New Research Suggests Need to Expand Incentives-Based View of Housing Crisis

Recently, researchers from Princeton and the University of Michigan published a paper that examines the role played in the financial crisis by distorted beliefs about house prices, as opposed to the role of poorly designed incentives that may have led institutions to take excessive risks in the housing market. The study tests whether mid-level managers in the mortgage securitization business were fully aware during the boom that housing markets were overvalued and that a large-scale crisis was likely and imminent. Looking at the house transaction activities of mortgage securitization agents, as compared to activities of certain control groups, the researchers found little systematic evidence that the average securitization agent exhibited awareness of problems in overall housing markets and anticipated a broad-based crash. The researchers believe the results suggest that securitization agents may have been subject to sources of belief distortion, such as job environments that foster group think, cognitive dissonance, or other sources of over-optimism. The researchers explain that their study potentially has implications for public policy because, they argue, policy responses to date have derived from an incentive-based view of the problem, and that fixing incentives, e.g. changing the compensation contracts of securitization agents, may be insufficient to prevent another crisis.