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What did economists get wrong about the financial crisis?

Speed read
  • Accepted narrative blames subprime borrowers for 2008 financial crisis
  • New big data analysis reveals real estate investors as the actual culprits
  • High-performance computing allows for innovative work in economics and other social sciences

The global financial crisis that began in the US in 2007-09 is blamed on the collapse of a superstructure of debt and financial derivatives perched on a bubble of untenable mortgages in an inflated American housing market.

<strong>Who’s to blame?</strong> Conventional narratives say low-income Americans caused the 2008 financial crisis by borrowing against the value of homes they couldn’t afford. A new analysis says different. Courtesy Jeff Turner. <a href='https://creativecommons.org/licenses/by/2.0/'>(CC BY 2.0)</a>But what brought about the collapse in the housing market? The widely accepted narrative blames Americans with subprime credit who borrowed against the value of houses they couldn't afford, in the mistaken belief that prices would never fall.

One long-term consequence of that narrative has been greatly tightened credit for all borrowers, especially individuals with lower credit scores. By eliminating mortgages for subprime borrowers, says conventional wisdom, the market will avoid the defaults and foreclosures that sparked the crisis.

But University of Pittsburgh economist Stefania Albanesi has turned to high-performance computing to find out if that narrative is mistaken. According to her latest research, subprime borrowers did not drive the mortgage crisis.

Working with a large panel of anonymous data on debt and defaults, it became clear that the biggest growth in mortgage debt actually came from borrowers with high and medium credit scores, not those with low scores. “It was the borrowers with higher credit scores who also represented a disproportionate number of defaults," explains Albanesi.

She also calls attention to the outsized role of real estate investors –in both the boom and bust of the housing market. “We found that real estate investors were responsible for most of the growth in mortgage balances and virtually all of the rise in defaults for prime borrowers,” explains Albanesi.

<strong>Economist Stefania Albanesi</strong> used high-performance computing to analyze credit report data for millions of borrowers, and concluded that real estate speculators—and not subprime borrowers—were the real cause of the rise in defaults. Courtesy Rain Rannu. <a href='https://creativecommons.org/licenses/by/2.0/'>(CC BY 2.0)</a>Albanesi makes clear her research’s implications for policies aimed at preventing upheaval in the housing market, and the subsequent effects on borrowers. “Increasing restrictions on loans to subprime borrowers may be misguided, as these borrowers contributed to the boom-bust in credit only marginally,” she says.

The credit report data came from the Federal Reserve Bank of New York’s Consumer Credit Panel/Equifax Data, which is a 5 percent random sample of all individuals who have a credit report with Equifax from 1999-2013.

These data contain over 600 variables to capture all financial liabilities such as bankruptcy and foreclosure, mortgage status, delinquencies, and other types of debt, including number of accounts and balances. After joining Pitt, Albanesi continued her work with a newly acquired set of Experian credit report data for 1 million borrowers starting in 2004.

This volume of data required computational power that was not available in the economics department. So Albanesi took her data set to the Pitt Center for Research Computing (CRC).

"I needed the Pitt CRC cluster to carry out the computations. We had in any one computation at least 250 variables for one million people. At the Pitt CRC, Barry was a great help in setting me up to use the cluster,” says Albanesi. “My graduate students are now set up as users.”

<strong>Reaching beyond hard science.</strong> The Pitt Center for Research Computing (CRC) provides high-performance computing resources to all faculty, not just those in the hard sciences. CRC staff — such as Barry Moore II, shown here— also offers assistance and consultation. Courtesy Pitt CRC.Barry Moore II, a research assistant professor at Pitt CRC worked with Dr. Albanesi. "For Dr. Albanesi and researchers working in similar fields, Pitt CRC resources offer access to orders of magnitude more computing power than is available on a desktop or laptop,” Moore says. "We can also aid in the installation of software packages and training for students in research groups."

Albanesi has also received attention for provocative work examining the roles of gender as an economic driver in economics.

“If you don’t take into account gender in macro-economic analysis, any conclusions will always be incomplete,” she says. Albanesi is now analyzing how the flattening of female labor force participation is changing the behavior of aggregate business cycles.

Read the original article on Pitt's site here.

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