Subprime is back

Subprime is back

History might repeat itself. Subprime loans, the sort that nearly destroyed the global economy, are on the way back. Greed never goes out of fashion.

The Wall Street Journal reports that prices of distressed bonds backed by subprime home loans, the sort of loans issued before the crisis to anyone with a pulse that had a sketchy credit history, have chalked up double-digit percentage gains this year. One prominent market index rose by a whopping 14 per cent. These days investors say the bonds look tempting because they are attractively priced and the US housing market is unlikely to crash again. Yeah right.

According to Bloomberg, investors are jumping in again thinking that the US housing market has already hit rock bottom so there's no danger of a crash reminiscent of what happened in 2008 when the market went into a tail spin. And alarmingly, we're seeing reports that US banks are loosening their standards and providing loans for people with questionable credit histories, attracting many first-time buyers into the market when they usually aren't able to make a sizable down payment. "Outside of housing, looser credit standards seem to be more common. The car industry attributes the rise in sales, in part, to loans being made to subprime borrowers with scores from 550 to 619, which made up 40% of car loans in the fourth quarter of 2011."

So the line is that this time, it's different. But that was the view before each disaster. Before the debt crisis of the 1980s, for example, economists said there would be no problem because commodity prices were strong, interest rates low and plenty of oil money was being recycled. Before the Asian meltdown in the 1990s, they said the region had strong growth and savings, conservative fiscal policies and stable exchange rates. And in the lead-up to the subprime crisis, everything was fine because of globalisation, the technology boom, a superior financial system and financial instruments that controlled risk and securitised debt – with former Federal Reserve chairman Alan Greenspan championing the ''This time is different'' argument. Derivatives have not been completely brought out from underground, banks will remain big and interconnected enough to present risks to the system with new financial tricks – and regulators have been left with the same discretion they had, and failed to use, before the crisis. History tells us it will happen again. A boost in investor appetite for risky bonds may spell disaster.

Photo source woodleywonderworks


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