An Inquest into the Subprime Crisis

, image by Paul Townsend

Coroners Inquests in Gloucestershire from The Gloucester Journal 1814

Juan Ospina and Harald Uhlig have posted Mortgage-Backed Securities and the Financial Crisis of 2008: A Post-Mortem to SSRN. Given that the market for private-label MBS pretty much died by 2008, the title is apt. The paper presents a challenge to many of the standard narratives that have developed to explain the causes of the subprime crisis and the broader financial crisis that followed. Other researchers in this area will surely take up the gauntlet thrown down by this paper. Hopefully, we will collectively come up with the right narrative to explain the whole mess. The paper opens,

Gradually, the deep financial crisis of 2008 is in the rearview mirror. With that, standard narratives have emerged, which will inform and influence policy choices and public perception in the future for a long time to come. For that reason, it is all the more important to examine these narratives with the distance of time and available data, as many of these narratives were created in the heat of the moment.

One such standard narrative has it that the financial meltdown of 2008 was caused by an overextension of mortgages to weak borrowers, repackaged and then sold to willing lenders drawn in by faulty risk ratings for these mortgage back securities. To many, mortgage backed securities and rating agencies became the key villains of that financial crisis. In particular, rating agencies were blamed for assigning the coveted AAA rating to many securities, which did not deserve it, particularly in the subprime segment of the market, and that these ratings then lead to substantial losses for institutional investors, who needed to invest in safe assets and who mistakenly put their trust in these misguided ratings.

In this paper, we re-examine this narrative. We seek to address two questions in particular. First, were these mortgage backed securities bad investments? Second, were the ratings wrong? We answer these questions, using a new and detailed data set on the universe of non-agency residential mortgage backed securities (RMBS), obtained by devoting considerable work to carefully assembling data from Bloomberg and other sources. This data set allows us to examine the actual repayment stream and losses on principal on these securities up to 2014, and thus with a considerable distance since the crisis events. In essence, we provide a post-mortem on a market that many believe to have died in 2008. We find that the conventional narrative needs substantial rewriting: the ratings and the losses were not nearly as bad as this narrative would lead one to believe.

Specifically, we calculate the ex-post realized losses as well as ex-post realized return on investing on par in these mortgage backed securities, under various assumptions of the losses for the remaining life time of the securities. We compare these realized returns to their ratings in 2008 and their promised loss distributions, according to tables available from the rating agencies. We shall investigate, whether ratings were a sufficient statistic (to the degree that a discretized rating can be) or whether they were, essentially, just “noise”, given information already available to market participants at the time of investing such as ratings of borrowers.

We establish seven facts. First, the bulk of these securities was rated AAA. Second, AAA securities did ok: on average, their total cumulated losses up to 2013 are 2.3 percent. Third, the subprime AAA-rated segment did particularly well. Fourth, later vintages did worse than earlier vintages, except for subprime AAA securities. Fifth, the bulk of the losses were concentrated on a small share of all securities. Sixth, the misrating for AAA securities was modest. Seventh, controlling for a home price bust, a home price boom was good for the repayment on these securities. (1-2)

The Financial Meltdown and Consumer Protection

photo by HTO

Larry Kirsch and Gregory D. Squires have published Meltdown: The Financial Crisis, Consumer Protection, and the Road Forward. According to the promotional material,

Meltdown reveals how the Consumer Financial Protection Bureau was able to curb important unsafe and unfair practices that led to the recent financial crisis. In interviews with key government, industry, and advocacy groups along with deep archival research, Kirsch and Squires show where the CFPB was able to overcome many abusive practices, where it was less able to do so, and why.

Open for business in 2011, the CFPB was Congress’s response to the financial catastrophe that shattered millions of middle-class and lower-income households and threatened the stability of the global economy. But only a few years later, with U.S. economic conditions on a path to recovery, there are already disturbing signs of the (re)emergence of the high-risk, high-reward credit practices that the CFPB was designed to curb. This book profiles how the Bureau has attempted to stop abusive and discriminatory lending practices in the mortgage and automobile lending sectors and documents the multilayered challenges faced by an untested new regulatory agency in its efforts to transform the broken—but lucrative—business practices of the financial services industry.

Authors Kirsch and Squires raise the question of whether the consumer protection approach to financial services reform will succeed over the long term in light of political and business efforts to scuttle it. Case studies of mortgage and automobile lending reforms highlight the key contextual and structural conditions that explain the CFPB’s ability to transform financial service industry business models and practices. Meltdown: The Financial Crisis, Consumer Protection, and the Road Forward is essential reading for a wide audience, including anyone involved in the provision of financial services, staff of financial services and consumer protection regulatory agencies, and fair lending and consumer protection advocates. Its accessible presentation of financial information will also serve students and general readers.


  • Presents the first comprehensive examination of the CFPB that identifies its successes during its first five years of operation and addresses the challenges the bureau now faces
  • Exposes the alarming possibility that as the economy recovers, the Consumer Financial Protection Bureau’s efforts to protect consumers could be derailed by political and industry pressure
  • Offers provisional assessment of the effectiveness of the CFPB and consumer protection regulation
  • Gives readers unique access to insightful perspectives via on-the-record interviews with a cross-section of stakeholders, ranging from Richard Cordray (director of the CFPB) to public policy leaders, congressional staffers, advocates, scholars, and members of the press
  • Documents the historical and analytic narrative with more than 40 pages of end notes that will assist scholars, students, and practitioners

I would not describe the book as objective, given that Senator Elizabeth Warren wrote the forward and the President Obama’s point man on Dodd-Frank, Michael Barr, wrote the afterward. Indeed, it reads more like a panegyric. Nonetheless, the book has a lot to offer to scholars of the CFPB who are interested in hearing from the people who helped to stand up the Bureau.