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KEITH HENNESSEY, DOUGLAS HOLTZ-EAKIN, AND BILL THOMAS 

the long run, but only that someone was willing to provide the initial loan.
Mortgage originators often had insufficient incentive to encourage borrowers
to get sustainable mortgages.

Some combination of the first two factors may apply in parts of the Sand States,
but these don’t explain the nationwide increase in prices.
The closely related and nationwide mortgage bubble was the largest and most sig-
nificant manifestation of a more generalized credit bubble in the United States and Eu-
rope. Mortgage rates were low relative to the risk of losses, and risky borrowers, who
in the past would have been turned down, found it possible to obtain a mortgage. 
In addition to the credit bubble, the proliferation of nontraditional mortgage
products was a key cause of this surge in mortgage lending. Use of these products in-
creased rapidly from the early part of the decade through . There was a steady
deterioration in mortgage underwriting standards (enabled by securitizers that low-
ered the credit quality of the mortgages they would accept, and credit rating agencies
that overrated the subsequent securities and derivatives). There was a contemporane-
ous increase in mortgages that required little to no documentation.
As house prices rose, declining affordability would normally have constrained
demand, but lenders and borrowers increasingly relied on nontraditional mortgage
products to paper over this affordability issue. These mortgage products included
interest-only adjustable rate mortgages (ARMs), pay-option ARMs that gave bor-
rowers flexibility on the size of early monthly payments, and negative amortization
products in which the initial payment did not even cover interest costs. These exotic
mortgage products would often result in significant reductions in the initial
monthly payment compared with even a standard ARM. Not surprisingly, they were
the mortgages of choice for many lenders and borrowers focused on minimizing
initial monthly payments.
Fed Chairman Bernanke sums up the situation this way: “At some point, both
lenders and borrowers became convinced that house prices would only go up. Bor-
rowers chose, and were extended, mortgages that they could not be expected to serv-
ice in the longer term. They were provided these loans on the expectation that
accumulating home equity would soon allow refinancing into more sustainable
mortgages. For a time, rising house prices became a self-fulfilling prophecy, but ulti-
mately, further appreciation could not be sustained and house prices collapsed.” 
This explanation posits a relationship between the surge in housing prices and the
surge in mortgage lending. There is not yet a consensus on which was the cause and
which the effect. They appear to have been mutually reinforcing.
In understanding the growth of nontraditional mortgages, it is also difficult to de-
termine the relative importance of causal factors, but again we can at least list those
that are important:

• Nonbank mortgage lenders like New Century and Ameriquest flourished un-
der ineffective regulatory regimes, especially at the state level. Weak disclosure
standards and underwriting rules made it easy for irresponsible lenders to issue