Lenders weren’t prepared for home-price declines

Part 2 of 5: Upheaval in the subprime market

(This is Part 2 of a five-part series. See Part 1, Part 3, Part 4 and Part 5.) In the first article in this series, I pointed to the ending of house-price appreciation as the immediate cause of turmoil in the subprime market. The rise in delinquencies, defaults and foreclosures has been concentrated among appreciation-dependent mortgages -- those that work for borrowers only if their properties appreciate. A large proportion but not all of such mortgages are subprime. While it is understandable why borrowers became caught up in the belief that house prices always rise, lenders are supposed to know better. Why was the mortgage lending industry willing to make loans that were workable for the borrowers only if their properties appreciated? Disaster Myopia: In 1986, with my colleague from Wharton, Richard Herring, I published an academic paper called "Disaster Myopia in International Banking." The paper set out to explain the international banking crisis of the early '80s, but on re...