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Thursday, September 25, 2008

What Caused the Credit Crisis?

In response to Once Again, It's Not Fannie and Freddie, Barry Ritholtz emails that it's not hard to figure out what caused the financial crisis:

The Underlying Basis of Finance & Credit, The Big Picture: Here is an oddly interesting observation:  Over the entire history of human finance, the underlying premise of all credit transactions -- loans, mortgages, and all debt instrument -- has been the borrower's ability to repay.

From 1 million B.C. up until the present, repayment ability was the dominant factor.

This goes as far back as when Og lent the guy in the next cave a few dozen clam shells in order to go and purchase that newfangled wheel.  If Og didn't think his neighbor would be able to repay him those clam shells, he never would've entered into what we can describe as the first commercial loan.

Since real estate loans are at the bottom of all of our current credit woes, let's take mortgages as an example. The historical basis for making a loan for a home purchase was several simple factors: Employment history, income, down payment, credit rating, assets, loan-to-value ratio of the property, and debt servicing ability. But for some crazy reason, those factors went away during the housing boom.

That may sound simple, but it becomes even more stark when viewed over a time line.

<-1 million B.C.--------------------------- 2002-07 ---2008->

Except for that 5 year period, the entire history of human finance was rather reasonable about the basis for making loans in general, and extending mortgage loans in particular.

Makes you wonder, doesn't it.

    Posted by on Thursday, September 25, 2008 at 06:44 PM in Economics, Financial System | Permalink  TrackBack (0)  Comments (26)


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