Years before the housing bubble burst, Milliman consultants were starting to see a lot of additional risk building up in the system, indicating that the industry might be misperceiving risk at a fairly sizeable scale. In April 2005, we warned lender clients that the confluence of risky innovative mortgage products with unsustainable home prices might spell a perfect storm for the industry. The following year, we published a widely read analysis, asking: What happens when credit risk comes home to roost?
“As home price appreciation escalated in many areas, lenders, capitalizing on demand and market opportunities, developed new and sometimes exotic types of mortgage products that enabled buyers to keep their dreams alive and the market afire. (…) A growing amount of statistical evidence and analysis by industry observers and advisors indicates that there is a significant level of risk associated with many of the newer loans—risk for homeowners and for those who underwrite or insure mortgages. And for numerous banks and insurance companies, that risk is compounded by the fact that individual mortgages are highly correlated in a manner unlike traditional insurance risks. Thus, the volatility of defaults can be significant, resulting in large swings as economic tides raise—and lower—all boats.
In this video, Milliman principals and consulting actuaries Michael Schmitz and Joy Schwartzman discuss early warning signs and the fall out of the mortgage crisis.