Natural experiments and debt-driven financial crises: mortgage finance booms in the 1920s and 2000s

Abstract

Purpose

The role of debt in episodes of financial stability is a topic of increasing important as the global economy struggles to recover from the worst crisis since the Great Depression of the 1930s. The purpose of this paper is to examine the mortgage finance booms of the 1920s and 2000s as natural experiments, new insights into debt-driven financial crises are gained.

Design/methodology/approach

The general methodology is interpreting anomalous historical events as natural experiments. The specific methodology is the approach to natural experiments provided by Joseph A. Schumpeter and Milton Friedman. The hypothesis tested is that laxity in lending standards was the prime contributor to the mortgage debt booms. In each case, we explain why factors other than laxity in lending standards would be secondary factors, with the pre-boom and post-boom lending standards providing the control groups of natural experiments. The two episodes of mortgage debt booms occurring under very different general economic and financial conditions provide an especially strong test of the hypothesized functional relationship.

Findings

The results of the two natural experiments support the hypothesis that lax lending standards were the prime contributors to the two episodes of debt-driven financial crisis.

Originality/value

From a social economics perspective, the insights gained are important because a major social goal has been to encourage greater opportunities for home ownership. The results of these natural experiments provide guidance for policymakers in the search for a viable balance between achieving that social goal and maintaining financial stability.

Citation

Leathers, C.G., Raines, J.P. and Richardson-Bono, H.R. (2015), "Natural experiments and debt-driven financial crises: mortgage finance booms in the 1920s and 2000s", International Journal of Social Economics, Vol. 42 No. 4, pp. 340-355. https://doi.org/10.1108/IJSE-12-2013-0282