Subprime and Alt-A Mortgages: Collateral Damage
Despite Commercial Financial Services’ debacle, the market made many of the same mistakes again a few years later in the subprime mortgage market. In the intervening years, there had been similar market stumbles involving manufactured housing loan-backed deals, home equity loan-backed deals, and investment-grade rated corporate CDOs, but the subprime debacle—which also encompassed risky mortgage loans made to more creditworthy borrowers—created ripple effects in the U.S. stock market and triggered a credit tightening in the consumer credit and corporate leveraged loan markets. It also made prime brokers and other lenders to hedge funds rethink the amount of leverage they allowed these borrowers to employ.
The subprime market developed for borrowers who have lower credit scores and traditionally have had more difficulty meeting the requirements for a home mortgage. Subprime borrowers typically had FICO scores below 650. These scores were developed by the Fair Isaac Corporation to provide rough guidelines of the credit capacity of consumers. They take into account new credit, types of credit the borrower already uses, length of credit history, amount the borrower owes, and payment history. Most of the weight is placed on the last three attributes. It was estimated that 27 percent of borrowers had scores below 650, and only 12 to 20 percent in total might be eligible for subprime loans, since borrowers with very low credit ...