In fact, nontraditional loans made up 59 percent of originations at Countrywide, 58 percent at Wells Fargo, 51 at National City, 31% at Washington Mutual, 26.5% at CitiFinancial, and 28.3% at Bank of America. Moreover, the banks expected that their originations of nontraditional loans would rise by 17% in 2005 to 608.5 billion. The review also noted the "slowly deteriorating quality of loans due to loosening underwriting standards.' In addition, it found that two-thirds of the nontraditional loans made by the banks in 2003 had been of the stated-income, minimal documentation variety known as liar loans, which had a particularly great likelihood of going sour.
The reaction to Siddique's briefing was mixed. Federal Reserve Governor Bies recalled the response by the Fed governors and regional board directors as divided from the beginning. "Some people on the board and regional presidents . . . just wanted to come to a different answer. So they did ignore it, or the full thrust of it,' she told the Commission.
Within the Fed, the debate grew heated and emotional, Siddique recalled. "It got very personal,' he told the Commission. The ideological turf war lasted more than a year, while the number of nontraditional loans kept growing"." (FCIC 2011: 20-21).
The Fed is dominated by neo-classical economists. What was the reaction of many of the Fed's senior economists to the facts of mortgage lending? They were enraged at their own supervisory messengers. It was just data -- supplied by the biggest banks -- yet because it was counter to their dogmas the reaction was "emotional" and "heated" and directed against the supervisors rather than the banks. The telling phrase about dogma is that opponents of supervision "wanted to come to a different answer. So they did ignore [the data]." The Fed is supposed to be the high temple of the quants that Chetty claims are transforming economics into a science.
But here is the real takeaway about economists and their pretensions to be scientists. The Fed employs hundreds of economists who are supposed to study important economic developments. There were no more important micro-foundational developments than the three mortgage fraud epidemics and the hyper-inflated bubble that they produced. The Fed's economists, according to the authors of the study I have been discussing, failed to study the four developments that were about to cause a catastrophe. To make it worse, only the Fed had the authority under the Home Ownership and Equity Protection Act of 1994 (HOEPA) to ban all liar's loans and the Fed held a series of hearings mandated by Congress at which there was extensive testimony about liar's loans. The Fed's economists, therefore, should have made studying the three mortgage fraud epidemics and the resultant bubble their highest research priority. That's what scientists would have done.
But those studies would have produced results that would have devastated the dogmas that rule the Fed's economists. The effectiveness of those ideological blinders in preventing serious research on the frauds by the Fed's economists continues to this day. This is a very old story. Michael Jensen, when he was the managing editor of the Journal of Financial Economics, discovered that no proposed article could get through peer review if it challenged the efficient market hypothesis. Jensen was a strong supporter of EMH, but he was appalled by this triumph of dogma over science. He published an "anomalies" volume, though as he noted in the first volume each of the contributors professed belief in EMH.
The strength of Jensen's endorsement for EMH, even when he discovered that his colleagues were ruled by their dogmas should be a cautionary tale with regard to Chetty's claim that this time it's different, this time economists will behave like scientists. Jensen stated: "I believe there is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis." If he is correct, then the costly collapse of EMH suggests that all other economic propositions rest on even shakier foundations built on friable dogma rather than bedrock facts.