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The Crash of the Housing Bubble

Explosion of Residential Mortgage Debt

According to the Case-Shiller housing index, residential housing prices peaked in July of 2006. Housing prices were still in decline at the time this chapter was written (summer of 2011). Credit for the bubble can be attributable to policy objectives as well as easy credit. Policy during both the Clinton and Bush administrations was clearly focused on increasing home ownership. This motive was not new; GSEs were established to expand the secondary market in mortgages by purchasing and securitizing conforming loans and creating mortgage-backed securities (MBS), transferring ownership (and risk) of cash flows to investors. MBSs were essentially plain vanilla pass-through securities with no credit enhancement and stable credit risk.

GSEs essentially enjoyed a carry trade in MBS due to their low borrowing costs; they were backed by the government and therefore had the highest credit quality. Some pertinent facts:

• Twenty percent of the mortgage debt was funded by MBS in 2003 (up from 5 percent in 1992).
• Forty-seven percent of all mortgage debt was held by GSEs in the form of MBS and whole loans by 2003.

Government's Role

As mentioned earlier, there has been a clear policy mandate aimed at increasing home ownership in the United States, for financial reasons (home equity was considered a form of savings) as well as for less tangible purposes. For example, home ownership is part of the American dream. HUD specified ...