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Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy by Aaron Task, Barry Ritholtz

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Chapter 10. The Machinery of Subprime

 

The superior man understands what is right; the inferior man understands what will sell.

 
 --Confucius

How did all manner of exotic subprime mortgages and their derivatives wind up festooned all over the global financial system? To understand that question, we need to put on our detective caps and do some digging.

In the old days, traditional lenders—depository banks—accounted for the lion's share of mortgage writing. They are fairly well regulated by both the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). These banks typically are run in a very conservative, purposeful fashion. Banks have a funny way of looking at lending: It's not the loans you reject; it's the ones you approve that get you into trouble.

Hence, traditional lending tended toward borrowers who could put down a large down payment, had good income and credit histories, and could service the debt easily. These were the prime borrowers, and they tended to make safe bets for lenders.

Over time, other nonthrift participants got increasingly involved in the home loan industry. Independent mortgage brokers were able to steer loans to any bank. The savvy ones developed a reputation for knowing which bank offered the best rates at any given time.

Some developed an expertise in home buyers who did not quite meet the high standards of the major banks. Borrowers with lesser bona fides were considered subprime. Perhaps their credit scores were not as strong, their down payments ...

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