Subprime Containment Theory Was A Lie

By Author: Lawrence Roberts
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Conventional wisdom (or market spin) was that the risk of default from subprime would not spill over into Alt-A and Prime loans. This argument was made because these two categories have historically had low default rates. Of course, this argument ignored the "liar loans" taken out by those with higher credit scores, the unmanageable debt-to-income ratios, and payment resets for interest-only and Option ARM loans which were also given to the Alt-A and Prime crowd. Historically, this group had not defaulted because they have not been widely exposed to these loan types.

An adjustable rate mortgage resets to a different (usually higher) interest rate or payment schedule at a time specified in the loan agreement. The increase in payment may be caused by an increasing interest rate or it may be caused by a recast of the loan to a fully-amortized payment schedule. In either case, the monthly payment will rise.

If a borrower is unable to make the new payment because wages did not increase or perhaps the payment increase was simply too large, the borrower will need to refinance to a new loan with an affordable payment ...
... structure. If at the time of refinancing the borrower is not eligible for available loan programs because the borrower or the property no longer meets the prevailing loan standards, the borrower may have no choice but to default on the existing loan and go through foreclosure on the property. In short, if borrowers cannot make the new payment or refinance, they will lose their homes. This is how many borrowers lost their homes during the Great Housing Bubble.

It was not the borrowers; it was the loans. Exotic loans were given to people of all credit backgrounds. Subprime borrowers where the first to show distress, but the Alt-A and Prime borrowers had the same problems and experienced the same outcome.

The only question about the subprime containment theory is whether or not FED Chairman Ben Bernanke and others who were espousing it were embarrassingly ignorant or knowingly duplicitous. Given their positions in government, it is most likely they were lying to the public to buy themselves time while they figured out what to do about the problem.
About Author:
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author's daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/ Visit Subprime Containment Theory Was a Lie.