Securities Regulation Daily Wrap Up, RISK MANAGEMENT—Study finds housing securitization insiders did not anticipate collapse, (Jan 23, 2014)

By Richard A. Roth, J.D.

A Real Estate Research article published by the Federal Reserve Bank of Atlanta analyzes a recent research paper and finds support for the position that Wall Street insiders did not intentionally lead investors to invest in securities the insiders knew would collapse. According to the authors of “Wall Street and the Housing Bubble,” the problem likely was that the insiders held overly optimistic views about housing prices, expecting prices to continue to climb so that housing-related investments would be profitable.

The Atlanta Fed article, written by Kris Gerardi of the Atlanta Fed and Paul Willen of the Boston Fed, provides a brief analysis of a research paper of the same name by Ing-Haw Cheng, Sahil Raina, and Wei Xiong. This paper describes a study comparing the personal housing-related decisions of Wall Street housing investment insiders to the decisions of two control groups — equity analysts who had no obvious connection to the housing market and attorneys who did not specialize in real estate law. According to the research paper, the insiders’ personal decisions showed little evidence that they were aware of coming problems in the housing markets that would foreshadow a collapse.

In fact, Gerardi and Willen say that the research paper’s authors were “a little timid” in their interpretation of the data. The study results actually showed that the insiders were significantly more aggressive in their personal housing decisions during the bubble period that preceded the crisis, they say. This implies the insiders had expectations about housing market prices that were even more optimistic than the expectations of either control group.

Financial crisis causes. According to Gerardi and Willen, the research paper helps explain a problem presented by the theory that financial institutions and insiders created and sold investments they knew would lose value — the financial institutions themselves ultimately lost “enormous amounts of money” on the securities they created. They say the companies were operating under an overly optimistic belief about the future of the housing market, which led them to conclude that prices would continue to rise and that even risky mortgage loans would continue to be good investments.

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