What causes the mess in sub-prime mortgages?

The sub-prime mortgages are given to low income people who are not able to service the mortgage loans. There is a high default rate on these loans. The losses are affecting meltdown in the global stock markets.

How did this mess come about? There are two main factors:

1) The mortgage brokers earn an attractive commission to sell the sub-prime mortgages. They are not concerned about the ability of the customer (i.e. borrower) to repay the loan, or if the property is good for the customer. The brokers are motivated by the sale, and the attractive commission.

2) The lender should be the party that is interested to ensure that the borrower can repay the loan. This was the situation in past years. In recent years, they have changed to a "broker" mindset. They sell the loans, and re-package and re-sell them to the market through the asset backed securities and the collaterised debt obligations. The original lenders earn an attractive margin for providing this re-packaging service, and do not take any risk.

This is quite sad. The mortgage brokers and mortgage lenders, in their eagerness to earn the commision and the margin, have created products that are bad for the customers (i.e. the people who borrowed on the sub-prime mortgage to buy expensive property) and bad for the ultimate investors (i.e. the people who bought the ABS and CDOs in the market).

Unfortunately, there are many other financial products in the market that fall in the same category. They include high cost life insurance products and structured products.