The Subprime Crisis: A Major Shift in Priorities for the SEC

Caught flatfooted by the meltdown in the subprime mortgage market, the SEC belatedly is investigating whether any wrongdoing occurred.  The origin of the subprime crisis is worth revisiting.  In a business environment featuring increasing home prices and significant demand for homes, “prime” borrowers with good credit locked in their rates.  Mortgage lenders extended credit to “subprime” borrowers with poor credit, who, due to poor underwriting practices, often were allowed to borrow more than they could repay. 

 

This practice was facilitated by the issuance of asset-backed securities. Mortgage lenders sold the loans to third parties who packaged them into pools and sold the cash flows to investors in the form of mortgage-backed securities. In turn, these third parties resecuritized the mortgage-backed securities to create collateralized debt obligations or "CDOs."