Chingo De Dinero

All of that sub-prime mess going on is a joke.  The banks were loaning money to people who couldn’t pay the loan.  I treat the previous statement as a fact, if these people could pay it back, the would not get sub-prime loans, they would get regular loans and avoid the higher rates. 

 Why would banks do this?  Two reasons, the default projections they were using were not good predictors of the future, they underestimated the true number of people that would default.  The second, is the downside risk….when you stop paying your loan, the bank forecloses on you.  So they sell your home, keep what you own them, and return the rest to you.  The only way to lose is if the value of the home is less that what is owed.  If you have a strong housing market, with prices rising rapidly, this does not happen often.  But, if prices start to drop, this can easily happen, thus why housing prices are so important to the sub-prime issue.  So going back to my first asset pricing model, the banks used a discount rate that was too low, it did not factor in the true size of default risk.  If the banks would have charged more for the loans, and set aside a higher reserve, we would not be seeing the headlines we are seeing right now.

 Back to my first statements, I think the banks got a little too optimistic, not that they are stupid, just a little too excited.  Now…they are paying for it, which they should.  Letting them suffer will result in them changing their models, and correcting the market.  That should be the end of it…the government does not need to come in and be a hero.  The banks agreed to lend money, and people agreed to borrow.  The people did not pay back, the banks lost money, so the banks will stop lending money to this sect of people.  All problems solved, the market working at its best.

As a side note, I like sub-prime loans, I actually have two for some condos I own.   One weird thing, the interest rate is less on my sub-prime, where I was viewed as risky and put very little down, than the prime ones, where I put more money down and was viewed as safer.  I guess mess like that is why the banks are having these record write-offs.