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472 Dissenting Statement

previous bubble was what caused the catastrophic housing price declines that fueled
the fi nancial crisis.

1. How Failures Among NTMs

were Transmitted to the Financial System
When the housing bubble began to defl ate in mid-2007, delinquency rates
among NTMs began to increase substantially. Previously, although these mortgages
were weak and high risk, their delinquency rates were relatively low. Th is was a
consequence of the bubble itself, which infl ated housing prices so that homes
could be sold with no loss in cases where borrowers could not meet their mortgage
obligations. Alternatively, rising housing prices—coupled with liberal appraisal
rules—created a form of free equity in a home, allowing the home to be refi nanced
easily, perhaps even at a lower interest rate. However, rising housing prices eventually
reached the point where even easy credit terms could no longer keep the good times
rolling, and at that point the bubble fl attened and weak mortgages became exposed
for what they were. As Warren Buff ett has said, when the tide goes out, you can see
who’s swimming naked.
Th e role of the government’s housing policy is crucial at this point. As
discussed earlier, if the government had not been directing money into the
mortgage markets in order to foster growth in home ownership, NTMs in the
bubble would have begun to default relatively soon aft er they were originated. Th e
continuous infl ow of government or government-backed funds, however, kept the
bubble growing—not only in size but over time—and this tended to suppress the
signifi cant delinquencies and defaults that had brought previous bubbles to an end
in only three or four years. Th at explains why PMBS based on NTMs could become
so numerous and so risky without triggering the delinquencies and defaults that
caused earlier bubbles to defl ate within a shorter period. With losses few and time
to continue originations, Countrywide and others were able to securitize subprime
PMBS in increasingly large amounts from 2002 ($134 billion) to 2006 ($483 billion)
without engendering the substantial increase in delinquencies that would ordinarily
have alarmed investors and brought the bubble to a halt. 46
Indeed, the absence of delinquencies had the opposite eff ect. As investors
around the world saw housing prices rise in the U.S. without any signifi cant losses
even among subprime and other high-yielding loans, they were encouraged to buy
PMBS that—although rated AAA—still off ered attractive yields. In other words, as
shown in Figure 2, government housing policies—AH goals imposed on the GSEs,
the decline in FHA lending standards, HUD’s pressure for reduced underwriting
standards among mortgage bankers, and CRA requirements for insured banks—
by encouraging the growth of the bubble, increased the worldwide demand for
subprime PMBS. Th en, in mid-2007, the bubble began to defl ate, with catastrophic
consequences.

46 Inside Mortgage Finance, Th e 2009 Mortgage Market Statistical Annual—Volume II, MBS database.