The financial crisis was the result of home buyers’ rational reactions to misaligned incentives – not fraud, argues Todd Zywicki, a George Mason University law professor and a Mercatus Center senior scholar.

Zywicki, who has studied the financial meltdown, argues that taking out a risky bank loan looks like a foolish choice today, but at the height of the housing boom was actually a smart decision for many people.

He says the crisis began when the Federal Reserve pushed interest rates to extreme lows from 2001 to 2004, making adjustable rate loans very attractive. It wasn’t until the Fed pushed rates back up that people walked away from their loans.

In the next phase of the crisis, Zywicki says, the availability of foreclosed properties pushed down home prices, which led to more home owners walking away from their properties. Now in the current phase of the decline, unemployment has led to even more foreclosures.

Zywicki writes: “The problem isn’t consumer gullibility or ignorance. Borrowers have shown they understand, and act on, the incentives they face all too well.”

Source: The Wall Street Journal

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