Subprime Homesick Blues.(The Talk of the Town)(Industry overview)

Not long ago, New Century Financial--a mortgage lender specializing in loans to the subprime, or high-credit-risk, market--dubbed itself "a new shade of blue chip." Today, with its stock price down more than ninety per cent in the past six months and the company close to bankruptcy, it looks more like a new shade of Enron. And it is not alone. In the past year, more than two dozen subprime lenders have shut their doors. The percentage of their borrowers who are delinquent (meaning that they've missed at least one payment) has doubled, and predictions of more than a million foreclosures have become commonplace. As concerns grow that the subprime crisis could spread to the rest of the housing market, pundits and politicians looking for a culprit have seized on New Century and its ilk, charging them with causing the crisis with their "predatory lending" practices, duping tens of millions of homeowners into borrowing more money than was good for them.

The backlash against the subprime lenders is understandable, since their business practices were often reckless and deceptive. Instead of responding to the slowdown in the housing market by cutting back their lending, they pressed their bets--last year, six hundred billion dollars' worth of subprime loans were issued. Many of the lenders hid their troubles from investors, even as their executives were dumping stock; between August and February, for instance, New Century insiders sold more than twenty-five million dollars' worth of shares. And there's plenty of evidence that some lenders relied on what the Federal Reserve has called "fraud" and "abuse" to push loans on unwitting borrowers.

For all that, "predatory lending" is a woefully inadequate explanation of the subprime turmoil. If subprime lending consisted only of lenders exploiting borrowers, after all, it would be hard to understand why so many lenders are going bankrupt. (Subprime lenders appear to have been predators in the sense that Wile E. Coyote was.) Focussing on lenders' greed misses a fundamental part of the subprime dynamic: the overambition and overconfidence of borrowers.

The boom in subprime lending made huge amounts of credit available to people who previously had a very hard time getting any credit at all. Borrowers were not passive recipients of this money--instead, many of them used the lax lending standards to make calculated, if ill-advised, gambles. In 2006, for instance, the percentage of borrowers who failed to make the first monthly payment on their mortgages tripled, while in the past two years the percentage of people who missed a payment in their first ninety days quadrupled. Most of these people did not suddenly run into financial trouble; they were betting that they would be able to buy the house and quickly sell it. Similarly, last year almost forty per cent of subprime borrowers were able to get "liar loans"--mortgages that ...