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That was exactly the point of my reaction to Jerome's argument that subprime loan borrowers were "willing gamblers": actually, they were clueless gambler. The very definition of a bubble is a shared belief, that the asset in question (housing here, but works the same for tulip bulbs, dot-com stocks...) will keep increasing in value and that when the mortgage resets, you'll just take a fresh new one or resell the house for a profit (to buy an even nicer one).

Plus the very strong pull of the "American dream": owning one's home (the US legal system is based on the property laws; unlike Europe, tenants have nearly no rights -- I know, I've been there).

When the nice mortgage broker explains that you too can be part of that home ownership dream: this is entirely legal (would I lie to you?) and when the introduction rate expires you'll have build plenty of equity in your house and refi will be a snap, not many people could resist the "dream".

Of course, the whole system worked (for a time) because neither the broker, nor the bank, nor the big guys like Goldman were holding the bag: they found a way to offload all the risks onto someone else while keeping the profits -- the very definition of modern finance.

A good opportunity to watch again this excellent presentation "How Subprime Works". Should be required reading on ET.

by Bernard on Sun Aug 29th, 2010 at 12:43:26 PM EST
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