September 28th, 2008

Money

"Subprime"

I share the stunned disbelief of seeing the enormous rewards to the men who destroyed so much of the US economy, where any sense of justice would require them to pay rather than being paid. Hopefully they will eventually face justice, one way or another. At the very least, their names will live in infamy. But let us not lose sight of this one thing: CEO compensation was not the cause of the subprime crisis and the meltdown that followed it. The cause was lending large amounts of money to the poor.

That's basically what "subprime" means, that the lender would not normally be able to service the loan. Of course, things did not seem normal back in the frothy days. The value of the house would rise by 20% a year, making a 100% mortgage into a less than 60% mortgage in two years. No need to have people repay anything in that time, not even interests. They could always refinance after a couple years, or simply sell the house with a huge profit and use that money to pay the mortgage on the next. Or they could just do it over again every couple years, never paying anything. It must have seemed foolproof, I guess, if you exclude the foolishness of thinking that house prices can rise 20% a year when wages rise 0.2% a year. It is a bit like designing a bridge taking into account every possible force that might affect it, except gravity.

It is said that the first rule of banking is "Never lend money to those who need it". If you don't understand that, just imagine that it's your money you are lending.