A Plague of Subprimes
A new and unwelcome term—subprime mortgage—has intruded itself into the vocabulary of the financial world in the past year, appearing in headlines and nudging into conversations at water coolers and on putting greens from Sacramento to Sydney. These mortgage instruments—written by dubious lenders to even more dubious borrowers—are not new in kind, but in recent years they have appeared in a quantity that is quite new—three to four times that previously seen. Like the common locust in ancient Egypt or the Oriental Rat Flea in 14th Century Europe, or certain fissionable isotopes of uranium in more recent times, subprime mortgages have demonstrated the principle of critical mass: Gathered in sufficient concentration, relatively innocuous things can become very formidable. What we have here is the 21st Century’s Great Subprime Plague.
The Wall Street Journal reported finding no less than $2.5 trillion in subprime mortgages in a survey of loans issued from 2001 to 2006—nearly half of them issued in the last two years of the period studied (Wall Street Journal, December 3, 2007). Bundled into bonds and sold to yield-hungry investors, this Vesuvius of bad mortgages began to tremble ominously in April 2007, when the housing boom that had fed it—and fed from it—went bust.
Signs of serious trouble, says a panel of economists commissioned to study the fiasco (Greenlaw, Hatzius, Kashyap and Shin, 2008) were apparent no later than August, 2007, when certain bellwether interest rates began to rise with no obvious explanation. The “Ted” spread—the difference between the 3-month Eurodollar deposit rate and the yield on a 3-month Treasury bill—spiked to more than 200 basis points, about 10 times its baseline. This surge substantially surpassed those this same indicator made a decade before in the Long Term Capital Management crisis, and in 2001 after the 9/11 terrorist attacks. In October, the Wall Street Journal referred to the rapidly emerging situation as a “new age of uncertainty” brought on by murky pricing in subprime mortgages. “Large parts of American financial markets have become a hall of mirrors,” said the newspaper (Wall Street Journal, October 12, 2007).