A great piece of research from the authors at the University of Michigan and Princeton University (*) tests the hypothesis that the bankers inside the sub-prime mortgage bubble knew it was all too good to last. They find the hypothesis false. Many of the bankers in mortgage securitisation (transforming bank mortgage loans into bonds that were sold on to third party investors around the world) were themselves mortgaging up to buy larger houses, suggesting they believed the boom was permanent.
The authors examined the actions of a random sample of 400 people who attended the 2006 American Securitization Forum’s industry conference in Las Vegas using public data on their house purchases. They compared this group with a control group of other well paid Wall Street finance and accounting professionals. If the “insiders” knew more than other finance professionals they presumably would have reduced or at least not increased their personal exposure to the housing market. But they did increase it, on average.
This doesn’t prove that bankers weren’t also cynical, selfish, greedy, or even (if you prefer) evil. But it does suggest that what went wrong in the run up to the sub-prime disaster in 2007 was a widespread misconception that the market boom was sustainable, in other words that this time was different.
Policy makers can, to some extent, modify incentives to stop people knowingly ripping off ignorant customers. But it’s much harder to legislate against systemic foolishness and over-confidence. Which is why it will happen again.
(*) Ing-Haw Cheng and Sahil Raina are at Michigan, Wei Xiong is at Princeton. The paper is called “Wall Street and the Housing Bubble”