Since the beginning of the subprime mortgage collapse, media pundits have spread the following misleading story: Thanks to government deregulation, the uptick in subprime mortgages dramatically increased home ownership in the United States. When home values decreased, these mortgages became undesirable, leading to massive defaults and the current crisis.

In reality, this story is not so much about increasing home ownership as it is about bad loans, and the tale it spins is not exactly correct. The increased availability of subprime loans did not successfully increase home ownership. When home prices dropped, all types of homeowners lost equity equal to the drop (or more, for those who developed negative equity) and are now losing their homeownership. What the price drop revealed is just how bad the subprime loans already were. Thus, the drop in home prices during this recession did not cause the subprime mortgage crisis; it simply revealed how severe the financial crisis had become due to the extensive use of subprime loans.

Contrary to popular belief, the current subprime mortgage crisis did not come about overnight. In trying to explain the crisis, and how it surprised so many people, many have come to accept inaccurate and incomplete sound bites as explanations for what is, in fact, a complex and multi-faceted crisis in which defective subprime loans (which were defective at the time of origination) were exposed by the recession. In the process, artificially increased homeownership went away.

first tuesday take: Government policy exploited the myth of the “American Dream” and got caught doing it, to everyone’s loss. No further take is needed if you read the linked report from the Cleveland Federal Reserve.

For a more in-depth demographic analysis of the fallout from the subprime mortgage crisis, see first tuesday’s May news blog: “Homeownership losses equal rental property investment gains”.

Re: “Ten myths about subprime mortgages”, from The Federal Reserve Bank of Cleveland