Information Degradation and the World of Subprime

Subprime plus two.  One of our axioms here at the Daily Reckoning is that information degrades like magnetism or radiant heat - by the square of the distance from the source.

We mention it today, because it helps explain the troubles in the subprime mortgage market. The old fashioned banker used to sit at his oak desk, and if a man wanted to borrow money, he'd have to sit down in the chair opposite him and explain himself. The banker would then ask a lot of nosey and awkward questions. And then, unless the two men knew each other, he'd want to see some proof - tax forms, pay slips, deeds, etc.

The banker would already have the man's banking records in front of him, because the man wouldn't dare to ask for a loan unless he'd been a good customer for at least a few years. And the banker probably would have driven by to take a look at the house, too, just to make sure it looked solid.

The whole encounter was laced with suspicion and doubt. Would the borrower lose his job? Did he have a drinking problem? Were things okay between him and his wife? How much was the house really worth? In the unlikely event that the bank had to sell it to get its money back, would there be enough margin for error? Lend 100% of the purchase price? You'd have to take your business elsewhere!

But in the great housing boom of 2006-2007, the suspicion and doubts disappeared, along with the oak desks and nervous interviews. No credit? No money? No job? No problem...

And then, the whole affair took two giant steps away from the basic transaction. The loan originator, we suspect, may not have met his borrower in some cases. But there is no doubt at all that the financier who put the loan into a mortgage-backed security had never laid eyes on him at any time.

And the math whiz who invented the collateralised debt obligation into which the mortgage was eventually stuffed, could care less if there was even a human being attached at the other end of his geekery. By the time the mortgage finally came to rest in the hands of an investor he had no idea what he actually had.

Bill Bonner
for The Daily Reckoning Australia

P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Related Articles:

• None Found