The Sub-Prime Hangover Continues

After a pretty scary correction less than two months ago, the US stock market (and most other global markets) are again motoring to new highs. And yet, today, the WSJ has this rather sober piece on the depth and length of the sub-prime crisis. The summary: sub-prime loans got made for longer, to broader sections of the socio-economic scale, than we thought. So the full unwinding may take a couple of years.

We're getting ourselves in a moral hazard vs. commonwealth dilemma here. On the one hand, allowing financially unsophisticated borrowers to whipsaw the credit markets doesn't sound like a very good idea. Some fairly unobtrusive regulation changes could limit the damage that could be done to the credit markets, mostly by some additional restrictions on the escalators and caps for adjustable-rate mortgages. (Note that most people were OK when they originated their loans. They just didn't believe that the rate adjustments would happen, or they thought they'd sell the house for a profit before they kicked in.)

Of course, these restrictions will inevitably limit the supply of loans to sub-prime customers. If we think that home ownership for the lower middle class is a social benefit, restricting the range of sub-prime loans will be deleterious.

Another take on this can be found in this TCS interview with Ken Fisher. If the majority individual borrowers are still deriving a benefit from sub-prime, and the financing and bundling people have learned their lesson and re-priced the risk, maybe leaving things alone is the right approach. As usual, waiting two years before addressing policy issues like this is almost always a good idea. (Remember SarbOx?)