The enduring lesson of virtuous cycle.

• Author: Motley, L. Biff
• Position: Customer Satisfaction

The unfolding statistical side of the so-called subprime mortgage crisis is pointing to a much more crucial lesson than we originally thought. At first, when subprime mortgages began to go sour, the assumption was that too many, loans had been made to low-income, low-credit-score, first-time borrowers who were not accustomed to home loans and their rules. However. forensic analysis of subprime portfolios reveals that a growing percentage of subprime loans originated during the years 2003 to 2005 were to borrowers with credit scores well above subprime levels. In fact, by 2007, over 60 percent of subprime loans were made to borrowers with credit scores well above subprime levels.

So, why would someone who qualifies for a normal mortgage chose one with a variety of features that sound good in the short run, but bite them in the long run? The answer is two-fold: (1) It was in the seller's self interest to sell these mortgages; and, (2) the buyer, though intelligent, was not schooled in the arcane ways of contemporary capital markets. Had these borrowers been fully informed of the inherent risks they were about to undertake--e.g, their payments would be going up dramatically in a couple of years; they may not be getting a lower initial payment anyway; they will face staggering late-payment penalties; they are paying top dollar for their house and it may go down in value; and in the end, they may lose their house and a lot of money--many would likely have opted for a regular mortgage. Of course, not all subprime borrowers would have qualified for a regular mortgage, but even these folks would probably be better off for not having gone through the gauntlet.

The other critical element in this conflagration of the mortgage market was the self interest of the mortgage...