EXCERPT: 'Hot, Flat, and Crowded,' by Thomas L. Friedman

The meltdown that occurred in the market was triggered by subprime mortgages, which allowed people with low incomes and tarnished or no credit histories to buy homes. At the height of the subprime craze, one Los Angeles mortgage broker told me, mortgages were being handed out by banks and mortgage providers to anyone who could "fog up a knife." People with incomes of $15,000 to $20,000, with no credit ratings, or in some cases without even a steady job or citizenship papers were granted mortgages to buy $300,000 and $400,000 homes—with nothing down. What is staggering is precisely how much we and others binged on these "subprime" mortgages, as though they were U.S. savings bonds, not hugely risky financial instruments. How did this happen?

According to Peter J. Wallison, an expert in financial policy and codirector of the American Enterprise Institute's project on financial policy, as of September 2008, there were roughly twenty-five million subprime and other nonprime mortgages outstanding, with an unpaid principal balance of over $4.5 trillion. Subprime mortgages, Wallison explained, are mortgages made to people with blemished credit and low scores on the standard measures used to estimate credit quality. Other nonprime mortgages—also known as Alt-A loans—"are mortgages that have adjustable rates, no or low down payments, and were made to people who did not have to state their income or their income was not verified," he added. These were often referred to as "liar loans," because you could cover up your financial weaknesses, still get a loan for little or nothing down and little to pay at first, and then the big payments would only kick in—or "reset"—later, in a year or two. In other words, the term "subprime loans" referred to the quality of the borrower—people known to be at risk of default from day one. "Alt-A loans" referred to the quality of the loan itself: the borrower may have a good or bad credit record, but these loans themselves were inherently risky because they were extended with little or nothing down, or with little or no credit history, or would reset at a much higher rate in the future, so there was always a good chance the buyer would not be able to meet the mortgage payments as a result of one or more of these conditions. As long as housing prices were going up, though, those holding Alt-A loans could just flip the house when the rate reset, as many speculators riding the boom did, and earn more than the original mortgage value. And brokers were not above telling people: "No worries: Buy now and if you can't meet your mortgage payments, just sell the house. Prices will only go up. It will be worth more tomorrow than it is today—for sure." When housing prices started to go backward, though, and the Alt-A or subprime payments really kicked in, many people holding them were crushed by debt. Their mortgages went up and their home values went down, so they could not escape.

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