The Stunning Subprime Mess

Last Updated Jan 30, 2008 11:56 PM EST

How bad is the subprime crisis?

This from the New York Times, in the wake of the Swiss bank UBS announcing huge write-downs related to subprime mortgages:

Banks worldwide have announced more than $135 billion in credit losses and write-downs since the turmoil in the U.S. housing market started last year, and some analysts estimate that total write-downs could reach $800 billion. (from UBS Take a $14 Billion Write-Off)
$800 billion? This number stunned me. How many subprime loans got made? According to the Center for Responsible Lending, there are $1.3 trillion in subprime loans outstanding. Almost $1 trillion of that came since 2003.

Since the subprime crisis has been the source of $135 billion in write-downs already, that reflects about 10 percent of the outstanding loans in the subprime market.

Of homes foreclosed on in 2006, 93 percent had subprime mortgages. At the moment, though, there are only 14.5 percent of subprime mortgage holders in default, according to the Federal Reserve Bank. Getting to $800 billion suggests that the market believes somewhere in the vicinity of 80 percent of subprime loans made in the last four years will go bad. Subprime? More like junk loans. Whatever happened to truth in advertising?

There are already ambulance-chasing consultants running around touting their risk management services (see, for instance, this pitch by Ernst & Young's Tom Connors for 'integrated GRC' (that would stand for governance, risk and compliance).

But a Yahoo! search for "financial risk analysis" returns 121 million items. Financial institutions have always made their money by their ability to assess risk. As Gary Becker posted on the becker-posner blog

No one can reasonably claim that these banks lacked the skills and knowledge to evaluate all the terms of, or the likelihood of repayment, on the subprime and other mortgages that they originated or held as assets.
Skip the consultants. Instead, pick through this required reading list on risk, compiled by Aaron Brown, fund manager, poker player and author of The Poker Face of Wall Street. There probably aren't many of those right now.
  • Michael Fitzgerald

    Michael Fitzgerald writes about innovation and other big ideas in business for publications like the New York Times, The Economist, Fast Company, Inc. and CIO. He’s worked as a writer or editor at Red Herring, ZDNet, TechTV and Computerworld, and has received numerous awards as a writer and editor. Most recently, his piece on the hacker collective the l0pht won the 2008 award for best trade piece from the American Society of Journalists and Authors. He was also a 2007 Templeton-Cambridge Journalism Fellow in Science and Religion.