Friday, March 16, 2007
Subprime yada yada
Subprime yada yada
Look, this whole sub-prime loan crisis is just a bunch of junk. Lenders were dumb enough to give money to people who statistically don’t plan to pay it back, sure these are moral individuals but their history speaks volumes for the financial past.
Here’s my take on the mess:
Sub-prime borrowers are less than the top quality of borrowers known as prime borrowers. Usually a sub-prime borrower has many credit blemishes such as bankruptcy, late payments or previous defaults on mortgages. The banks who take these loans assign incredibly high interest in order to cover any potential risk generated from accepting the loan. First mistake, issuing a high rate to someone who has problems paying.
The financial industry is backwards. See, a person who makes $100,000 a year with a prime credit score could get a home loan with a 5.77% rate. Someone who makes $30,000 a year with a bad score could get a home loan but would expect to pay 8.5% plus. This represents a difference of nearly $300 per month on a loan of $150,000. Granted, income does not affect your credit score but typically those who make less have a lower credit score due to lack of money to make payments. Loans to sub-prime lenders have much higher default rates as well.
See how the sub-prime market is destined to collapse? The worse some one’s ability to pay, the higher the monthly payment. That makes no sense mathematically, of course their will be a higher default rate, especially when interest rates are that high. I think this sub-prime mess was long overdue. It simply cannot sustain itself when those who can’t pay, pay the most.
The thinking was that if home prices continue to rise, people with bad credit would be able to refinance and get a better rate after making payments on time, or sell the home for a profit. These lenders weren’t investing in future homeowners! More or less they were making a direct play on the future of home prices!
This sub-prime stuff is just out there to make investors jump. Its just an excuse for the hedge funds to dump shares, really. There was no reason that the dow should have dropped 500 points other than profit taking. Lets not try to cover up what really happened, we just wanted to cash in our earnings.
I don’t want to get far from the point that the sub-prime investment arena is junk. Trust me, its junk and you don’t want any exposure to it, but it wasn’t the reason for the drop. Don’t invest in any sub-prime lenders, just stick to what you know. Value plays in a cheap market.