The government is exerting a little pressure on the lenders to freeze interest rates for those with adjustable mortgages. I think that’s the right strategy to help protect the overall economy without sacrificing taxpayer dollars. Not that its a perfect plan; Cato Institute Senior Fellow Alan Reynolds in his Wall Street Journal editorial Dissecting the Bail Out Plan deconstructs the plan to show it helps, at most, 360,000 borrowers. Nearly half of the sub-prime loans are fixed rate loans, according to Reynolds, and there might be some costs incurred by the quasi-federal Fannie Mae and Freddie Mac getting involved.

Many people seem OK with the idea of letting the investors take the full hit, and … I’m presuming … giving the property to the borrowers who signed up for loans they couldn’t afford. The idea behind this incredibly bad idea is that the loan documents are probably confusing. But at least the borrowers had the documents to look at. The investors were presented with “packages” of loans graded on a scale from high to low quality. The packaging of subprime loans in portfolios with good loans, and then averaging the risk so the investor seems to be buying a package of “pretty good” loans can be deceptive: the investor really doesn’t realize the risk in the package of loans. That’s why national lenders who don’t issue subprime loans have a portfolio that contains a certain percentage of bad loans … but even they don’t know how many. As loans are repackaged with other loans and resold, a virtual shell game has existed that obscures the true numbers.

The borrowers at least had the loan documents to look at, even if they didn’t read them.

Howard Audsley, a MO farm appraiser who has developed courses on land appraisal, notes that in looking at the entire mess, you can see that the historic standards were not upheld:

So aside from all the money that was dispersed, what went wrong? The lending industry is based on a system of checks and balances……the Five C’s of credit:

http://www.loanuniverse.com/credit.html

In the subprime mess, just about every one of these were ignored. Collateral (as reflected by an accurate appraisal) is one of them. Appraisals are to be relied upon in the loan process as offering a realistic level of market value. Lending only a portion of that creates a built in cushion of equity from the borrower. When all the standards are ignored, such as when appraisers are instructed by lenders to make deals work or lose the business, and there is no equity, trouble is bound to happen. So why ignore the Five C’s? Money.

From Subprime Loans – What’s the Problem?

Money is indeed the problem. I know several loan brokers, and they tell me if there’s a product available to be sold … if the lending banks say “we’ll write 10 loans this week to people with credit scores below 600 with no verification of income” … they will sell that product. The lending banks expect them to. The subprime banks originating those loans have been hit hard, with many now bankrupt, but the loans were then packaged with healthy loans and sold off, as noted above.

In the end, if the lenders can’t lend support by freezing rates or working out with the borrowers, then the “pain” that the subprime lending brought us has to be endured. Otherwise, we’ll see this same type of activity again in a few years. As Audsley says, “A government bailout would only encourage more of the same type of reckless behavior.”

Yep.

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