The broader implications of the sub-prime mess

I sometimes wonder if people who analyze the financial markets miss the forest because they are looking too closely at the trees. Why else would someone ask, as some analysts have done this week, why investors are leery of buying shares in the big U.S. financial institutions?
It seems self-evident that the U.S. sub-prime fiasco and subsequent revelations about how sub-standard mortgages were repackaged and sold around the world are reason enough to avoid this sector, at least until it becomes clear the crisis is over. Announcements this week of billions more in write-downs related to this mess indicate it is not yet contained — even within the institutions most affected.

More importantly, the practices uncovered in the initial stages of the crisis raise broad questions for investors about how the financial sector goes about its business and whether regulators are adequately protecting their interests. Stepping back even further, there is a large question mark hanging over the U.S. economy.

The list of dubious practices begins with the offer of mortgages to people who could not afford the payments. Some of these mortgages appeared designed to fail, with built-in increases in the interest rate. So-called neutron loans – they killed the people and left the houses – don't sound like particularly sound business for a bank, unless of course you sell the mortgage to someone else who then assumes the risk, which is what happened.

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