As the president and members of Congress consider possible home-mortgage consumer protection, policymakers and analysts continue to dispute causes of the 2007-2008 foreclosure crisis, which triggered a much deeper and more serious financial crisis and ultimately an economic recession. Did banks prey on unwitting consumers, or did households overreach and borrow more than they could afford?

A new study by University of Arkansas economists suggests the latter. The researchers found that most households in foreclosure were relatively affluent and highly educated people, with few or no children, living in geographical areas that experienced extremely rapid real estate appreciation—the housing bubble.

Although the economists found some evidence of predatory lending, they concluded that a more accurate explanation of the foreclosure crisis was that consumers overreached and bought more housing than they could afford.

The researchers are careful not to excuse Wall Street banks, however, because reckless lending enabled households to become dangerously leveraged.

"Our evidence does not disprove or excuse reckless subprime lending by the large Wall Street banks," says Tim Yeager, associate professor in the Sam M. Walton College of Business, in Fayetteville, Ark., and lead author of the study, titled, "The Foreclosure Crisis: Did Wall Street Practice Predatory Lending or Did Households Overreach?"

"We argue that there is plenty of blame to go around for the financial crisis. Both banks and consumers overreached. Banks extended too much credit to households, and households purchased more home than they could afford," Yeager says.

Relying on massive data provided by Acxiom, the Gadberry Group, and RealtyTrac, which are private companies that compile information about demographics, real estate properties, and foreclosures, Yeager and four of his colleagues in the department of finance at the Walton College combined data on demographics and foreclosures to create profiles of households in foreclosure during the third quarter of 2008. They also analyzed geographic patterns of mortgage foreclosures.

The researchers used Acxiom's PersonicX classification system to identify and examine the characteristics of households in default during the third quarter of 2008. The system separated U.S. households into 21 life-stage groups—"Gen X Singles" or "Mixed Boomers," for example. Each group had specific demographic characteristics, such as age, marital status, number and age of children, and household income, that tied them together. Other data helped Yeager and his colleagues understand property characteristics, such as market values and loan-to-value ratios, of homes in foreclosure compared with those not in default status.

Working with this data, the researchers developed two categories of groups based on formulas for "excess foreclosure shares" and "relative default rates." The first calculation determined, in absolute numbers, which groups accounted for the most foreclosures. The second calculation—relative default rates—showed which groups had the highest likelihood of foreclosure. If predatory lending was occurring, households within this category were most likely to be victims.

Results showed major differences in rankings between the two categories. Groups at the top of the absolute-number list differed dramatically from those at the top of the likelihood category.

By far, the group with the greatest excess foreclosure percentage was "Cash & Careers," the most affluent generation (Generation X) of adults born between the mid-1960s and early 1970s. Members of this group had high household incomes, high education levels, high home values, and none to only a few children. Also, members of this group were classified as aggressive investors, most of whom lived in areas, such as in California, Nevada, Arizona, and Florida, that had experienced rapid real estate appreciation.

"Cash & Careers" ranked seventh in the list of groups most likely to default. At the top of this list were four groups—"Mixed Singles," "Gen X Singles," "Boomer Singles," and "Beginnings"—characterized by low income and low net worth. Again, members of these groups were most likely to be victims of predatory lending. Except for "Boomer Singles," these groups show up at the bottom of the excess foreclosure list.

"Although we did find evidence that low-income households had a higher statistical likelihood of foreclosure, most households in foreclosure were relatively affluent and well-educated," Yeager says. "Also, these household defaults were strongly clustered in southwestern and southeastern states, which is consistent with the overreaching-consumer explanation of the foreclosure crisis."

Overall, results showed that most foreclosed households were not "duped" into bad loans, Yeager says. Instead, they were caught up in a housing price bubble in which both consumers and lenders were too aggressive. This finding is critical because strong consumer protection laws alone will not prevent future price bubbles or financial crises.

"The policy implication from our results is that strong consumer protection laws, though necessary to prevent Wall Street banks from offering high-risk loans to the most vulnerable, will not be sufficient to prevent another financial crisis like the one the U.S. economy experienced in 2007 and 2008," Yeager says. "A return to high price appreciation could again set off dynamics in which borrowers with decent credit overreach and end up in homes they ultimately cannot afford. The only comprehensive solution may be to pop housing bubbles, which is a much more complex task that would require the Federal Reserve to recognize and limit asset price bubbles."

Yeager is a former economist at the Federal Reserve Bank of St. Louis.