Tan Kin Lian's Blog: What causes the mess in sub-prime mortgages?

Tuesday, August 21, 2007

What causes the mess in sub-prime mortgages?

The sub-prime mortgages are given to low income people who are not able to service the mortgage loans. There is a high default rate on these loans. The losses are affecting meltdown in the global stock markets.

How did this mess come about? There are two main factors:

1) The mortgage brokers earn an attractive commission to sell the sub-prime mortgages. They are not concerned about the ability of the customer (i.e. borrower) to repay the loan, or if the property is good for the customer. The brokers are motivated by the sale, and the attractive commission.

2) The lender should be the party that is interested to ensure that the borrower can repay the loan. This was the situation in past years. In recent years, they have changed to a "broker" mindset. They sell the loans, and re-package and re-sell them to the market through the asset backed securities and the collaterised debt obligations. The original lenders earn an attractive margin for providing this re-packaging service, and do not take any risk.

This is quite sad. The mortgage brokers and mortgage lenders, in their eagerness to earn the commision and the margin, have created products that are bad for the customers (i.e. the people who borrowed on the sub-prime mortgage to buy expensive property) and bad for the ultimate investors (i.e. the people who bought the ABS and CDOs in the market).

Unfortunately, there are many other financial products in the market that fall in the same category. They include high cost life insurance products and structured products.

5 comments:

Anonymous said...: Dear Mr Tan,

You mentioned about high cost life insurance products.

A few months ago, you said that a life insurance plan that gives out a regular payment reduces the return to the policyholder. NTUC has now introduced a new plan that pays out 5% of the sum asssured each year. Does your remark apply to this plan as well?; August 21, 2007 8:54 AM
Anonymous said...: This is another endowment product or more precisely anticipated endowment masqueraded as some kind of saving plan. As it is well known all traditional plans carry high cost. It is marriage of two types of plans.
Before you jump into it get an adviser to give you an objective analysis.; August 21, 2007 11:14 AM
Anonymous said...: My insurance agent has told me that this plan is similar to what Prudential offers. No prizes for guessing how this comes about. Repackaging old product for new under new brand. So what is the fuss?; August 22, 2007 2:20 AM
Anonymous said...: Read the above postings on this subject, revosave by Income.
It is a dumb product which instead of increasing the return, it gives worse than you get by putting into an old fashion endowment plan. And the difference is huge. This is real dumb
investing in this product. Someone calls it REVERSE-SAVE and this more like it.
Check it out with your agent if you don't believe what we say.; August 22, 2007 3:28 PM
Anonymous said...: i dont see the point of buying life insurance anymore other than health insurance

can insurance companies promise of at least a 10% return in our money invested per annum?

our real returns after 40 years of premium paying maybe 0.5 percent

example payout 4.5percent
inflation 4%

our real returns maybe only less than 0.5%; March 03, 2008 11:35 AM