What could they have done differently?
*Disclaimer* I don’t know much about accounting (or anything in business for that matter) at this point in time. This will be the first time I will be looking into the sub-prime mortgage crisis and my opinions could well be wrong. However this is exactly what it looks like, my opinion on this topic. Hopefully it is sufficient for the purposes of this discussion and this class.
The first thing to consider is what a sub-prime mortgage is. A subprime mortgage is granted to borrowers whose credit history is not sufficient to get a conventional mortgage. Often these borrowers have impaired or even no credit history. Subprime mortgages often offer interest-only loans. That's because an interest-only loan is easier to afford. The loan doesn't require that any of the principle be paid for the first several years of the loan. Most borrowers assume they will refinance before the principal needs to be repaid, and the monthly payment increases. If they can't refinance, they often are forced to default because they can't make the higher payment1.
This seems straight forward enough, but even at this stage the danger is coming into focus. Interest rates usually are fixed for the first couple of years but can ramp up later with a large monthly payment. I assume at this point that the main reason someone would do this is if they were expecting to sell the home, and the housing market had been low for quite a while. If the person doesn’t manage to sell the home they will most likely default and end up being foreclosed on, which is exactly what ended up happening. At this point I would say that this isn’t even close to the accounting profession being a problem but I will keep going deeper.
Usually when banks or mortgage companies give out loans / mortgages they invest using Mortgage-backed securities (MBS). MBS are investments where their value is