How much has the market learned from the financial crisis a decade back? And are we prepared for the next crisis? Darrell Duffie and Amit Seru, both professors with Stanford’s Graduate School of Business spoke recently  to Edmund L. Andrews for the institute’s Insights blog about their concerns with the current U.S. housing market.
Both the professors of finance have spent considerable time studying the underlying causes of the Great Recession and believe the conditions that led to the last crisis could still very well be lurking in the market.
Seru, whose chief focus has been assessing responsibility for the subprime mortgage crisis among banks and regulators, stressed that the causes of the next financial meltdown remained unpredictable. According to him, the large number of market variables made it difficult for anyone to be able to forecast clearly. He contended that the best method for preventing future shocks to the financial system would be by passing legislation that requires banks to keep bigger “equity capital buffers” to withstand unanticipated market turbulence.
In an interview with DS News, Natalya Vinokurova, Assistant Professor, Wharton School, University of Pennsylvania echoed this sentiment saying that not enough liquidity in the system was likely to cause the next housing bubble. “The liquidity comes in part from the quantitative easing of policies adopted to ease the aftermath of the 2008 crisis,” she said.
Seru said that the creation of mortgage contracts with “semi-automatic relief mechanisms” that automatically index borrowers’ rates, so they vary according to local economic conditions, was yet another way to address the issue of liquidity as well as the fear that real income failures might lead to an increase in foreclosures once again.
Duffie, who has advised the U.S. and foreign policymakers on the weaknesses in the financial system prior to the meltdown, agreed that the recovery after the Great Recession may only have averted the real repercussions of the crisis rather than resolving it, especially in that certain banks and institutions remained “too big to fail.”
Recently, Sen. Bernie Sanders (I-Vt.) introduced a legislation aimed at breaking up the nation’s biggest banks and risky financial institutions. “No financial institution should be so large that its failure would cause catastrophic risk to millions of Americans or to our nation’s economic well being,” Sanders said in a statement after introducing the legislation. “We must end, once and for all, the scheme that is nothing more than a free insurance policy for Wall Street: the policy of ‘too big to fail.’”
While Duffie considered the reforms in U.S. banking and restructuring of U.S. debt since the crisis a step in the right direction, he remained skeptical about the steps being taken to keep another threat at bay. He said that Washington regulators have, since the crash, been “easier on the banks” than they should have been.
Looking specifically at the housing market, Michael Calhoun, President of the Brookings Center for Responsible Lending said in a recent paper that while regulatory safeguards that were put in place subsequent to the crisis have made today’s housing market much safer and resilient, “more could have been done to aid homeowners in the crisis and work remains to provide families with sufficient affordable, sustainable housing for today and in the coming years.”
Seru pointed out that Fannie Mae and Freddie Mac—Government-Sponsored Enterprises (GSEs) considered by many to be too heavily invested in the housing market—are now even more. Whereas, before the housing bust, GSEs accounted for 75 percent of mortgages bought and sold by private lenders, the share of GSEs in the market has since grown 20 percent, a
remarkable 95 percent overall. Seru considers this a troubling trend.
Additionally, Seru said that nonbank lenders were even more important in the mortgage market now than they were before the crisis. “No one knows what their balance sheet looks like, but they are selling all their mortgages to Fannie Mae and Freddie Mac. It is worth remembering that two of the largest and most notorious non-bank lenders, New Century and Ameriquest, went belly up first and helped trigger the last crisis,” he told Andrews.
Click here to read the complete interview with the Stanford professors.