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What Really Happened in the Subprime Crisis?

I have been continually debating the causes of the subprime crisis with a good friend who spent two decades on Wall Street and whose moral and intellectual character I highly respect. Clearly it’s a multifaceted phenomenon that involved a great deal of greed and foolishness, which I summed up in this Yahoo!Finance column. (Although I regret that I failed to mention regulators who were asleep at the wheel and legislators who were in the pocket of the financial services industry, rather than watching out for consumers.)

But bottom line, my friend maintains that consumers are at fault. Yes, brokers, lenders, securitizers and investors were all involved. But people should simply have known better, she says. If they had not  signed documents they did not fully understand, if they had not taken out mortgages they could not afford when the rate readjusted, if they simply ignored the refinance offers piled up in their mailbox — none of this would have occurred. They should have known better.

I agree with her in part; I’m a big believer in caveat emptor. When we bought our home, we put 20 percent down (saved over a dozen years) and took out a 30-year, fixed-rate, 5.18% mortgage because we were fully cognizant of the risks of an adjustable-rate loan. There were too many unknowns — what if we couldn’t refinance when the rate adjusted? What if the price of our home declined? I wanted a payment I could be certain of over the long-haul. (I call it the Starbucks mortgage because if we both lost our jobs we could afford the payment by working as a baristas. Or bartenders. Maybe I should call it the Pub Mortgage.)

However, I believe that the subprime crisis is not simply a story of irresponsible and greedy Americans who bought five houses with no money down hoping to flip them. There was indisputably a great deal of fraud. For example, Ellen E. Schultz — my favorite investigative reporter at the Wall Street Journal — exposes the story of some senior citizens who were defrauded during the subprime crisis (sub. may be req). It’s a tragic tale. 

That story (which should have run on A1 and not D1) needs to be told by more media. Because if this crisis goes down in history as a story of personal irresponsibility alone, we won’t as a nation make the regulatory changes that need to occur. (At minimum, mortgage brokers should be subject to the same suitability requirements that financial advisors are.)

If anything, the crisis demonstrates that a common sense outlook, a viewpoint that carefully weighs the worst-case scenario, that crunches all the numbers in detail, is essential to economic survival. (And sometimes even then, everything still comes crashing down.)

By the way, I feel the same about college tuition as I do about mortgages — there are too many unknowns in terms of our ability to get loans or scholarships. So we have been sacrificing elsewhere in our budget and saving since the kids were born to foot the bill for bachelor’s degrees in full. The Wall Street Journal recently did a piece (sub. may be req.) on how the kids of parents who can pay the tuition have regained their advantage in college acceptances. So if if this goal is important to you, and you haven’t started saving, it’s time to get going.

What do you think caused the sub-prime mortgage crisis? Is it a failure of individuals, institutions, government or a combination thereof? You can comment here or email me at laura at laurarowley.com.

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