The housing crisis has left quite a mark on economy. Eight years after the real estate bubble began to burst, the economy as a whole has still not fully healed from the crash that followed.

At the time — and ever since — most people have blamed that bubble, and its bursting, largely on the sub-prime mortgage market: lenders that offered loans too freely to borrowers who often weren’t financially secure enough to warrant them. But research by Wharton real estate professors Fernando Ferreira and Joe Gyourko disagrees with that theory. Their paper is titled, “A New Look at the U.S. Foreclosure Crisis: Panel Data Evidence of Prime and Subprime Borrowers from 1997 to 2012.”



In this interview with Knowledge@Wharton, Ferreira, who is also research associate for the National Bureau of Economic Research, discusses why the prime market was at least as responsible for the crisis as the sub-prime market, the nature of housing cycles, and the possibility of another bubble down the road.



An edited transcript appears below.

Knowledge@Wharton: Let’s look at the research and explain exactly what you really found out here. Why was the housing crisis not just the problem of the sub-prime market?

Fernando Ferreira: That’s a good question. Let’s start with why people focused so much on sub-prime lending. It was a new type of lending focusing on riskier borrowers who didn’t have money for the standard 20% down payment, who didn’t have a history of stable employment, or who didn’t have a high enough credit score to apply for conventional standard loans, so-called “prime” loans. Lenders became quite creative in terms of finding ways to provide loans to those individuals, to those families. And to be honest, those families are riskier, but they are almost middle class. That’s why that market got so much attention, because suddenly, a lot of people — especially minorities, who were out of the mortgage market for such a long time — were able to participate in the housing boom. And at that time — 2004, 2005 and 2006 — that was viewed as a very good thing. We knew we were improving. We were allowing those families to reach the American dream of ownership.

Knowledge@Wharton: So instead of just keeping it pared down to the people that had good credit scores and could put 20% down, banks were lending to a wider clientele. Not seeing those borrowers as that risky was a shift for the industry at that point.

Ferreira: Conditions in 2004 and 2005 were quite similar to today. Markets were rebounding. Prices were increasing. The number of transactions was up. Unemployment was down. Life was good. Everything felt pretty good. Nobody was predicting a Great Recession.

In those circumstances, what the lenders do is they lend. So that’s part of my research. Lenders — sub-prime lenders or prime lenders — usually never drive the cycle. They react to a lot of economic circumstances. So right now, in 2015, the markets are good — very few foreclosures, and we haven’t had a major hiccup in the past six, seven years. They look at that scenario and say, “Why not expand credit?” In 2004, 2005, it was exactly the same situation.

“We have almost no loans being issued by the so-called sub-prime lenders. What we have right now is prime lenders trying to make that loan process, the whole underwriting, a little bit more flexible.”

Knowledge@Wharton: So the assumption is that what happened with the housing crisis was really the fault of the sub-prime market, but your data suggests that, while that was a part of it, the prime market was really as big, if not a bigger, issue?

Ferreira: Yes. Let’s split the housing market into four major components. There’s the prime sector. That’s always around 60% of the market. That’s the bulk of the mortgage market. There are the governmental loans — HUD, FHA and VA — which are about 10% to 15% of the market. Then there’s sub-prime. Sub-prime started in the mid-1990s with about 5% to 10% of the market. And that increased to 20% — big, but a third the size of the prime sector. And then you have all-cash transactions: investors or wealthy people. And that’s about 10% of the market. So during the whole time period, even at the height of the housing boom, sub-prime was never more than 20% of the market. And the prime sector was 60% or more and increasing. My research from the mid-1990s to the late 2000s shows that even the prime sector increased a lot during the 1990s and 2000s, at the expense of the governmental loans.

Knowledge@Wharton: Because of the way the economy was going back then, people were feeling much better, there was more money, jobs were better, salaries were better. So people had that money to basically throw around.

Ferreira: It’s like today. If you ask me today who is getting more loans, riskier borrowers or the middle class, [it’s] the middle class that sees a market that’s stable, that had jobs for the past five, six years, people that were able to save for their down payment — they are the ones getting earlier into this market.

Knowledge@Wharton: As your data shows, there were a lot more foreclosures out of the prime market than the sub-prime market. With market share going up to 20% for sub-prime, is that number going to basically stay where it is? Or are we going to see that shrink down because of how much tougher it is now for people to be able to get a loan?

Ferreira: Yes.

Knowledge@Wharton: Zero down on a home is just not a feasible option these days.

Ferreira: Well, the sub-prime market collapsed after the Great Recession. We have almost no loans being issued by the so-called sub-prime lenders. What we have right now is prime lenders trying to make that loan process, the whole underwriting, a little bit more flexible. And you have the government with a lot more market share, because with the FHA, you can still get 97.5% LTV (loan-to-value ratio) loans. But that will change. And it should change, because that’s what people want. You see more and more, you read the articles in the newspapers and on TV, about middle-class families complaining that they can’t get a mortgage.

They can’t qualify for a mortgage. So slowly but surely, we’ll have more pressure on lenders to expand that market, to allow, again, the same story, to allow families to consume housing. Because ultimately, that’s what people want.

Knowledge@Wharton: So then it really shouldn’t be a surprise that the greater share of foreclosures after the bubble burst were from the prime market, because, as you alluded to, the prime market was three times as big as the sub-prime market, even at its height.

Ferreira: Well, what happened is, it was pretty easy when the crisis started to blame it on those lenders. And some of the lenders, some of the sub-prime lenders, really had bad practices. They were pushing exotic loans to people that couldn’t afford even a month of the mortgage payment. But they were a very small fraction of the sub-prime market, as well.

But those are the people that defaulted and had delinquencies and were foreclosed on first…. So in a way, [the press and researchers were] too quick to get that early data from 2007 and early 2008, where you saw a majority of foreclosures being sub-prime. And then you had all the news that Countrywide was doing so many bad things.

“Under those circumstances, there’s just one solution. And the solution is mail the keys to the bank.”

Suddenly, there was a focus on all the problems of sub-prime, all the problems with low-income borrowers — they shouldn’t have taken those loans, and that’s why everything has collapsed. But it turns out that, just a few months later, when the full effects of the recession were being realized by everybody, and that’s what our data is picking up, it shows that the phenomenon was widespread. It was not concentrated solely on the sub-prime sector.

Knowledge@Wharton: So it wouldn’t have mattered one way or another whether you were in the prime market or the sub-prime market. If you were getting a zero down or 10% down loan on your house, or if you were actually able to do 20% or 30%, this was going to happen?

Ferreira: More equity helps. Having a higher down payment helps. It’s always a good idea to put some money down. But it would not have prevented foreclosures, and let me explain why. In many markets in the Great Recession and the housing bust, prices fell by about 40% to 50%.

In places like Las Vegas, prices were about $500,000 for a house, and in a matter of months, they dropped to about $200,000. So prime and sub-prime borrowers bought homes for $500,000 and now, one year later, they see themselves in a situation where they’re unemployed, they can’t make the mortgage payments, and they have no job prospects, because the economy was just awful in 2008-2009. And they say, “We can’t make the payment; let me sell the house.” And when they go on the market, good luck finding a buyer for that house.

Under those circumstances, there’s just one solution. And the solution is mail the keys to the bank, mail the keys to the lender. And that’s when you have a foreclosure.

Knowledge@Wharton: Obviously, we are still feeling the effects of this even today, because, if you go look on a variety of the different real estate websites, you will still find a good many houses that are listed as foreclosures. Maybe not as many as were listed a couple of years ago, but you still have a lot of properties that fall under that foreclosure realm.

Ferreira: The crisis was major. It was the event of our lifetimes, and a bad event. So around 2008 and 2009, in certain markets, you had about 10% to 20% of the stock of homes being foreclosed. Those markets were the weaker markets, such as inland California, areas like Fresno and Modesto, or smaller markets in Florida, for example. And it took a very long time to resolve the situations. And part of the reason is there are no buyers. Only now, with the markets more normalized, it’s just easier to resolve those situations. And there is another detail. During that time period, lots of lenders and banks decided it was a good idea to postpone the resolution of those problems as much as they could, just to avoid realizing those early losses.

“I predict that, very soon, that same group of people will feel like they want to be part of this American dream of ownership. And they will be able to buy homes.”

Knowledge@Wharton: You mentioned that perhaps the research from back several years ago may be playing into this, as well. I guess, in some respects, then, we still don’t have a full, true understanding about housing cycles and how they affect the markets, or the potential of the U.S. having another bubble down the road.

Ferreira: That’s correct. We know some basic facts about how cycles work in the housing sector. And it starts with construction. It always takes a long time to build houses, to build apartments, to build any type of real estate.

Specifically in the example of houses, it’s a lot because of regulation. There are a lot of bureaucratic steps that developers need to take in order to even start the construction of a housing unit. Once the construction starts, it could go fast — as fast as four, five, six months. But the whole process usually takes one or two years. So developers start to plan construction when times are good, when they think there will be demand for that type of product. But it takes two years for that to happen, for the product to come live, and people can actually buy and move into those homes. The lag is just gigantic.

In times of boom, when thousands and thousands of developers are planning all that construction, and they’re providing all that extra supply of homes, they cannot forecast — or it’s nearly impossible to forecast — any type of recession, any type of negative shock that will happen in the labor market, in international markets. We have this recent Chinese problem. It’s just impossible to forecast that. And when you have this negative shock, it’s very hard for them to stop the construction. And if the house is already built, it’s important to get rid of that stock of houses. Because once you build it, it’s there. It’s pretty expensive to get rid of that construction.

So that’s the basic nature of the cycle. In boom times, you have an oversupply of homes. Shocks happen when the recession hits. You have a drop in demand, a dramatic drop in demand. And that oversupply is hanging there for a long time. Prices drop. And when prices drop, you have all sorts of actors — borrowers and lenders and banks — all running for the hills because it becomes a very complicated situation.

Knowledge@Wharton: So then where are we headed in the next few years? Because you see the various reports that the housing numbers are kind of going up and down; there are some months that are good for both new homes and existing homes. We see a variety of stories that more people are renting now than ever before, especially the millennial generation waiting a little bit longer to buy. The housing sector is better than what it was a few years ago, but it’s certainly not where we hope it would be. And realistically, I don’t think we can expect it to be in that area for several years.

Ferreira: I think there are two things. There is a temporary, transitory component, which is that the Great Recession happened recently; especially younger families had a hard time with the job and employment situation. Only recently they were able to feel more secure in their jobs and maybe get some raises and feel more confident that they could actually save and be ready to buy a home, or improve their credit scores, and so on. That’s part of the reason why more people are renting now, and they want to rent, especially the below-35 age group. That will change quite soon. Provided that we don’t have another major economic crisis, that will change. I predict that, very soon, that same group of people will feel like they want to be part of this American dream of ownership. And they will be able to buy homes. So in that sense, I think the scenario of the mid-2000s will get back pretty quickly, actually. It could be here already, or this year or next year.

Now, there are certain longer run trends that go against that. And the longer run trends are many. We are getting the first jobs much later. We’re staying longer in school. We are getting married much later. We’re having kids later or having fewer kids, period. And we are moving from city to city and from job to job much more frequently. All those long-term trends make homeownership a much tougher proposition, a much riskier investment.

“As soon as lenders start to react to the good business conditions, they’ll provide more lending. And if, one day, a crash happens, they’ll be blamed again.”

Knowledge@Wharton: So we’re talking about a change that maybe is going to stay for quite some time. Maybe we shouldn’t expect to start to see the age of first-time homebuyers dip significantly in the next few years just because of how our society is evolving right now.

Ferreira: Yes. I teach a real estate class here at Wharton, and I tell my own students, “If you know for sure that you’re going to be living in the same city, in the same neighborhood, at least for the next five or six years, then start thinking about buying a house, start doing the math. It doesn’t mean that you should buy a home.” But that should be the starting point.

Now, it turns out that, for most people under 40, it’s highly unlikely that they will stay in the same job and they will be living in the same city over the next five or six years, because that’s just the nature of current labor markets. On top of that, you need all those other issues. You know, do you have enough savings? Could you put 20% down? Is this the right option for you? Do you have kids already and are you thinking of enrolling them in a certain public school, and that’s why you need to buy a home close by? There are many things that one should consider in that decision, which means that, under those circumstances, renting is just a much safer and better proposition.

Now, the problem is there is a stigma. People don’t want to be renters. And it’s true that there are lots of landlords out there, especially small landlords, who are not extremely professional. And sometimes it’s hard to find high-quality housing for rent.

Knowledge@Wharton: Now that your research is out, will there be more of a fresh look, especially from the media and going forward, about how that period is going to be viewed historically, reexamining the blame that sub-prime took in this? Are we going to take this historical example as a lesson, so that we can watch this play out and understand what occurred, so we don’t fall into the same type of bubble again?

Ferreira: Unfortunately, I don’t think so. Let me give you an example about lenders. Lenders got all the blame, especially sub-prime lenders, for the crisis. So what’s happening right now in this recovery? Are we giving thank-yous to the lenders because perhaps they’re helping with the recovery? Absolutely not.

What we are actually reading in the news is that people, and sometimes even politicians, are criticizing lenders because they are being tough — too tight with their underwriting standards. So as soon as lenders start to react to the good business conditions and to the pressures from the people, they’ll provide more lending. And if, one day, a crash happens, they’ll be blamed again.

Knowledge@Wharton: So if that trend comes back, it really does fall even more so on the consumers themselves to really be aware and to know their situations so that they don’t potentially fall into a foreclosure situation down the road.

Ferreira: Yes. And that’s where part of the research is going — trying to understand not just the financial components of the decision making of buying versus renting, but the more psychological factors. What are the raw expectations? Are those expectations about future price appreciation, for example? Are they realistic or unrealistic? Bob Schiller, who won the Nobel Prize in economics, is the most famous person doing research in this area. And his work shows that, even to this date, on average, and especially in certain markets, people still have unrealistic expectations about future price appreciation. They still expect that prices will go up by 5%, 8%, sometimes even 10%, in every year over the next 10 years. That’s not going to happen.