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Subprime bailout and moral hazards
Posted by: Jon Henke on Monday, January 28, 2008

Inevitably, when Bad Things happen to a lot of people at once, politicians show up to rescue everybody involved from the consequences of risk or bad choices. But while mercy is a virtue in an individual, a government policy of mercy for bad choices creates moral hazards that can create both immediate (to other taxpayers) and long-term (to future lenders and borrowers) negative consequences.

In the event that politicians propose a subprime bailout of lenders or of homeowners, what steps will the politician take to ensure that these people are not rewarded for their fraud.
Most fraud in subprime lending appears to have been so-called “fraud for purchase” – lying about income so as to win a mortgage approval. In reviewing a sample of “no doc” loans that relied on borrowers’ statements, the Mortgage Asset Research Institute recently found that almost all would-be home owners had exaggerated their income, with almost 60 per cent inflating it by more than 50 per cent.
To be clear: neither fraudulent borrowers nor lenders who enabled or turned a blind eye to fraud, should be compensated or rescued for the consequence of their fraud. If a subprime bailout rewards those who committed fraud, it will be an explicit legislative invitation to continue the fraud. How you avoid rewarding that fraud, though, seems like quite a difficult problem.
 
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How to avoid rewarding them? Let them fail. Let them lose their shirts and their homes. Bail them out not at all.

I’ll never understand what attracts people to ARMs or any other unpredictable financial arrangements. Life turns on a dime: buy tunafish and powdered milk.
 
Written By: dicentra
URL: http://dicentrasgarden.blogspot.com
It isn’t just the borrowers than need to meet reality face first. Its the lenders as well. They indulged in all these loans, looking the other way, profiting from the transaction fees and increased pressure on home prices.
 
Written By: jpm100
URL: http://
Clearly mal-investment must be liquidated to restore financial health.

We need to understand the economic need for the sub-prime industry. There are two main needs for sub-prime loans and the 2/28 arm in particular: poor credit or rolling over of credit card debt.

Those with poor credit seek the 2/28 subprime arm short term financing while they improve their credit and qualify for a prime loan with lower interest rates. The vast majority of borrowers historically refinanced before the reset period.

The second type of borrower seeks to roll-over credit card debt. Let’s remember that credit cards are even riskier as there is no collateral backing the loans and nothing that can be sold to pay off the loan. Once again, subprime mortgage loans allowed many people to get out of the 15% to 18% interest rate on their credit card by rolling their credit card debt into their home loan. Cash-out refinancing their homes with a subprime (7-11%) brings down their mortgage rate and they get a tax deduction on those interest payments to boot!

Of course, getting out before the reset (as in the case of the credit curing borrower) or rolling credit card debt into a subprime both require home equity. Now that housing prices have fallen those opportunities are gone.

Towards the end of the housing boom a third type of borrower became important: the speculator. In this case the object was to sell the home in two or three years and pocket the gain. Even if one was behind paying the mortgage, the price appreciation paid off the mortgage with a large profit leftover.

The problem now is the fire sale of homes in the foreclosure pipeline. They will depress prices and lead to further defaults. Quick liquidation helps to solve this problem. Dragging it out only makes it worse. Let’s remember the failure of Japan to liquidate bad investments in the 1990s led to a decade of economic malaise.

Helping people to avoid the consequences of their acts is always foolish and counter-productive.
 
Written By: Jason Pappas
URL: http://libertyandculture.blogspot.com/
Inevitably, when Bad Things happen to a lot of people at once, politicians show up to rescue everybody involved from the consequences of risk or bad choices. But while mercy is a virtue in an individual, a government policy of mercy for bad choices creates moral hazards that can create both immediate (to other taxpayers) and long-term (to future lenders and borrowers) negative consequences.
See. e.g., those who choose to live in Florida.
 
Written By: mkultra
URL: http://
I too don’t like the moral hazard aspect of the solutions, but I am not too worried about the private programs done so far - slightly lower interest rates or 10% off mortgages won’t save someone who over-stated their income by 50-60%. Plus the banks are paying and so hopefully have learned the lesson (until the cycle repeats itself.) Once the taxpayer starts paying for this stuff, it is a very different animal.

Inflating your income by 50%...that seems like a lot. I wonder how many of those people lying about their income did so not in order to buy a house for themselves but as speculation (serial flipping.) This is important as help at the margin won’t help speculators who were betting on an ever-rising housing market. With demand and pricing down, they will be going bust period.




 
Written By: Harun
URL: http://

 
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