Tuesday, June 19, 2007

SubPrime by Choice

One of the key assumptions of neoclassical economics, one that colors theories and analysis put forth by its practitioners, is that people act in their own rational self interest. How, then, can they explain this report from Fannie Mae that half of the sub-prime loans they purchased in 2005 were held by borrowers that could have qualified for prime loans?

Let's pause for a second to digest that.

The difference between prime and sub-prime loans could be up to 3 percentage points. Even if it's just two points, you're looking at hundreds of dollars a month on your standard Los Angeles mortgage.

So who doesn't shop around when they are taking out a $300,000 loan? Rational people for whom the the several hundred dollars a month is worth less than the time it would take to find a better loan? I'm pretty sure that The V-Train's meddlesome cousin (a former sub-prime loan underwriter) has something to do with this.

Or perhaps people act in their own self interest only if they can recognize what their interests are. Rational, but retarded.