Intelligent people, including my wife, have been asking me questions about the subprime mortgage crisis. The point that seems to stump them is why a relatively small percentage of subprime mortgage defaults has led to a spiraling national credit crisis, how it happened, and where do we go from here. They were good questions, and if you are wondering the same thing, read on…
So what’s the deal with the subprime mortgage meltdown?
Well, imagine that the markets involved are analogous to a house with three stories. Each of the floors represent an industry related to the housing market and each of the upper stories are dependent on the one right below it.
The first floor represents the primary mortgage market (homeowners and their banks or mortgage lenders)
The second level represents the secondary mortgage market (where government-enabled agencies and private lenders by bundled bank mortgages)
The third represents the credit derivatives market (where securities created in the secondary mortgage market are pooled again with other debts and with various risk preferences)
The primary mortgage market is huge, but the second and third levels are just as huge. It makes for a pretty big meltdown when it all starts to unravel.
Continue reading ‘Why Did Subprime Loans Become Such a Big Deal?’
