Topic: EconomicsHousing

Last updated: February 24, 2019

If we try to find a culprit for the subprime crisis, we can’t expect to attribute the blame to one entity. This phenomenon is the result of the wrong behaviour of more parties.
For sure most of the blame is on the lenders, because they are the mortgage originators and let funds people with poor credit and high risk of insolvency.
The placing on the market of capital liquidity produced two effects: in one hand it lowered the interest rate, in the other hand it depressed risk premium. So both lenders and investors sought riskier opportunities to increase their investment returns.
We should also mention the homebuyers, who were buying houses that they could not definitely afford, in fact they were able to make this purchases only because they were offered low introductory rates and minimal initial costs. They were hoping in a price appreciation, which would have allowed them to refinance at lowest rates and take the equity of the home for use in other spending, but instead of this, the housing bubble burst and prices dropped rapidly.
Investment banks worsen the situation buying the mortgage from lenders and securitising them into bonds, that were sold to investors through CDOs (collateralized debt obligation).
Banks had an incentive to “securitize” loans they originated because this removes the loans from their books. The transfer of these loans (along with related risk) to security-buying investors in return for cash, replenishes the bank capital. This enabled them to remain in compliance with capital requirement laws while lending, again, and generating additional origination fees.
Other responsibilities can be attributed to the rating agencies, that gave the higher quality value to CDOs, while a more accurate analysis, would have shown that they had the much lower rating. The argument is rating agencies were enticed to give better ratings to continue to receive service fees, or they ran the risk of the underwriter going to a different agency.
Much of the blame must be placed on investors, which were the ones willing to purchase these CDOs at ridiculously low premiums. These enticingly low rates are the reason why there was such a huge demand for subprime loans.


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