Alex A. Hutnik

Recently, there has been a lot of press coverage (in between clips of Paris Hilton going to jail) about something called subprime lending. I’d like to explain what the current problem is to aid anyone trying to better understand the articles about it.

There is one basic banking idea you should understand for this post: the most common way banks make money is by charging people interest on loans, credit cards, mortgages, etc. The interest that they charge depends a lot on how comfortable they are with whether or not you will be able to pay back the loan. The more risk you have, the higher the interest.

So, about 10 years ago, banks started to feel pressure from their owners to be more profitable. In order to do that, the bank had to either charge more interest on loans or find more customers to apply for loans. Some banks chose the latter, and began to take on riskier customers. These customers are known as ’subprime’ customers, because their credit ratings are not the greatest. These subprime loans typically had low interest rates at first and were attractive to people with low credit scores (indeed, low interest rates are attractive to anyone regardless of credit rating). But the banks still consider these customers risky, so they charged higher interest rates. Nothing unusual here, except that many banks fully expected customers to default on the loans. Real estate prices were rising so the bank could either make money when the customer paid back the loan, or they could make money by foreclosing on their house and selling it. They were making money coming and going: both money from the customer until he defaulted and money from the sale of his house too.

If a bank knew that a borrower was going to be unable to repay his loan but lent him the money anyway, the bank would be guilty of what’s called ‘predatory lending’. This is something that is forbidden by law. In fact, there is a federal investigation going on to determine if any laws were broken.

So why so much press coverage? Because hundreds of thousands of people are facing foreclosure on their homes.

You can read more about this on the wikipedia article: http://en.wikipedia.org/wiki/Subprime_meltdown.

Popularity: 18% [?]

Marginal Revolution: How much is the Internet worth?

Tyler Cowen posts about a working that tries to determine how much the internet is worth to consumers in the U.S.  He bases his appraisal on the amount of money spent online.

Popularity: 11% [?]

Slate has an easy-to-follow article about the study of eBay auctions by economists.  An excerpt, with a link:

Are eBay auctions rational or irrational? - By Tim Harford - Slate Magazine
Auction theory offers an argument that a secret reserve price is better. A secret reserve price allows bidders to see each other’s gradually ascending bids and thus draw confidence that they are not alone in prizing the item. Even though the bids are too low to beat the reserve, they serve an important purpose of reassuring bidders that others are also interested. An open reserve price on eBay makes that reassurance impossible; nobody can submit a bid below the open reserve, and lacking any signs of confidence from other bidders, nobody may submit a bid above it either.

Popularity: 12% [?]

Tyler Cowen of Marginal Revolution posts about an interesting phenomenon: nearly one third of all households have house numbers that start with 1.  And, the popularity of each subsequent number decreases logarithmically.

Popularity: 9% [?]

Dani Rodrik asks, “Would you rather be poor in a rich country or rich in a poor country?” Intuition got me this one right, but I was still surprised by the answer: And the Winner Is…

Popularity: 9% [?]

It’s something many high school seniors think about: Should I go to college and spend $100,000 ($160,000+ if you go to Case) to go to college or should I start working. On one hand, starting to work right away means you can start earning more money right out of high school. However, your wages will likely plateau. But would that still be better than graduating in debt? Nobel economist Gary Becker examines this trade-off:

The Becker-Posner Blog: The Benefits of Education-BECKER

Popularity: 9% [?]

Dr. Becker, of the University of Chicago, wrote a very interesting blog post about how information asymmetry should be at the basis of tort law reform:

The old rule of caveat emptor, or buyer beware, is too rigid in a world where buyers of products, or of medical and other services, may be much less informed about possible risks than are the producers or doctors who provide them.

You can read the rest here: http://www.becker-posner-blog.com/archives/2007/04/improving_the_t.html

Popularity: 7% [?]