The Underlying Basis of Finance & Credit

Saturday, September 20, 2008 | 02:44 PM

Here is an oddly interesting observation:  Over the entire history of human finance, the underlying premise of all credit transactions -- loans, mortgages, and all debt instrument -- has been the borrower's ability to repay.

From 1 million B.C. up until the present, repayment ability was the dominant factor.

This goes as far back as when Og lent the guy in the next cave a few dozen clamshells in order to go and purchase that newfangled wheel.  If Og didn't think his neighbor would be able to repay him those clamshells, he never would've entered into what we can describe as the first commercial loan.

Since real estate loans are at the bottom of all of our current credit woes, let's take mortgages as an example. The historical basis for making a loan for a home purchase was several simple factors: Employment history, Income, down payment, credit rating, assets, loan-to-value ratio of the property, and debt servicing ability. But for some crazy reason, those factors went away during the housing boom.

That may sound simple, but it becomes even more stark when viewed over a time line.


<-1 million B.C. --------------------------- 2002-07 ---2008->


Except for that 5 year period, the entire history of human finance was rather reasonable about the basis for making loans in general, and extending mortgage loans in particular.

Makes you wonder, doesn't it.


UPDATE: September 26, 2008 5:46am

As mentioned last night, there is a specific reason for this change:  During that 5 year period (02-07), the basis for mortgage lending was NOT the borrowers ability to pay -- it was the lender's ability to securitize and repackage a mortgage

Saturday, September 20, 2008 | 02:44 PM | Permalink | Comments (82) | TrackBack (1) add to | digg digg this! | technorati add to technorati | email email this post



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» An Important Point about the Recent Past from The Left Coaster
Barry Ritholtz has an important point to make about what led up to our current financial crisis which was strangely out of step with the sensible way humans use to consider important in extending credit through out history: Since real estate loans are ... [Read More]

Tracked on Sep 20, 2008 5:26:08 PM


Must have been the Community Reinvestment Act.

Yeah, that's the ticket -- the CRA!

Posted by: Barry Ritholtz | Sep 20, 2008 2:57:40 PM

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