Bill Nygren: “How does subprime loans affect Washington Mutual (Wamu)?”
"One sector of the market that continued to decline in March as the rest of the market recovered was the consumer lending companies, especially those involved with subprime mortgages. A mortgage is generally termed subprime if the borrower does not have strong enough credit to qualify for a traditional “prime” mortgage. And just like in the corporate market, where junk bonds have higher yields than investment grade bonds, mortgage lenders charge a premium on their riskier subprime mortgages to compensate for higher default risk. But in the past few years, with defaults on most corporate and consumer debt at very low levels, those premiums collapsed as investors convinced themselves that cyclic-low default rates had become permanent. Subprime mortgages were being underwritten at such narrow premiums that if defaults returned to historic norms, they would no longer be worth the full amount of the mortgage."
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