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New Research Finds Affordable Housing Policies Did Not Lead to Financial Crisis

By Wisconsin School of Business

June 14, 2016

Wisconsin School of Business study with Federal Reserve finds no evidence that affordable housing mandates affected lending volumes, loan pricing, or default rates

While many factors contributed to the financial crisis of 2008, new research from the Wisconsin School of Business at the University of Wisconsin–Madison debunks the narrative that affordable housing policies were an underlying cause. Researchers from the Wisconsin School of Business and the Federal Reserve have found no evidence that affordable housing mandates led to the subprime mortgage collapse. Also, the study showed that these policies did not affect lending volumes, loan pricing, or default rates.

Andra Ghent, associate professor of real estate and urban land economics at the Wisconsin School of Business, together with co-authors Rubén Hernández-Murillo of the Federal Reserve Bank of Cleveland, and Michael T. Owyang of the Research Division of the Federal Reserve Bank of St. Louis, evaluated subprime lending in relation to the two primary affordable housing policies for owner-occupied homes in the United States—the Community Reinvestment Act (CRA) and the affordable housing goals of Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac.

“The picture that emerged from our study was that the typical subprime borrower had income over $100,000 and lived in a low-income neighborhood. It suggests that borrowers and loan originators overstated borrower incomes to get the loans approved,” says Ghent of the Wisconsin School of Business. “If meeting affordable housing requirements had been the primary concern, we’d expect to see exactly the opposite—namely, an understatement of borrower income so that the loans would satisfy those goals.”

Ghent adds, “We found that a majority of the loans were originated by nondepository institutions that were not even subject to the Community Reinvestment Act. And in the years leading up to the housing bubble, the GSEs did not see a substantial increase in their lending goals that would have driven an increase in loans to low-income people.”

Researchers reviewed data from more than 720,000 subprime mortgages in California and Florida at the height of the subprime lending boom. Those states had large shares of subprime mortgage originations and experienced a significant volume of defaults during the housing bust. For the first time, this study matched Home Mortgage Disclosure Act (HMDA) data, typically used to determine whether financial institutions are serving the housing needs of their communities, to loan-level data from private-label mortgage backed securities (PLMBS) deals.

At the same time, Ghent and her co-authors evaluated 100 randomly chosen prospectus supplements for PLMBS to assess how, if at all, these documents referenced how the underlying loans satisfied affordable housing goals or whether the securities were CRA qualified. While these documents discuss many of the loan characteristics, not a single one referenced GSE affordable housing goals or the CRA.

The supplements did reveal that the GSEs were major purchasers of mortgage-backed securities, and thus played a role in encouraging subprime lending. But the empirical evidence provided no link between the GSEs’ decisions to purchase these securities and their affordable housing goals. As these securities were widely seen to be highly profitable during the subprime boom and were being purchased by many investors other than the GSEs, the GSEs may have bought them because they offered attractive yields.

The paper, “Did Affordable Housing Legislation Contribute to the Subprime Securities Boom?”, was recently published in Real Estate Economics and is available online.