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Background of sub-prime lending

Sub-prime lending was a result of the increasing demand in the marketplace for loans to less-than-ideal customers, meaning, those with imperfect credit and who are therefore unable to avail funding through normal sources. This induced many companies to enter the market taking advantage of low prime interest rates and the resultant negative real interest rates thereby resulting in the sub-prime markets to flourish. With such modest rates, the leverage arising out of borrowing in sub-prime enhanced their returns on investments.

Further, in 1999, Fannie Mae, largest home mortgage underwriter in US, because of pressure from the Clinton administration, relaxed credit requirements on loans it buys from other lenders, hoping it would result in more loans to minority and low-income buyers and also targeted maintaining 50% portion of their portfolios in loans to minority and low -income borrowers.

These loans intended to serve the purpose of those who would otherwise find it difficult to raise funding and for those who avail such loans understanding that they are higher risk, and that they must take all diligent efforts to service the loan payments, interest and principal.

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