The default on subprime-backed securities is the major cause of our financial crisis. These were poorly formed and regulated securities that were highly risky and made a bunch of people rich. No securities, no financial crisis. Maybe a bunch of people losing their homes or not buying a home in the first place, but no financial crisis.
Borrowers defaulting on loans did cause the default of the securities. However, the lower income borrower is not the major culprit here. Read on to take a little quiz.
Guess what publication said this:
But the data contradict the conventional wisdom that subprime borrowers are overwhelmingly low-income residents of inner cities.
Was it A. Mother Jones, B. New York Times, C. Washington Post, or D. Wall Street Journal
Correct answer is D. Wall Street Journal in The United States of Subprime.
Who can we blame then? Is it the affluent?
An article on seeakingalpha.com, Subprime Mortgages Crossing Income and Credit Strata, summarizes the WSJ article says:
In fact, there were even high concentrations of subprime loans in affluent areas with high housing appreciation rates; areas that now lead the nation in foreclosures.
So the affluent areas not only lead in foreclosures in number of foreclosures, but because the homes are more expensive, they dramatically lead in the dollar amounts for foreclosures.
Maybe it was real estate investors. They had a 64% increase in the number of high rate loans says the WSJ:
Lenders did little to discourage speculation by real-estate investors, which contributed to rising home prices. Last year, 13% of all high-rate home loans were for properties not occupied by owners, up from about 9% in 2004, the data show.
Maybe it was the white high income borrower:
Among borrowers characterized in the data as white with annual income of at least $300,000, the number of high-rate loans jumped 74% last year, the numbers show.
It certainly wasn’t the FHA:
The Federal Housing Administration, a New Deal-era mortgage insurer targeting buyers with little or poor credit, began losing market share to aggressive subprime lenders.
Nor was it Freddie and Fannie because of the loans they made. Freddie and Fannie are in trouble because of their buying of subprime-backed securities. You can read about it in Business Week.
Here’s the money quote:
Start with the most basic fact of all: virtually none of the $1.5 trillion of cratering subprime mortgages were backed by Fannie or Freddie.
The Business Week article says in summarizing a Federal Reserve report:
The study identifies five causes of the subprime meltdown:
Convoluted loan products that consumers didn’t understand.
Credit ratings that didn’t do a good job highlighting the risks contained in subprime-backed securities.
Lack of incentives for institutional investors to do their own research (they just relied on the credit ratings).
Predatory lending and borrowing (which I think means fraud perpetrated by borrowers).
Significant errors in the models used by credit rating agencies to assess subprime-backed securities.
If you really want to know what caused the melt down, you can read the Federal Reserve report Understanding the Securitization of Subprime Mortgage Credit.
As a closing though, has depression/recession ever been caused by a decrease in worker productivity and not by the banking and financial industries?