From the Federal Reserve Bank of San Francisco:
Figure 3 shows that one can observe similar comovement between asset prices and investment in the U.S. housing market. From 2001 to 2006, house prices nearly doubled, rising much faster than the underlying fundamentals, as measured by rents or household income. An accommodative interest rate environment, combined with a proliferation of new mortgage products (loans with little or no down payment, minimal documentation of income, and payments for interest-only or less), helped fuel the run-up in house prices. At the time, Fed Chairman Greenspan (2005) offered the view that the financial services sector had been dramatically transformed by advances in information technology, thus enabling lenders "to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately." Feldstein (2007), citing a number of studies, argues that the rapid growth in subprime lending during these years was driven in part by "the widespread use of statistical risk assessment models by lenders."Any comments from readers?
The subprime lending boom was later followed by a sharp rise in delinquencies and foreclosures, the collapse of numerous mortgage lenders, massive write-downs in the value of securities backed by subprime mortgages, and record-setting levels of unsold new homes. In retrospect, enthusiasm for a "new era" in credit risk modeling appears to have been overdone. Persons (1930 pp. 118-119) describes the fallout from an earlier era of rapid credit expansion as follows: "It is highly probable that a considerable volume of sales recently made were based on credit ratings only justifiable on the theory that flush times were to continue indefinitely….When the process of expanding credit ceases and we return to a normal basis of spending each year...there must ensue a painful period of readjustment."