Adam J. Levitin - The Great American Housing Bubble: What Went Wrong and How We Can Protect Ourselves in the Future

Were an odd couple. Were a law professor and a real estate economist separated by a generation and, on a good day, about two hours on the Acela Express. Weve been collaborating on scholarship and policy work since 2008, and we owe our acquaintance to the financial crisis that followed the collapse of the Great American Housing Bubble.

In September 2008, when the entire US economy appeared to be imploding, we both found ourselves participating in a number of conference calls as part of brain trusts to which members of Congress were turning for ideas on how to help bail out not just banks but also beleaguered homeowners. We recognized in the course of those calls that we could do a lot more together than we could separately. Adam knew something about the mechanics of securitization and foreclosures, and Susan knew quite a bit more about real estate economics. We realized that by putting these pieces together we could articulate a much more coherent critique of what went wrongand a much sharper formula for how to fix itthan we could individually. Over the years we have batted ideas back and forth and educated each other, while working through our thinking on housing finance in a series of articles, book chapters, congressional testimonies, and policy briefs. This book is the culmination of our efforts.

Our immodest goal in this book is to provide the definitive account of the creation and collapse of the Great American Housing Bubble and to set forth tangible principles and metrics to guide housing finance reform. Put differently, this book is about what went wrong in housing finance and how to fix it. Astonishingly, over a decade after the bubble burst, no definitive account yet exists of the bubble, which brought on the greatest destruction of wealth in modern memory, culminating in the financial crisis of 2008. While there are numerous accounts of the financial crisis of 2008, the events of the fall of 2008 are very much an epilogue to the story of the bubble. The question that concerns us is what went wrong in the housing finance market such that there was a bubble in the first place.

As of our writing, in the beginning of 2020, the housing finance system in the United States remains broken. The bubble drove home prices in some parts of the country to record highs. The collapse of the bubble triggered the worst financial crisis since the Great Depression. It also left a legacy of over 7 million homes sold in foreclosureone in every nineteen housing units in the United States, with millions of families displaced and many others trapped in houses that they could not sell without taking a loss. More than a decade later, the effects of the collapse still linger in the form of depressed interest rates. Although the housing finance system is currently stable, it remains on government life support and is, incredibly, still in limbo.

Understanding what caused the bubble is paramount for preventing a recurrence and for ensuring a stable housing finance system going forward. If we dont understand what caused the Great American Housing Bubble that destroyed trillions of dollars of wealth, destabilized numerous communities, precipitated millions of home foreclosures, and played a key role in tectonic shifts in global financial markets, how can we ever hope to prevent future bubbles?

We believe it is important to understand what happened in the housing market not only for its own sake, but also because of the lessons it holds for rebuilding the housing finance market. Given the far-reaching effects of housing finance in consumers lives (where and how we live), in the economy ($11 trillion of mortgage debt, financed through $9.5 trillion of various mortgage-related securities), and ultimately even in the political system (homeownership affects civic participation), it is imperative the housing finance system ensure Americans have access to affordable, stable, and fair housing finance.

The story we tell is not about people directly, or at least it does not feature individuals. You will not meet colorful stock characters from the bubble years like the charlatan mortgage broker, the wily house flipper, the hapless subprime borrower, the do-nothing regulator, the Cassandra professor, the unctuous lobbyist, the smarmy politician, the rube asset manager, the eccentric genius investor, or the rapacious Wall Street financier. They make great fodder for journalistic accounts, and we love reading about them, but their personality quirks are a distraction from the search for what went wrong; more importantly, these synecdoches, although helpful for casual discussion, offer no help in figuring out how to fix the market.

Instead, ours is a story of two intertwined marketsthe housing market and the housing finance marketthat are populated by institutions, financial products, and regulations. These markets are indelibly connected for a simple reason: most Americans purchase their homes on credit; without mortgage credit, our housing stock and our whole way of life in America would look radically different. Ours is a tale of the possibilitiesand limitsof markets, and the complicated role of government in markets. Ultimately it is a story about what sort of country we live in and what sort of country we will leave to our children and grandchildren: can we bequeath them a country with a strong homeownership culture, stable neighborhoods, and sources of retirement savings, and fair access to adequate credit? The question of who can get housing financing and on what terms affects consumer behavior, community makeup, local democracy, and the economy as a whole.

These lofty points aside, every story needs a protagonist, and we have one. The hero of our story is the thirty-year fixed-rate mortgage (FRM) or 30-year fixedthe American Mortgage, a uniquely American financial product that has unusual benefits for consumers and market stability. The American Mortgage only emerged following World War II. It is the product of substantial regulatory interventions in the mortgage market and requires a certain institutional and regulatory environment to thrive. The story of the American Mortgage is one of enormous social benefits resulting from government interventions in the market.