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Economists advise acknowledging the possibility of house price declines

Posted by: Leslie Black-Plumeau on May 8, 2012 - 2:19pm

Facts refute the popular story that the nation's foreclosure crisis resulted from financial industry insiders deceiving uninformed mortgage borrowers and investors, according to the authors of a new national-level report from the Boston Federal Reserve Bank.   Borrowers and investors made decisions that were rational and logical given their ex post overly optimistic beliefs about house prices, the authors explain. 

The report, entitled "Why Did So Many People Make So Many Ex Post Bad Decisions?", concludes that policies be designed to accomodate "the limits of our understanding of price asset bubbles."  

The report's conclusions pertain to both financial institutions and borrowers.  Financial institutions should be able to withstand a serious price shock, such as a 20 percent decline in house prices, without liquidity problems.   Borrowers need to be advised that the price of their home could fall and be able to withstand such a decline.

Graphic:   "Why Did So Many People Make So Many Ex Post Bad Decisions?" by Christopher L. Foote, Kristopher S. Gerardi, and Paul S. Willen, Federal Reserve Bank of Boston, page. 48.



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