The Virtue of Home Ownership and the Vice of Poorly Secured Lending: The Great Financial Crisis of 2008 as an Unintended Consequence of Warm-Hearted and Bone-Headed Ideas

Abstract

This article utilizes a simple economic model of asymmetric information to model a pooling equilibrium in the housing market. There are two types of households in the model — disciplined and undisciplined. Disciplined households are able to distinguish themselves by saving a significant portion of their income for a down payment on a home leading to a stable equilibrium. A change in government policy which requires a rate of home ownership greater than the proportion of disciplined households causes the equilibrium to collapse. I argue that change in U.S. housing policy driven by federal legislation had exactly this effect on the housing market and was the actual cause of the 2008 financial crisis.

Keywords: housing crisis, default option, moral hazard, unsecured lending

JEL Classification: G20, K10