richardson eds., 2009).
162. Id. (quoting The Structured Finance Rating Process, TAIWAN RATINGS, http://www.taiwanratings. com/en/criteria/SF-ratingprocess.asp (last visited Jan. 13, 2012)) (internal quotation marks omitted). The ratings agencies also made their models available to investment banks, which then designed their products to game the ratings models. See Gretchen Morgenson & Louise Story, Rating Agency Data Aided Wall Street in Deals, N.Y. TIMES, Apr. 24, 2010, http://www.nytimes.com/2010/04/24/business/24rating.html?dbk.
163. See, e.g., GARY SHORTER & MICHAEL V. SEITZINGER, CONG. RESEARCH SERV., R40613, CREDIT RATING AGENCIES AND THEIR REGULATION 5-6, 11 (2009). Ratings methodologies changed frequently for structured-finance products and were not always consistent between existing and new issues. Mason & Rosner, supra note 19, at 19, 21, 22 n.75. These models also failed to incorporate much of the available mortgage data (or lack thereof), such as debt-to-income ratio, appraisal type, and lender identity. Id. at 23-24.
164. See Gretchen Morgenson, Debt Watchdogs: Tamed or Caught Napping?, N.Y. TIMES, Dec. 7, 2008, http://www.nytimes.com/2008/12/07/business/07rating.html? pagewanted=all;
165. Joshua D. Coval et al., The Economics of Structured Finance 4 (Harvard Bus. Sch., Working Paper 09-060, 2008), available at http://www.hbs.edu/ research/pdf/09-060.pdf.
166. Because the issuers of structured products were looking to manufacture as much investment-grade paper as possible, the rating agencies were under pressure to award investment-grade ratings, even if it meant making "out of model adjustments." See Kia Dennis, The Ratings Game: Explaining Rating Agency Failures in the Build Up to the Financial Crisis, 63 U. MIAMI L. REV. 1111, 1137-38 (2009)
167. (quoting U.S. SEC. & EXCH. COMM'N, SUMMARY REPORT OF ISSUES IDENTIFIED IN THE COMMISSION STAFF S EXAMINATIONS OF SELECT CREDIT RATING AGENCIES 14 (2008), available at http://www.sec.gov/news/studies/2008/ craexamination070808.pdf).
168. As Patrick Bolton, Xavier Freixas, and Jacob Shapiro have theorized, it is much easier for a rating agency to inflate ratings in a boom market because there is less of a chance of a rating being wrong in the short term and the benefits of new business generation are larger. See Patrick Bolton et al., The Credit Ratings Game 13-15 (Nat'l Bureau of Econ. Research, Working Paper No. 14712, 2009).
169. See Moody's Investors Serv., Annual Report (Form 10-K) (Dec. 31, 2010), available at http://files.shareholder.com/downloads/MOOD/1722710333x0x448994/ A62AF06C-38B5-4429-A15036AE9485822F/2010AR.pdf.
170. See Vasiliki Skreta & Laura Veldkamp, Ratings Shopping and Asset Complexity: A Theory of Ratings Inflation 16-20 (Soc. Sci. Research Network, Working Paper No. 1295503, 2008), available at http://ssrn.com/abstract=1295503.
171. For more information about ratings shopping in the context of commercial mortgage-backed securities, see Andrew Cohen, Rating Shopping in the CMBS Market (Sept. 2011) (unpublished paper), available at http://www.federalreserve.gov/ events/conferences/2011/rsr/papers/Cohen.pdf;
172. Timothy J. Riddiough & Jun Zhu, Shopping, Relationships, and Influence in the Market for Credit Ratings (Nov. 2009) (unpublished paper), available at http://www.hhs.se/df/seminarsworkshops/documents/riddiough.pdf;
173. Richard Stanton & Nancy Wallace, CMBS Subordination, Ratings Inflation, and Regulatory-Capital Arbitrage (July 11, 2011) (unpublished paper), available at http://faculty.haas.berkeley.edu/stanton/papers/pdf/cmbx.pdf.
174. See Larry Cordell, Yilin Huang, & Meredith Williams, Collateral Damage: Sizing and Assessing the Subprime CDO Crisis 10 (Fed. Reserve Bank of Phila., Working Paper No. 11-30, 2011), available at http://papers.ssrn.com/ sol3/papers.cfm?abstract-id=1907299.
175. See Mark H. Adelson & David P. Jacob, The Subprime Problem: Causes and Lessons, J. STRUCTURED FIN., Spring 2008, at 12, 12-17.
176. See Anna Katherine Barnett-Hart, The Story of the CDO Market Meltdown: An Empirical Analysis 10-11 (Mar. 19, 2009) (unpublished B.A. thesis, Harvard College), available at http://www.hks.harvard.edu/m-rcbg/students/dunlop/2009- CDOmeltdown.pdf.
177. See Global CDO Issuance, SEC. INDUSTRY & FIN. MARKETS ASS'N, http://www.sifma.org/uploadedfiles/research/statistics/statisticsfiles/ sf-global-cdo-issuance-sifma.xls (last visited Jan. 13, 2012) (select the "Collateral" tab in the Excel spreadsheet).
178. See Yongheng Deng et al., CDO Market Implosion and the Pricing of CMBS and Sub-Prime ABS, at 4, 28 fig.3 (Apr. 2008) (unpublished article), available at http://www.reri.org/research/article-pdf/wp150.pdf.
179. See Asset-Backed Alert: The Weekly Update on Worldwide Securitization, THE ABS DATABASE, http://www.abalert.com (last visited Mar. 10, 2010). Between 2001 and 2007, 75% of global CDO issuance was U.S.-dollar denominated. See Global CDO Issuance, supra note 218 (select the "Denomination" tab in the Excel spreadsheet).
180. See Richard Herring & Susan Wachter, Bubbles in Real Estate Markets 4 (Zell/Lurie Real Estate Ctr., Working Paper No. 402, 2002), available at http://realestate.wharton.upenn.edu/research/papers.php?paper=402. Shorting real estate should not be confused with a short sale in which a mortgage lender agrees to let a borrower sell property for less than the full amount due on the mortgage and forgives the deficiency.
181. See, e.g., J. Michael Harrison & David M. Kreps, Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations, 92 Q.J. ECON. 323, 324-25 (1978) (arguing that differences in investor opinions combined with short-sale constraints can create a "speculative premium");
182. Charles M. Jones & Owen A. Lamont, Short-Sale Constraints and Stock Returns, 66 J. FIN. ECON. 207, 209 (2002) (finding "that stocks that are expensive to short ⋯ [have higher valuations] and low subsequent returns");
183. Edward M. Miller, Risk, Uncertainty, and Divergence of Opinion, 32 J. FIN. 1151, 1154 (1977) (arguing that in a market where short selling is limited and investors hold a divergence of opinions, asset prices may rise above fundamental levels because the price only reflects the views of optimistic investors);
184. José A. Scheinkman & Wei Xiong, Overconfidence and Speculative Bubbles, 111 J. POL. ECON. 1183, 1208 (2003) (arguing that, if short sales were prohibited and some investors were overconfident regarding asset appreciation, then asset prices would rise above their fundamental values).
185. See, e.g., VINOD KOTHARI, SECURITIZATION: THE FINANCIAL INSTRUMENT OF THE FUTURE 524-25 (2006);
186. David Mengle, Credit Derivatives: An Overview, ECON. REV., Fourth Quarter 2007, at 1, 1-2.
187. GILLIAN TETT, FOOL'S GOLD: HOW THE BOLD DREAM OF A SMALL TRIBE AT J.P. MORGAN WAS CORRUPTED BY WALL STREET GREED AND UNLEASHED A CATASTROPHE 124-25 (2009).
188. See Jesse Eisinger & Jake Bernstein, The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going, PROPUBLICA (Apr. 9, 2010, 1:59 PM), http://www.propublica.org/article/all-the-magnetar-trade-how-one-hedge-fund- helped-keep-the-housing-bubble.
189. This is a distinct type of leverage than that which is usually considered in the case of CDOs, namely the leverage of the protection seller who does not have to commit full funding of its position upfront, enabling it to deploy those funds elsewhere. See Erik F. Gerding, Credit Derivatives, Leverage, and Financial Regulation's Missing Macroeconomic Dimension, 8 BERKELEY BUS. L.J. 29, 40-41 (2011). It is also distinct from a third type of leverage in the CDO space, namely the leveraging of a limited number of PLS tranches into a much greater systemic financial exposure through synthetic securitization. Synthetic CDOs also greatly amplified the financial risk on a set group of mortgages. Thus, Larry Cordell, Yilin Huang, and Meredith Williams have found that, between 1999 and 2007, 5,496 BBB-rated PLS were referenced some 36,901 times in 727 publicly traded CDOs, which had the effect of "transforming $64 billion of BBB subprime bonds into $140 billion of CDO assets." Cordell, Huang, & Williams, supra note 210, at 2, 10, 34 tbl.6.
190. See Ingo Fender & Martin Scheicher, The ABX: How Do the Markets Price Subprime Mortgage Risk?, BIS Q. REV., Sept. 2008, at 67, 67-68.
191. The ABX was launched on January 19, 2006. See CDS IndexCo and Markit Announce Roll of the ABX.HE Indices, BUS. WIRE (Jan. 19, 2007, 8:00 AM), http://www.businesswire.com/news/home/20070119005133/en/CDS-IndexCo-Markit- Announce-Roll-ABX.HE-Indices.
192. For details on the ABX index methodology, see Press Release, MarkIt, Index Methodology for the ABX.HE Index for the Sub-Prime Home Equity Sector ("ABX.HE Index Rules") (Sept. 5, 2008), http://www.markit.com/assets/ en/docs/products/data/indices/structured-finance/ABX%20rules%20revised%209-9-08. pdf.
193. A similar index, the CMBX, exists for CMBS. See The CMBX: The Future Is Here, NOMURA FIXED INCOME RES., Mar. 23, 2006, at 1, available at http://www.securitization.net/pdf/Nomura/CMBX-23Mar06.pdf;
194. Alan Todd & Yuriko Iwai, An Introduction to the CMBX.NA Index and Single-Name CMBS CDS, CMBS WORLD, Spring 2006, at 29, 29, available at http://www.crefc.org/assetlibrary/F1F85F3A-D0A5-4EF6-AACD-D73C7ADEF496/ 994a8967a1614f9cb3da761b5d8818602.pdf;
195. see also CMBX Draws Fire for Lack of Transparency, COM. MORTGAGE ALERT (Mar. 14, 2008), http://www.cmalert.com/headlines-search.php?s=CMBX. +Index+Draws+Fire+for+Lack+of.+.Transparency (arguing that there is a lack of trading-volume information on CMBX);
196. Trade Group Urges More CMBX Disclosure, COM. MORTGAGE ALERT (Mar. 28, 2008), http://www.cmalert.com/headlines-search.php?s= Trade+Group+Urges+More+CMBX+Disclosure. 252.
197. See John Geanakoplos, Solving the Present Crisis and Managing the Leverage Cycle, FRBNY ECON. POL'Y REV, August 2010, at 101, 110-11, available at http://www.ny.frb.org/research/epr/10v16n1/1008gean.pdf.
198. See Jerome S. Fons, Shedding Light on Subprime RMBS, J. STRUCTURED FIN., Spring 2009, at 81, 89.
199. Cf. Karl E. Case, Jr. et al., Index-Based Futures and Options Markets in Real Estate, J. PORTFOLIO MGMT., Winter 1993, at 83, 84 (arguing that "[t]he establishment of real estate futures and options contracts could spectacularly lower transaction costs for trading in real estate");
200. Michael C. Lovell & Robert C. Vogel, A CPI-Futures Market, 81 J. POL. ECON. 1009, 1009 (1973) (arguing to "extend the concept of a futures market to provide a means of hedging against fluctuations in ⋯ the consumer price index");
201. Mark J. Powers, Does Futures Trading Reduce Price Fluctuations in the Cash Markets?, 60 AM. ECON. REV. 460, 464 (1970) (arguing that futures markets should "result ⋯ [in] more informed decision making and prices that are more closely representative of basic supply and demand conditions").
202. See Richard Stanton & Nancy Wallace, ABX.HE Indexed Credit Default Swaps and the Valuation of Subprime MBS 5 (Feb. 15, 2008) (unpublished paper), available at http://escholarship.org/uc/item/5s75x0ns#page-1.
203. See Gary Gorton, Information, Liquidity, and the (Ongoing) Panic of 2007, 99 AM. ECON. REV. 567, 572 (2009).
204. See Gary Gorton & Andrew Metrick, The Run on Repo and the Panic of 2007-2008, at 8 (Mar. 9, 2009) (unpublished paper), available at http://econ-www.mit.edu/files/3918.
205. See Gary Gorton & Andrew Metrick, Securitized Banking and the Run on Repo 10 n.12 (Yale Int'l Ctr. for Fin., Working Paper No. 09-14, Nov. 9, 2010), available at http://ssrn.com/abstract=1440752 (discussing rehypothecation as a multiplier).
206. See Mike McNamee, Lewis S. Ranieri: Your Mortgage Was His Bond, BLOOMBERG BUSINESSWEEK (Nov. 29, 2004), http://www.businessweek.com/magazine/content/04- 48/b3910023-mz072.htm.
207. See Reshmaan N. Hussam et al., Thar She Blows: Can Bubbles Be Rekindled with Experienced Subjects?, 98 AM. ECON. REV. 924, 924 (2008) ("[I]n order for price bubbles to be extinguished, the environment in which the participants engage in exchange must be stationary and bounded by a range of parameters. Experience, including possible 'error' elimination, is not robust to major new environment changes in determining the characteristics of a price bubble.").
208. See Thomas W. Merrill & Henry E. Smith, The Property/Contract Interface, 101 COLUM. L. REV. 773, 777 (2001) ("[T]he adoption of novel forms of property has implications not only for the immediate parties to the transaction but also for third parties, who must incur additional costs of gathering information in order to ⋯ decide whether to seek to acquire these rights."). (Pubitemid 33652111)
209. Thomas W. Merrill & Henry E. Smith, Optimal Standardization in the Law of Property: The Numerus Clausus Principle, 110 YALE L.J. 1, 26-27 (2000).
210. See Joshua Fairfield, The Cost of Consent: Optimal Standardization in the Law of Contract, 58 EMORY L.J. 1401, 1404 (2009) (arguing that standardization of contracts reduces the information costs of contracting);
211. Joshua A.T. Fairfield, The Search Interest in Contract, 92 IOWA L. REV. 1237, 1256-57 (2007) (same).
212. The principle of standardization in the mortgage market is not itself a novel or radical one. The idea has worked well in the past, creating a deep, liquid market and enabling mortgages to be sold on the To-Be-Announced (TBA) market, meaning that the mortgages are sold to the GSEs before they are actually closed. The existence of the TBA market allows borrowers to lock in their mortgage rates months before their closing. See JAMES VICKERY & JOSHUA WRIGHT, FED. RESERVE BANK OF N.Y., TBA TRADING AND LIQUIDITY IN THE AGENCY MBS MARKET 12 (2010), available at http://www.ny.frb.org/research/staff-reports/ sr468.pdf.
213. See Adam J. Levitin, Andrey D. Pavlov & Susan M. Wachter, Dodd-Frank Act and Housing Finance: Can It Restore the Private Risk Capital to the Securitization Market?, 29 YALE J. ON REG. (forthcoming 2012).