Shiller Defends Subprime Lending

Monday, 20 Jul 2009 12:13 PM

By Julie Crawshaw

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Housing guru and Yale economist Robert Shiller says subprime lending wasn’t bad, it just came at the wrong time.

“The subprime mortgage is an example of a recent invention that offered benefits and risks,” permitting people with bad credit histories to buy homes, Shiller writes in The New York Times.

“This might have represented financial progress if it weren’t for some problems that the designers evidently didn’t anticipate. As subprime mortgages were introduced, a housing bubble developed.”

Compared with conventional mortgages, the subprime variety typically involved higher interest rates and stiff prepayment penalties, Shiller notes.

“To many critics, these features were proof of evil intent among lenders,” Shiller says, yet higher rates compensated lenders for higher default rates and prepayment penalties made sure that people whose credit improved couldn’t just refinance somewhere else at a lower rate.

“This made basic sense as financial engineering — an unsentimental effort to work around risks, selection biases, moral hazards and human foibles that could lead to disaster,” Shiller says.

Felix Salmon finds Shiller’s points appalling.

“Shiller seems to think that the best response to harmful financial innovations like CDOs is even more financial innovation, to reverse the damage initially caused,” Salmon writes in Reuters.

“Wouldn't it be better just to scale back the amount of financial innovation we had in the first place? Net-net, financial innovation is a bad thing: the downside, during times of crisis, is higher than the upside in more normal years.”

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