Much of the mythology built up around subprime helped convince lots of people that the problem would stay isolated to subprime loans, and not spread to the rest of the mortgage market. This fed the feeling that mortgage backed securities were being underpriced, that housing prices would stabilise and that we’d get some kind of soft-landing in housing. If the mortgage problem was just about predatory lenders and deadbeat borrowers, the eventual costs would surely be quite limited.
Well, that didn’t work out. Mike Rorty takes a look at a recent study by the Boston Fed that devastates the subprime villain mythology. It turns out that roughly 28 per cent of all mortgages defaults, and 60 per cent of all subprime defaults, were mortgages that started with a prime mortgage.
This point is key. There’s a real tendency to Other subprime mortgage holders. They are idiots, crooks, dupes, minorities, single mothers, easily mislead, liars and criminals, etc. But right here, 28% of all mortgage foreclosures, and 60% of subprime foreclosures, are from people who started with a prime mortgage. Those are the Us — good credit scores, 20% down, pay the bills on time. . . .
So what happened to them? We know what this is not — it isn’t “I think I want to borrow $50,000 against my house to buy a new car, redo my kitchen and maybe buy a TV.” That’s a home equity loan, and it doesn’t show up here. Though there are exceptions, general consumption based refinances don’t tend to go subprime — the rates are too high. What we expect is what the Fed finds — prime households experiencing financial distress.
The Fed study goes on to conclude that even if many of these borrowers hadn’t refinanced into subprime loans with funky repayment schedules, they would have defaulted anyway. It wasn’t just some bad lending that broke the system. It was widespread financial distress. We were much poorer than we thought, and we’re even poorer now.