Why is the market reacting so negatively to the sub-prime lending issues?

Question

sub-prime lenders give loans to people with bad credit. It's a small segment of the market. The news is coming out that people are defaulting on these loans.. Why is this suprising? it's a sub prime market. Of course risky loans to people with bad credit are going to be defaulted on. The market is plummeting on this news as if it is a suprise somehow.
What gives?

Answer 1

You are correct that it is a small segment of the market but one that represents billions of dollars. Correct also is that these are riskier loans and they should not be blind to the repercussions of loaning money to questionable borrowers. The rub is that several lenders, correspondent lenders and brokers with poor policing have taken the already liberal sub prime quidelines and then fudged on the borrowers application for income and other areas. The foreclosure scenario we all see now has resulted in review of these loans and in general fraud and deception has not been uncommon. Wall Street is screaming because they bought these loans based on the guidelines unaware (supposedly) of the the rampant abuse. People who had no business owning a home got one now they don't and the Walls Street is left holding the bag. So it is coming down to the fraud issue that has accelerated the foreclosure market and Wall Street is not buying now or at best, cracking down.
Some lenders have been forced tp buy back loans that were fraudulent. For example, Option 1 just had to cut a check for 100MM I believe.

Answer 2

If the subprime market were limited to borrowers with poor credit, you would be correct.

However, it is not. Lenders have expanded their subprime offerings to target those who have no credit, those who have good credit but are not financially savvy enough to find better sources, and those who have no business getting any loans at all.

As a result, the subprime market is quite large, and has become a harbinger of what will happen with the regular market in a few weeks or months.

Hope that helps.