What the Subprime Loan Crisis Means to You

The average man on the street is probably a mortgage holder and has some vested interest about how the subprime market works. But what the average homeowner may not know if how the subprime lending credit crisis will affect capital markets for decades to come. Reliance on the credit rating of a company has cut premiums when the risk was much higher than participants felt they were led to expect. American credit markets have become the business driver of many industries and reach around the globe.

The subprime mortgage loan started out as an unwanted stepchild. Credit availability was originally aimed at people who could afford to pay a prime rate of interest in additional to repaying the principal. The subprime term was meant to discourage credit lenders from offering it to unlikely borrowers, and thus fixed an extra point or two onto the prime lending rate for a mortgage of property or business loan. When writing the loan, banks knew their credit risk portoflio of loans could only include so many of these subprime loans to balance the overall risk.

But as real estate values started booming recently, many lenders took the view that the underwriter of the funds originating the loan monies could bear a substantial share of the credit risk. These finance companies were on the hook to pay back the debt in case the lender defaulted. The worst thing that could normally happen was that the home loan would be rewritten for more points, or interest on the principal (amount borrowed).

But when the stock market volatility and bond fund vogues flattened, Wall Street started urging large institutional investment funds to back mortgage-backed securities funds. Credit ratings were assumed to block out unqualified borrowers. These were the safest of investments because in order for the paper on these loans to become worthless, huge unprecedented numbers of borrowers had to default and give up their homes, scarring their credit records forever. And that could never happen.

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