The Great Recession Was Caused By Mortgage Suppression

Developing the Erdmann Housing Tracker to more comprehensively quantify the causes of high housing costs has radicalized me a bit. When I wrote “Building from the Ground Up”, I still was operating with a model of the recession where the Fed originally caused a nominal slow-down that was deeper than it needed to be, and then, after their big error from September to December 2008, mortgage suppression added a second, deeper recession that mostly hit working class homeowners, which has been either ignored or written off as part of a larger, inevitable wealth shock.

Quantifying the costs of the mortgage clamp down has led me to pull the effects of mortgage suppression back in time in to ascribe more importance to it. Mortgage suppression caused the crisis and the recession, and by 2008, the errors the Fed was making were greatly amplified by the damage of the mortgage suppression. If mortgage access after 2007 had remained at a level similar to previous recent norms, there would probably not have been a recession.

I have had a series of posts in my back pocket for a while that I haven’t written yet, but some chatter on twitter today got me worked up, so that I decided while the series on this topic will have to wait, I can write up one short post laying out the story here.

Really, you can tell the story with a single picture. Here, I have housing data from Atlanta and the New York Fed’s estimate of credit scores on mortgage originations. Here, the indicator I am using is “the % of mortgages being originated for borrowers with credit scores under 760”.

Figure 1

For 2 full years, before any of the price stuff happened, housing production collapsed. As Figure 1 shows, in Atlanta, it was down about 70% by the end of 2007!

Now, I would put most of this on the Fed, and I would argue that basically none of it was necessary. But, mostly this is an example of how much leeway the Fed has to screw up and still turn the boat around. Even a 70% decline in housing starts wasn’t associated with much of a wealth shock. This is the point of Ed Leamer’s “Housing is the business cycle” paper. Cyclically, housing is a leading indicator. But, it’s a production cycle, not a price cycle. (As I have pointed out before, the moral panic was so pervasive that even Leamer importantly punted on his insight and encouraged a continuation of the collapse in housing starts.)

Lending standards had tightened up a bit in 2007. Mortgage lending to credit scores under 760 was down about 10% from the norm by the end of 2007. (It hadn’t been unusually high during the boom! Don’t believe the hype!) After the end of 2007, the change from pre-existing norms really took hold. Lending below scores of 760 fell to less than 70% of its previous proportion. It remains lower than that to this day.

The real collapse in low tier home prices, especially relative to high tier home prices in Atlanta, happened in line with this decline, starting at the end of 2007 and continuing through 2010.

It is hard to overstate the crazy, lagging, pro-cyclical position of that policy shift. The unprecedented tightening in lending standards that was associated with a decline of 30% in low tier home prices in Atlanta, was imposed under conditions where new home production was already down by 70% in a city where neither production nor prices had been especially high, and where rent inflation was rising as production declined.

The Case-Shiller high tier vs low tier comparison is actually a bit understated here, because these are pretty broad estimates, covering basically the top half and the bottom half of the market, so even the high tier measure was affected by tight lending. In the Erdmann Housing Tracker, where I can identify income-sensitive price trends more precisely, the differences can be identified more clearly. Figure 2 shows the price trends in Atlanta for a ZIP code with average adjusted gross income of $190,000 (2022 $) vs a ZIP code with average adjusted gross income of $40,000. The decline in home values in the poorer ZIP code hit bottom at 70%! (This is on a log scale for symmetry. On an arithmetic scale, that’s a 50% drop.) And, that drop was eventually reversed, and then some, in spite of maintaining tight credit norms, because it has devastated the housing construction market in Atlanta, leading to rising rents.

Figure 2

Figure 2 is based on my price/income model. This helps clarify that the early price softness in 2007 was related to declining income growth related to broader monetary policy. (Prices dipped a bit, but price/income trends were level.) This is a common pattern across cities, though Atlanta was hit especially hard. A sharp, income-sensitive separation in home values coincided with the sharp drop in mortgage lending to credit scores below 760, and it happened well before the September 2008 crisis.

Tight lending caused the crisis.