Ignorance has largely been blamed for the financial crisis – but ignorance didn’t play nearly as big a part as most people think, said Paul S. Willen, senior economist and policy advisor for the Federal Reserve Bank of Boston.
Both borrowers and lenders knew more about their financial dealings than many experts and politicians are giving them credit for, Willen said at a New England Consumer Advisory Group (NECAG) conference Tuesday in Boston. Both sides were seduced by the seemingly never-ending rise in housing values, he said, which blinded them to the known risks.
The issue is still important because policymakers are insistent upon more disclosures in financial transactions. But, Willen said, including more information about the transaction would have done little to dissuade borrowers from taking on risky mortgages, and lenders from investing in them.
That’s akin to telling passengers about to board the Titanic that the ship was understocked with life boats. That information wouldn’t have stopped them from boarding, he said, because they were certain the boat was "unsinkable" – the same way both lenders and borrowers were sure housing prices were equally unable to go down. With that certainty fixed, no amount of warning signs deterred them.
For example, he said, an August 2005 report from Lehman Brothers shows that the firm was aware that a decline in housing values would have been catastrophic. The report acknowledges this, yet is blithely certain that housing values will continue to rise.
It’s likewise with borrowers, he said. Mortgage specialists did oftentimes pitch them deals for homes they couldn’t afford, but it was a far easier sell because so many other borrowers had successfully flipped their homes in the years before housing values started to crest.
The blame, therefore, lies squarely with the housing bubble and financial players’ inability to see it for what it was. Willen acknowledged that bubbles are hard to predict and can’t be stopped once in motion, but he said that the system can be built studirly enough to protect everyone in it. It’s important to broaden one’s view and ask if the underlying assumptions hold up – in this case, whether a mortgage or an investment can withstand a 30 percent drop in housing prices.
Willen’s speech was part of a day-long discussion on the financial crisis and policymaking, particularly the Dodd-Frank bill, which will try to prevent a similar situation in the future. NECAG, which is a collection of regulators, attorneys, academics, consumer advocates and others, hosts a such conferences to address important issues in the financial sector.
