Subprime Mortgages

Introduction

By now, we have all heard of subprime mortgages and are learning daily of the widespread effects that a large number of non-performing mortgages and foreclosures in a weak housing market can have. Hundreds of billions of dollars of losses have been accounted for already. Many financial firms have already failed. Firms that have been venerable names on the investment and banking landscape for over a hundred years (such as Lehman Brothers) have been swept up and wiped out in the subprime fallout despite having survived world wars, stock market crashes and the Great Depression. The world’s largest insurance company, AIG, last week was forced into the conservatorship of the government, exchanging 80% ownership in the company for a very suddenly needed bridge loan of around $80 billion. Just the month before, AIG was considered quite sound, profitable and secure, and then saw their fortunes change rapidly and shareholder value decline by 90%.

Only last summer I would have been hard pressed to find anyone outside of the financial industry who had ever heard of subprime mortgages. As house prices reached their peak over a year ago and the number of foreclosures began to edge higher we began to hear of this risk more and more with each passing day. I think it will be worthwhile to consider the series of events that contributed to our current worrisome state, and in so doing I will also lay blame – not for any unbecoming or unseemly reason, but because I think it will be useful in interpreting the blur of headlines and finger pointing and recriminations that fill the media today, and most importantly, so as to understand the complexity of this issue and how similar problems can be viewed or predicted in the future. I apologize that it will be a long read, however, trillion dollar problems can rarely be blamed on any one man or institution, nor can they be discussed in just a page or two.

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