The problem? Lenders made loans to San Diegans, in 2005, based on guidelines that were meant for Houstonians. San Diego appreciated some 100% or more in the period of 2000-2005; far above the expected appreciation rate. Reversion to the mean theory dictates that underperformance is in the cards for San Diego for 2006-2010 while out performance is expected for Houston. The national data hid the fact that the riskier loan product was made, an a very risky asset in San Diego, in 2005.

Money is ammoral and naturally flows to higher returns. Residents of industrial cities, like Philadelphia, took advantage of the easy credit revolution and migrated to Cape Coral, FL. It was rational, in the Philadelphian’s mind, to bid up the price of Southwestern Florida real estate because the borrowing terms were so inexpensive. The Philadelphian’s perspective of value was 175% higher than a Floridian’s. The problem is that the underlying economic base didn’t support the appreciated price in the boom town; this removed the ability to service the new debt. That combined with the now risky collateral, made for the lending disaster we face today.

The real reason for the sub prime mortgage market collapse?

CONTINUE