Wrong assumptions in the financial crisis

The purpose of this paper is to show how some of the assumptions about the current financial crisis are wrong because they misunderstand what takes place in the mortgage market.

The paper discusses four wrong assumptions: one related to regulation, one to leveraging, one to subprime lending and one to predatory lending. It briefly discusses some policy implications.

The role of the state in the mortgage market is more complex than suggested by those who blame the state for not doing anything. The concept of leveraging can explain, at least in part, why the losses in financial markets are bigger than the losses in the housing market. Many subprime loans were sold to prime borrowers. Subprime lending was not designed to increase homeownership rates, but to fuel profits by exploiting vulnerable borrowers.

It is too easy to argue that everyone made mistakes; most borrowers cannot be blamed for being sold risky, overpriced loans. A rescue plan is needed for defaulting borrowers and those already in foreclosure.

The paper does not present new research, but brings together research that demonstrates that the roots of the crisis in the mortgage market are in many ways different from what is suggested by professionals and journalists alike.