Let's say you're a poor minority and you want to buy a house. You've looked but even the most modest homes are too expensive. Nevertheless you really want to own something so you hire a realtor and you find a home that you love but don't think you can afford.

"Don't worry," says the realtor, "I know someone who can help."

"But my credit's not all that good either" you say.

The realtor beams. "No problem. We can get you into an ARM"

"What's that?" you ask.

"Why it's an adjustable rate mortgage" the Realtor answers, "the starting rate is really quite affordable, even on your salary."

"But what about when it goes up" you ask.

"Don't worry!" the realtor says, "you can re-fi and even if you can't your salary will probably will go up! You can't lose.

The realtor works a deal with their mortgage broker. The realtor makes a commision. The broker makes money too and the lender sells the loan. Meanwhile your employer says that raises are out of the question and that cut backs will have to be made. You're put on part time. You get a second job but even with that you're barely scraping by and then the mortgage rate goes up...

Yes, it's all your fault, right?

Should the little guy who wants to own a home be responsible? Yes, to a degree. Do most reasonable people assign him the most blame? No. But progressivebulldog states that "the lender sells the loan" and this is where the real problem lies. Fannie mae and Freddie mac have pushed for lower lending standards for years in order to get more minorities and lower income people to be able to own their homes. The intentions may be good but it forced lenders to lower the bar without regard to the consequences. If you as a lender had to hold these loans you would make sure that most the loans were good loans. If you can just sell your more questionable loans and still make money, well then what the hell... full steam ahead.

ThatSo: If you as a lender had to hold these loans you would make sure that most the loans were good loans.

LeRoy: Well, yes, that's exactly right. And that is the way things used to work in America, when it came to home loans. The smaller community bankers knew their customers, and had a very good idea about their ability to pay. The securitization of mortgages, the idea of slicing and dicing them and then repackaging them into such novel financial instruments as collateralized debt obligations (CDOs) and all the various derivatives, and the resulting leverage that ensued, is the real crux of this financial bubble and implosion.

And the idea of securitizing mortgages, packaging them into CDOs, and then selling them to naive investors and shady operators all over the world----those ideas were not invented in the ghettos of America....They were invented on Wall Street and in the backrooms of big financial companies and investment banks. By men wearing ultra-expensive business suits, who would then go out and dine on $1000 business lunches. And who continue to laugh all the way to their banks, and dream about how wonderful and comfortable their retirement mansions in Bermuda and the Bahamas will be.

Nice work if you can get it.

It's not all the borrower's fault, but the blame should be shared.

Anyone signing a contract has a responsibility to understand the obligations that contract puts on them, and understand that they are agreeing to take on those obligations. Anyone who can't afford a couple hours of consultation with an attorney if they don't understand the terms of that contract probably shouldn't be involved in a transaction with a six-figure price tag attached.

The situation you describe is a case of predatory lending to some extent (with the lender believing they'll come out OK either because they'll have sold off the loan before the inevitable default, or because appreciation in the collateral value will guarantee that whatever payments are made are pure profit), but it works largely because it plays on the greed of the buyer which differs from the greed of the lender only in terms of scale.

As it shook out, most of the lenders involved in these kinds of deals got wiped out, along with whoever bought the repackaged loans (and the U.S. taxpayers in the cases of loans repackaged by Fannie/Freddie), with the lawmakers who trumpeted how great the expansion of homeownership was trying to use yet more tax money to bail out the irresponsible buyers and maintain prices at a level which is unaffordable to those of us who didn't rush in and borrow money we couldn't pay back. I guess the lesson here is to either be rich or be poor, but if you're in the middle it'll be coming at you from both ends.....

bmgreene,

You state your case eloquently and as someone who bought what he could afford (and who wishes he was starting out in the housing market right now with prices way down) I sympathize with a lot of what you're saying.

Surely there was wishful thinking and/or outright greed on the part of buyers as well as on the part of lenders. However, I think there are a couple things to consider that argue in the buyers' favor: 1) When they get guidance from a lender they will tend to believe it's expert advice, especially since the lender loses along with the buyer if the loan fails. 2) Contracts aren't written to be understandable. I wonder among the poor how many think first to get a lawyer to review legal documents (imagine the business generated by Internet terms of use!).

As for bailing out irresponsible buyers, I thought we were bailing out the irresponsible lenders first! Regardless, not bailing out these buyers means a harsh blow to cities that often were blameless.

Most of the irresponsible lenders have already gone under or have been bought up for pennies on the dollar against their peak valuations (AHM, CFC, etc...). At this point we're mostly bailing out banks who bought bundles of loans which were constructed to prevent any real transparency as to the quality of the loans contained in the bundle. These banks have also (cumulatively) already written off hundreds of billions of dollars in losses on these securities. From what I can tell, the only ones getting off scott free are any members of Congress who get re-elected next month since there was strong bipartisan opposition to regulating derivatives markets while their only apparent result was expanding homeownership to lower and lower income buyers. The finger-pointing and recusals now are CYA attempts by the same pols who chose to sit on the sidelines while the whole house of cards was built, and now want to escape culpability when it inevitably tumbles down.

It's unfortunate that many of the buyers may have been unaware that the lenders were actually selling them something, or didn't realize that the home being used as collateral for the loan (and usually the additional insurance premium they were required to pay if they didn't put much down as was often the case in the second half or more of the bubble inflating) was protecting the lender from loss in the event of a foreclosure. Technically, the only real damage to a borrower who's being foreclosed with no equity in the property (most of the option-ARM loand were structured such that those making the minimum payment weren't paying down any principal when they did so), is more damaged in terms of their credit rating than in terms of actual financial loss. Without equity, any buyer who put nothing down can consider the payments they've made to be little different from rent (all of them would have still needed a place to live if they hadn't bought those houses), and if they were making the option minimum payments on an option-ARM they may well have been paying below market rent for the place they were living.

bmgreene:

Most of the irresponsible lenders have already gone under or have been bought up for pennies on the dollar against their peak valuations (AHM, CFC, etc...). At this point we're mostly bailing out banks who bought bundles of loans which were constructed to prevent any real transparency as to the quality of the loans contained in the bundle. These banks have also (cumulatively) already written off hundreds of billions of dollars in losses on these securities.

Once again, I agree with the gist of what you're saying here, but I can't help but laugh a little at this. Shall we apply a cost-inflated version of your earlier statement:

"Anyone signing a contract has a responsibility to understand the obligations that contract puts on them, and understand that they are agreeing to take on those obligations. Anyone who can't afford a couple hours of consultation with an attorney if they don't understand the terms of that contract probably shouldn't be involved in a transaction with a six-figure price tag attached."

to banks buying up bad mortgages?

As I said in my earlier post, contracts (and sophisticated transactions in general) are not meant to be understood.

I've almost stopped being surprised at how much smoke and mirrors surrounds even the most stolid-seeming businesses.

Once Congress mandated the GSEs to get more involved with making mortgages more "affordable", there were a lot of sub-prime MBS packages floating aroung which had an implicit guarantee from the U.S. government. I'm not sure if further repackaging allowed for those to be intermingled with non-GSE (and therefore less thoroughly guaranteed) MBS packages when many of these got rebundled into SIVs and super-SIVs, but this guarantee would have only served to give a reduced perception of risk on at least some of the non-transparent products the banks were buying. Plus, the CDS contracts gave a sense of security against default risk (it turns out much of what has frozen up the credit markets is counterparty risk and banks finally backing down from the level of risk appetite they had over the last few years).

You're right, the banks shouldn't have been trading in opaque securities the way they did, and the institutions and shareholders have now paid the price for that at this point. I've argued on here against blaming CEO compensation for the problems with the exception of the golden parachute provisions (which I agree should be severely curtailed or eliminated altogether, but that's the responsibility of the boards who agree to such terms), and would like to see regulation to reduce the level of incestuousness between top execs and boards of directors. The current explosion in overall compensation kicked off around the same time the deductability limit for CEO salaries was put at $1M/yr in an effort to limit CEO pay directly, and I doubt there'd be any greater degree of success from direct regulation of severage packages.