Thursday, August 16, 2007

One of the mysteries of the American subprime mortgage mess, now sinking financial markets worldwide, is how so many bad loans got written.

Well, that mystery isn't very deep. Lenders used to care about who they loaned money too, because they'd be out the money if they didn't pay back. Mortgage markets haven't worked like that for years: the loans get resold in a secondary market, so all the originating lender cares about is that the homeowner stay solvent long enough for the mortgage to get flipped. It's a pretty simple point (though, as of a couple of years ago, I was annoyed to note that the highly credentialed experts defending the business had somehow failed to notice).

But that doesn't solve the mystery. It just moves it. OK, the originating lenders were writing crap loans because they could sell them --- but why was anyone in their right mind willing to buy?

Why were they willing to buy? Because the financial rating agencies were telling them that this crap did not stink. And why were they saying that? Because of a bunch of rulings which simply defy common sense. Witness yesterday's story in the Wall Street Journal (link works for me), which explains at great length that

In 2000, Standard & Poor's made a decision about an arcane corner of the mortgage market. It said a type of mortgage that involves a "piggyback," where borrowers simultaneously take out a second loan for the down payment, was no more likely to default than a standard mortgage.
They reversed themselves in 2006, at which point the statement was obviously false. But it was obviously false in 2000, as well. A buyer who can't scrape together cash for a down payment is obviously living closer to the edge than one who can. That's the whole point of requiring a down payment, which had been standard practice in the mortgage market for decades.

This sort of moral hazard and pure arrant stupidity in positions of power would be a marvelous object lesson for libertarians to cite, if only Standard and Poor's were part of the government. But since they were in the private sector, we're supposed to just assume the invisible hand will hold them accountable. Not a problem --- if they were the only ones getting hurt.


Anonymous Anonymous said...

The link doesn't work.

11:48 AM  

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