Vintage Defaults

The graph shown represents the performance of mortgages by year issued. The year issued is referred to as the “vintage”, like wine. The Y axis is the ratio of loans that defaulted per loan made. A normal curve, as displayed by 2001 – 2004, is a shallow logarithmic curve. Once the default rate for a vintage goes from increasing at an increasing rate to increasing at a decreasing rate it is considered “seasoned”. 2001 was a recession year, so it is a bit of a benchmark.

The problem clearly arises in the 2005 vintage, when the economy was doing relatively well; the Fed had started raising interest rates in mid-2004. In early 2006 it was clear something was wrong in the mortgage market; the line deviates from the normal curve and crosses above the 2001 line at an increasing rate. The mortgages from 2004 start to have trouble at this point too, as the 2004 line crosses above the 2002 line. So the problem should’ve been apparent. On the other hand sub-prime mortgages were only a market of $500 billion in 2005 (pretty small in the grand scheme of finance), the tools and connections that enabled the economy to rest on $500 billion of sub-prime equity are complex and opaque, and no one wants a bubble to end.