Don't Go Blind from the Subprime

If you picked up a newspaper in the past few weeks, you probably saw at least one article detailing the downward spiral of the subprime mortgage market. These stories usually paint the same picture: the ridiculously risky lending practices of recent years are coming back to haunt the housing market and could take the economy down with it.

Before you get caught up by the scary headlines and start preparing for the worst, let's put things in perspective. According to the Mortgage Bankers Association, only 6% of homeowners have subprime, adjustable rate mortgages. At the peak of the 2001 recession, only one-tenth of these types of mortgages foreclosed. Even if we hit those levels this time around, it's difficult to see how it would translate into economic disaster. It's just too small of a phenomenon.

In addition, the risk associated with subprime mortgages has been spread throughout the entire financial system through a process called securitization. Banks packaged subprime loans into mortgage-backed securities and then parceled them out to those willing to bear the risks. In other words, the risk is not concentrated amongst the few—which means the probability of a system-wide financial collapse is minimal. To be sure, some mortgage lenders at the margin may go bust. But it won't be enough to meaningfully reverberate through the financial system.

The real risk in all of this is political. Democrats in Congress are currently on the warpath, seeking to prosecute against firms using "predatory lending" practices. To the extent they are successful in changing laws and reducing access to credit for risky borrowers, there could be lasting repercussions throughout the economy.

But in the meantime, don't go blind by the subprime worries. Stay focused on the strong economic and market fundamentals that continue to power this bull market forward.