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September 19, 2011


I don't get this. Of course lax underwriting standards were an important cause of the crash. A very obvious explanation that is ignored in this post is that even non sub-prime mortgages did not have satisfactory underwriting standards on average to begin with. And even if those mortgages saw an increase in their default rates, those default rates are still less pronounced than those for the sub-prime mortgages. If mortgages were required to have a max LTV of 80% (bye-bye FHA, VA, and USDA mortgages), along with a minimum credit score (say, 650) and max PITI and DTI ratios of say, 30/40, then any recession, if any, would be far less pronounced. If you had those UW guidelines, then a large housing bubble would not have developed. If a less pronounced bubble did develop, you wouldn't see as sharp a decline in home values. Any decline in this scenario would have a modest effect on default rates since (1.) people's homes suffer less depreciation ,(2.) homeowner's have more equity to begin with (think that 80% LTV requirement), and (3.) minimum credit scores and lower max ratios bolster the credit quality of homeowners.

The authors do not deny the importance of underwriting standards. The more important questions are how much they matter relative to other factors such as housing prices, under what conditions, and whether underwriting standards were a cause or effect of rising house prices (and expectations about them).

As noted at the end of the post, there is abundant research finding that underwriting standards have a prime explanatory role, contrary to the research highlighted.

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