Is subprime loan something new? is it invented relatively recently as a new financial product?

I am asking because I wonder why there's the subprime crisis all of the sudden. I understand that the problem is that subprime loan has variable interest rates so when rates get too high, people can't pay. However, why didn't this happen before (in the entire human history, or at least in the history of modern economics - I am not aware)? (Somehow I doubt it - but, Were there new government laws that triggered or encouraged this disastrous consequence?) Who's responsible? Who let this happen? Someone should have seen and catch this problem (economists, legislators) earlier.

Is subprime loan something new? is it invented relatively recently as a new financial product?
No, sub-prime lending is not a new phenomenon. It has been around for centuries. WHat is new is the extent to which regulated commercial banks have gotten involved with sub-prime lending. Prior to the last decade or two, specialized finance companies and private individuals provided high interest loans to high risk borrowers.





Involvement by commercial banks grew out of several concurrent phenomena.





First, the growth in prime customers- those with good incomes, good credit, and cash for down payments- slowed dramatically as home ownership rates exploded. To continue to grow their businesses banks had to create new products- such as sub prime mortgages- to reach out to new groups.





Second, improvements in technology and quantitative methods allowed banks to better understand and price risks.





Third, improvements in financial technology (i.e., OTC derivatives, structured finance, etc.) allowed banks to alter their risk exposures (i.e., credit, interest rate, reinvestment, liquidity, pre-payment, etc.) by separating them out and distributing unwanted risks to parties who were best able to absord each specific risk. In other words, the idea of a bank originating a mortgage and holding the whole thing for the life of the loan is an anachronism.





Fourth, at no point in the history of the united states have real estate loans been such a sure thing as they were in the 1990s and early 2000s. Appreciation rates were in the double digits for much of the period and always positive. Appreciation was the norm across the entire country- it was not specific to regional or loacal events. Also, productivity rates exploded, which resulted in huge increases in personal incomes. For these reasons, even the most reckless lenders could turn huge profits, no matter how stupid their lending decisions.











Now, I want to make one point of correction in your question. A variable rate loan is NOT the same thing as a sub-prime mortgage. A sub-prime mortgage is one made to a borrower who has "poor" credit, "too much" debt, "little" income, or for a property that is deficient (i.e., no running water or condemned). It is coincidence that many if not most of these loans had variable rates. Conforming mortgages can have floating rates as well.








I question just how much of a crisis this is- at least for now. Financial institutions have collectively written off HUNDREDS OF BILLIONS of dollars over the last six months and we have seen no bankruptcies or liquidations worth speaking of. Private mortgage insurers are still solvant, despite their stock values taking a beating. The mortgage industry has shed tens-of-thousands of jobs, but the unemployment rate is holding steady. Against better judgement, the government is stepping in to help borrowers who were probably to stupid to get mortgages in the first place, which will alleviate some of the politically-sensitive pain. Finally, the credit crunch is only affecting those who would want sub-prime mortgages. Conforming conventional mortgages and governemnt guaranteed mortgages (FHA and VA) are still freely available because the GSEs (fannie and freddie) guarantee liquidity.








That being said, the worst is still to come, so I could have egg on my face from holding out hope. Home prices are still falling, defaults are climbing, and banks are announcing a continuous stream of bad news. Just how much more the economy and financial services industry can absorb remains to be seen.
Reply:There have been real estate crashes before. The way the loans were set up was new. People never used to buy a home with no money down.
Reply:Sub prime lending has been around, but I think it was bundling these sub prime loans into marketable securities that was new. This "securitization" of the loans is what really helped the market for sub prime loans take off.


Regulators were not experienced in dealing with them, and the people who determined the ratings on them were paid by the same people selling them, creating some incentive to exagerate the value.


I think the lesson has been learned, having a bunch of new regulation will likely just cause new problems, rather than correct anything.