08S7C's Economics Blog

Warren Buffett being interviewed about the subprime lending market

Q: What do you think about what’s going on in the subprime lending market?

W.Buffett: Lots of people borrowed money to buy houses that they don’t want to own anymore, or can’t make the payments on. Intermediaries and lenders will suffer. Will it spill over into other parts of the financial system? My guess is no. If unemployment doesn’t go up and interest rates don’t rise, I don’t see the subprime mess being a trigger for a wider financial contraction.

We’ve looked at the 10Qs and 10Ks of a number of financial institutions. A number are accruing earnings on loans even though the borrower is making only the lower option payment. I think it’s a case of dumb lenders lending to dumb borrowers. The growth in subprime was largely a bet that housing prices would keep rising. It worked until it didn’t. It’s similar to what happened to the manufactured housing industry in the 1990s. When supply expanded, some borrowers didn’t want to own the asset unless its price kept going up.

On a lot of these defaulted loans, the borrower didn’t even make the first payment. Early-payment defaults shouldn’t happen. That happened in the late 1990s in manufactured housing. When loans are packaged and securitized and local lenders aren’t part of the process, discipline leaves the system. You’ll have some faraway institution making a loan on a piece of property, and the local lenders will know that it’s a crazy loan to make. But when those loans get securitized, discipline leaves the system. The overhang of bad loans hasn’t yet worked its way through the system. In some cases it will take a few years. The overhang is huge. People who thought they were flipping are the ones who are getting flipped.

posted by Desmond @ 8:26 PM