In what Tyler Cowen says is a must-read post, Calculated Risk writes,
I think it is important to understand that loans with high DTI were an enabler for speculation during the housing bubble, and this speculation pushed up house prices. So, although the authors argue high initial DTI loans are not a good predictor of defaults, the prevalence of high DTI loans was evidence of a bubble – and a good predictor of a housing bust.
DTI is the ratio of mortgage debt to income. For an individual borrower, it is not a reliable predictor, for two reasons. One is that people with the same income can have different spending and saving habits. Another is that income is often measured with error, sometimes with deliberate falsification but sometimes randomly. If I have enough salary income to qualify for a mortgage, I might not bother to include my capital income on my application.
Although DTI is a noisy indicator for the individual, a policy of accepting high DTI loans is likely to lead to higher default rates than a policy that is more restrictive. Thus, I agree that the high prevalence of such loans portended trouble.
READER COMMENTS
Dan Weber
Apr 12 2009 at 2:41am
This runs against the experience of Clayton Homes that Buffett put in his latest shareholder letter (PDF)
Now, Buffett obviously is not a neutral party here, being an investor in Clayton Homes. The Fed paper isn’t loading for me so I can’t look for confounding factors.
(leaving the same comment at MR. CR’s posts are great but the comments are a disaster area.)
DG
Apr 13 2009 at 12:23am
I agree that most people who put a large down payment of their own money will stay as long as possible even if they owe more than its worth, but what about all the loans that were nothing down at all? These people have no skin in the game and no real reason to fight it out. There were a large number of these loans in 05-06 when the market peaked. These loans also represent the largest overall loses for banks. Many actually come out ahead overall when you factor in 10-12 months living rent free in the home.
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