Deemed as the biggest economic bubble since the Great Depression of 1928, today the subprime crisis has spread its tentacles and gripped both sides of the Atlantic. Until the crisis manifested itself so menacingly, there were apparently no checks and balances to rein in practices that later proved disastrously wrong. While the CEOs assuming responsibility is understandable, it is surprising how the rest of the top management have escaped scrutiny, at least so far. As the crisis rolls on engulfing the broader credit market, there are definite indications that it has acquired all the characteristics of a systemic spillover, calling for coordinated action by the policy makers and top managers worldwide.

Subprime lending is the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history. The phrase also refers to banknotes taken on property that cannot be sold on the primary market; including loans on certain types of investment properties and certain types of self-employed persons. While there is no official credit profile that describes a subprime borrower, most in the US have a credit score way below 723. Fannie Mae has lending guidelines for what it considers to be `prime' borrowers on conforming loans. Their standard provides a good comparison between those who are `prime' borrowers and those who are `subprime' borrowers. Prime borrowers have a credit score above 620 (credit scores are between 350 and 850, with a median in the US of 678 and a mean of 723), a Debt-to-Income ratio no greater than 75% (meaning that no more than 75% of net income pays for housing and other debt), and a combined loan-to-value ratio of 90% (meaning that the borrower is paying a 10% down payment). Any borrower seeking a loan with less than these criteria is a subprime borrower by Fannie Mae standards. Thus the term `subprime' refers to the credit status of the borrower (being less than ideal) and not the interest rate on the loan per se.

Capital markets operate on the basic premise of risk vs. reward. Investors taking a risk on stocks expect a higher rate of return than do investors in risk-free treasury bills, which are backed by the full faith and credit of the US. The same holds good for loans. Less creditworthy subprime borrowers represent a riskier investment, so lenders will charge them a higher interest rate, than they would charge a prime borrower for the same loan. A subprime loan is normally offered at a rate higher than A-paper loans, due to the increased risk associated with it. To avoid the initial hit of higher mortgage payments, most subprime borrowers take out Adjustable Rate Mortgages (ARMs) that give them a lower initial interest rate.

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