Industry airheads inflated the subprime bubble

The subprime-mortgage meltdown, which has triggered a larger meltdown throughout the credit markets, is the latest example of grand-scale faulty logic and short-term thinking.

Sadly, history is littered with examples of grim situations that apparently emerged through a near-complete lack of forethought. Think in terms of the infamous Y2K scare that left many of us wondering if our computer systems promptly would shut down on Jan. 1, 2000, simply because some computer whiz a long time ago neglected to factor in the notion that the 1900s would eventually end.

Think also in terms of the brilliance behind the alternative minimum tax, which might have initially seemed like a good way to snag a handful of wealthy tax-dodgers. Too bad they forgot to include an adjustment for inflation.

Now, with the subprime market’s ripple effect, it once again begs the question: What were they thinking? While there may be solid arguments for the benefits of homeownership, and subprime lending could easily be cited as a means to that end for some people, that shouldn’t be allowed to trump a rational threshold or formula in the business of lending.

I can’t imagine how anyone at any level could have thought the subprime bandwagon was anything but a fragile house of cards. Call me naive, but it seems just about everyone involved had to know that they were pumping air into a bubble.

Consider, for example, the mortgage brokers — more than 400,000 strong at the peak and mushrooming across the country with a loan approval process that had seemingly sunk to the level of video rental scrutiny.

In the mortgage business, this is known as “low documentation” or “no documentation” lending. Some in the business even opted for the phrase “liar loans,” in perhaps an ironic attempt at truth in lending.

After all, why shouldn’t somebody with no proof of income be able to take out a mortgage equal to 100% of the appraised value of a home? It is the American dream, right?

This is — or was — the subprime-mortgage business as it morphed out of the larger real estate bubble that gathered steam from a refinancing boom and the lowest mortgage interest rates in history.

By 2005, with institutional investors having developed a King Kong-size appetite for asset-backed securities, subprime became the next and most extreme stage of blind-faith lending.

But when the refinance volume fell off, instead of slowing down, the industry armed itself with all manner of creative financing and zeroed in on the short-term prospects of high-risk borrowers.

The monthly average issuance of subprime asset-backed securities grew to almost $50 billion during the peak from 2005 through the first half of this year, climbing from a $4.5 billion monthly average in 2000.

Then the party came to a screeching halt in July when some of the leading rating agencies started crying foul by severely downgrading the quality of bonds backed by all that subprime debt. Since July, the monthly average issuance of subprime-asset-backed securities has dropped to $9.5 billion.

It is easy, and suddenly fashionable, to accuse the rating agencies of being asleep at the wheel with regard to subprime loans. But the blame should be shared by the entire industry, which spent so much creative energy feeding a system that ultimately relied almost entirely on the ability of high-risk borrowers to make their mortgage payments.

What were they thinking?