Last week, I heard BBC announce the 10th anniversary of the beginning of the financial crisis. This is dated to the decision by the French bank BNP Paribas to prohibit withdrawals from two hedge funds that were heavily invested in subprime mortgage backed securities. According to BBC, this was when lending began to freeze and house prices began to fall.
The problem with BBC’s story is that house prices had already been falling for more than a year. While the nationwide decline was still relatively modest, around 4 percent, the drop in many of the most active markets was more than 10 percent.
This was the reason that the mortgage-backed securities in the Paribas hedge funds had plunged in value. When people bought homes with zero or near zero down, and the price dropped by 10 percent (and was falling rapidly), the mortgages suddenly did not look like very good investments.
While some people may try to make good on a mortgage that exceeded the value of their home, many others would simply walk away. This was especially likely when the mortgage was an adjustable rate mortgage that was due to reset to a much higher interest rate in the next year or two.
This timing matters because the financial crisis was first and foremost the story of the housing bubble. If mortgage debt had not been tied to an asset that was hugely over-valued, there would not have been a crisis shaking the financial system. This is true even if we recognize the corruption of the financial sector and the number of people who were dealing in complex financial instruments they did not understand.
It is understandable that economists and economic reporters would like to turn attention away from the housing bubble since it was easy to see for anyone paying attention at the time. The country had an unprecedented nationwide run-up in house prices, as house sale prices rose far faster than the overall rate of inflation across most of the country. This was a break…