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Old 04-08-2008, 12:03 AM
Anyuser Anyuser is offline
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Join Date: Dec 2006
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Default Re: I wish it had been "Financial Instrument ABCs"

Originally Posted by AemJeff View Post
Some people did dumb things, some were given loans that the issuer was in a better position than they were to understand was a bad idea, others were plainly duped. I'd rather see the financial institutions take the majority of the damage - people applying for mortgages aren't financial experts, and often aren't accustomed to bargaining on this scale. I was in the refinance market last year and mortgage brokers were pulling tricks like agreeing to issue a fixed-rate loan and then faxing me paperwork for an ARM, for instance. (True story.) These folks have an advantage over consumers, on the whole, because the deals they're arranging are within their area of expertise, while people buying properties may be engaging in a transaction on this scale for the first (or only) time in their lives. Let the bankers worry that if they issue a really bad loan, there's a chance they'll have to eat it. Obviously I'm not talking about marginal cases, but I'm not talking only about clear cases of deceit, either.
It's hard for me to fully agree with you for the following reasons:

How do we distinguish between borrowers that deserve a break and those who don't? I understand a typical defaulting borrower to be one that employed the single most powerful force in the universe: wishful thinking. That borrower took out an ARM thinking, I'll be making more money 1/3/5 years from now when my rate resets, and my house will increase in value 5/10/15 percent in the meantime. That borrower wasn't necessarily dumb or duped, he or she was simply wrong. Why should that borrower be bailed out by the taxpayers or by resonsible borrowers (through higher interest rates)?

A phrase we hear a lot is "predatory lending." In the context of home loans, that phrase makes absolutely no sense to me. A predatory loan is one in which the lender would rather repo the collateral than have the loan repaid: a pawnshop loan, for example. A "subprime" loan by definition is a risky, that is under collateralized, loan. In a subprime deal the house seller got his purchase price, the buyer/lender got his fling in a house he really couldn't afford, and the only party that got royally, royally screwed was the lender. The rule of thumb is that a lender will recover 50% of its loan after a foreclosure. Exactly what is predatory about that? Repeat: the bank effectively gave the borrower hundreds of thousands of dollars, but the bank got only half back. What's the most vivid counterexample imaginable? A bank suckers some dumbass into an ARM, and the bank knows the borrower will never be able to afford the reset, so the snidely whiplash bank will repo the house? That simply doesn't jibe with reality. What would be the circumstances of a borrower that deserves a break? What would one look like? I suggest if you looked at 100 foreclosures you'd coming away thinking that 99 of the borrowers deserved no sympathy.

The real bad guys are long gone: the mortgage brokers. The had zero skin in the game. They could care less if a loan repaid or went bust. They made big, fat commissions for originating loans for the mortgage banks and the Wall Street buyers. Some loans paid higher commissions than others, I don't know why, and those were the loans the mortgage brokers steered their borrowers to. One would think that a good solid loan would earn a higher commission, but apparently that wasn't the case.

Another problem is that even if you could identify a lender that deserved to be held down and given a haircut, it's hard to get at that lender. Banks hate like death itself to repo real estate, and most likely would be eager to do a sensible workout. That's what it was like in the old days, when your local savings and loan held your mortgage for its own account. These days, maybe the borrower lied to the mortgage broker. Maybe the mortgage broker lied to the commercial bank. Maybe the institutional investor who securitized the mortgages could give a shit if the loans were decent. Maybe the ratings agencies are self-serving liars. Maybe the guy left holding the bag is some muncipal treasurer who thought he was buying AAA bonds. Putting aside whether the borrower deserves a workout, nobody in the trail of the mortgage has legal authority to negotiate or agree to a workout. Literally. This is one reason we're in financial straits today: there is no means for a workout. The bank that sends out mortgage statements is probably just a servicer for Wall Street investors. If you were to say to that bank, I have some temporary, ahem, cash flow problems and I need to work a deal with you, the bank would likely say, I'm not even authorized to discuss the topic with you.

I can't buy the proposition that the borrowers lacked information, either. The ungodliest complicated portion of a loan these days is the truth in lending paperwork. The interest reset and monthly debt service is spelled out in black in white. Wishful thinking makes borrowers illiterate.

A fix would be to force, by regulation, the mortgage originator to hold the first piece of the mortgage for its own account, and to comply with margin requirements for any purchaser of the mortgage. This would effectively prohibit banks from making dumb loans. Issuers of mortgage securities should also hold the first piece for their own account (this is often the case now, not by regulation, but because nobody would buy the piece of shit). Sellers of credit default swaps should have balance sheet requirements, should mark to market continuously, and comply with margin requirements when the obligations they're insuring go pear-shaped. Had these requirements been in place 3-4 years ago, we wouldn't have the problems we have now. In other words, the borrowers defaulting now never would have gotten the loans in the first place.
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