EclectEcon

Many years ago, Stan Liebowitz analyzed the Boston Fed's study on mortgage discrimination. His finding? It was flawed beyond belief. From the NYPost (via Newmark's Door [still the first blog I read each weekday]),

...[A] "landmark" 1992 study from the Boston Fed concluded that mortgage-lending discrimination was systemic.

That study was tremendously flawed - a colleague and I later showed that the data it had used contained thousands of egregious typos, such as loans with negative interest rates. Our study found no evidence of discrimination.

Nevertheless, political correctness carried the day:

No sooner had the ink dried on its discrimination study than the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: "discrimination may be observed when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants."

Some of these "outdated" criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification. Instead, the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant's ability to manage debt.

Stan warned back then that such policies could lead to bigger problems in the future:

For years, rising house prices hid the default problems since quick refinances were possible. But now that house prices have stopped rising, we can clearly see the damage caused by relaxed lending standards.

This damage was quite predictable: "After the warm and fuzzy glow of 'flexible underwriting standards' has worn off, we may discover that they are nothing more than standards that lead to bad loans . . . these policies will have done a disservice to their putative beneficiaries if . . . they are dispossessed from their homes." I wrote that, with Ted Day, in a 1998 academic article.

Sadly, we were spitting into the wind.

What bothers/puzzles me is that investment bankers bought these collateralized debt instruments. Surely, even three years ago, people could see that these sub-prime mortgage packages were not bundles of independent risks but were bundles of highly correlated risks, all of which would tumble if/when housing prices began to fall. Even if the regulators forced lenders to make crappy loans, and even if the lenders fobbed them off on investors as quickly as they could, who was forcing these investors to buy the packages? Didn't they do their due-diligence and risk-analyisis?