New Voices at Fisher - Ben-David on the Mortgage Crisis

Itzhak (Zahi) Ben-David, Assistant Professor of Finance, is an economist and avid observer of human behavior. In 2006, while a PhD student at the University of Chicago, he began interviewing real estate agents about the effect of tax changes on property prices.

Ben-David's resulting research on the so-called "cashback transaction" - where borrowers could borrow 100 percent or more of the house's value - shed light on the ticking bomb that was the U.S. housing sub-prime market. Ben-David's story appeared originally in The New York Times Magazine's Freakonomics section in June 2007, when the market was still at its peak, and his foresight earned kudos in the Freakonomics blog in April 2008.

"Everyone was optimistic about the real estate market; people believed that real estate prices would never fall down. It was kind of free money - somebody else (the bank) paid for your house, why not buy a bigger house? That was the atmosphere in those days," he says.

Between the beginning of 2000 and the middle of 2006, as the consumer price index rose 21 percent, average housing prices rose 93 percent -- and much more in some markets. Buoyed by the U.S. housing market boom, people in all income groups were eager to get a piece of the American dream - home ownership. Mortgage brokers, real estate agents and banks were all too happy to help, securing zero-down mortgages and creative financing.

"It worked out well for the borrowers who were interested in buying a big house without a down payment and it worked well for the intermediaries who wanted a transaction," says Ben-David. "Mortgage brokers earned 100 percent commission so the attitude was to lend as much as you could. The mortgage banks were usually intermediaries themselves because they sell the mortgages to somebody else in the secondary market." Firms like Freddie Mac and Fannie Mae sold these mortgages to international pension funds - investors who were not very knowledgeable about what they were buying.

Ben-David says the cashback issue is a symptom of overleveraging - similar to what occurred in the stock market in the 1920s and in early 2000. Regulators were aware of these schemes but had difficulty finding evidence to prosecute. One warning sign is seeing systematic foreclosures with the same mortgage broker - but in those years that didn't happen often. House prices continued to rise, and people were able to refinance.

Ben-David joined Fisher's faculty in summer 2008 and he believes that Fisher can be a resource in the crisis's aftermath. Current projects include surveying CFOs in the S&P 500 on their confidence in the market and how their attitudes affect their investment practices. In addition, he's begun a project that assesses what type of incentives work for over-leveraged homeowners and other individuals to reduce their debt.

Recently, Ben-David completed a project in which he and co-authors examine whether financial counseling for borrowers is a beneficial policy. They base their research on a pilot project that took place in 2006 in Chicago. The pilot required borrowers in a number of zip codes to meet with a counselor before signing the mortgage documents.

"Basically if you wanted to refinance or buy a house, you would go to a mortgage broker, get an offer, then go to a counselor for advice. In fact, default rates declined following counseling," he says. What the researchers learned was that mortgage brokers, uncomfortable that a third party would be reviewing offers and meeting with clients, rejected many people immediately - individuals who otherwise would be approved and later most likely default. Ben-David said following counseling, people did not change the type of loan; the ones who did change to less risky products did so to avoid counseling. He concludes that the threat of regulation was the driving force behind the positive outcome, and not necessarily the informational content in counseling, as people often think.

Ben-David urges Fisher students to embrace the learning opportunities before them, and to think long-term, rather than focusing on simply their next job opportunity.

"I am challenging my students to be more critical - to think more widely, to not stick to formulas, and to think a bit more outside the box," he says.

View a complete list of journal articles, books, and book chapters authored by Fisher faculty members.

In Their Own Words

Keely Croxton
Listen to Assistant Professor of Finance Itzhak (Zahi) Ben-David discuss his breakthrough research on the mortgage crisis.

Intellectual Output