User1

Risk Management in the Financial Industry

This a poorly written article which illustrates limited understanding of finance. Unfortunately, this is the same level of understanding that most mainstream media articles on this subject exhibit.

The first chart above equates mortgage securitization with lending to sub-prime borrowers. This is incorrect. Securitization of mortgages has nothing to do with the credit quality of the borrower. Both prime and sub-prime mortgage pools have been securitized. One could argue that securitization created moral hazard in the origination of mortgage loans. That moral hazard impacted both prime and sub-prime loan pools. The severity of the loss on sub-prime pools will be greater due to the characteristics of the sub-prime borrower, but that does not justify the author's equating securitization with sub-prime borrowing.

The author also equates a specific loan structure (adjustable rate) with sub-prime borrowers. This is another fallacy. Both prime and sub-prime borrowers took out adjustable rate mortgages during the run-up to the current credit crisis. The motivations of prime versus sub-prime borrowers in selecting an adjustable rate loan structure may be quite different, and on average, the sub-prime borrower may experience higher default levels than the prime borrower, but that is again due to the characteristics of the borrower, not the loan.

In summary, a financial blogger should be savvy enough to keep in mind that sub-prime refers to the characteristics of the borrower, not the structure of the loan or the subsequent securitization of the loan. Leave the confusion to WSJ.