Saturday, November 17, 2007

US House outlaws "Predatory Lending"

New thought crime, "Predatory Lending". Sounds worse than loansharking. Congress wanted to be seen doing something about the sub prime mortgage scam. Sometime around 1990 or so someone on Wall St invented the "mortgage backed security". This was a brokerage house IOU "backed" by home mortgages that channeled the interest yield on a home mortgage to investors (rather than to the lending bank) . The brokerage house bought home mortgages from the issuers (banks) and did some legal magic to wave a thin coating of "backing" over the IOU's. The sub prime crisis currently rocking Wall St occurred when investors discovered how thin the coating really is AND that the mortgages are going into foreclosure at a much greater than expected rate.
The bad effect of this financial wheeling and dealing is the willingness of banks to grant mortgages to shaky borrowers, backed by inflated property evaluations. Once the issuing bank could sell the mortgage, they stopped caring whether the mortgage would default in the future, and lending standards were lowered, a lot. The new house bill proposes to penalize lenders for granting mortgages that the borrowers won't be able to pay.
Mortgage lenders used to be fairly tight in the granting of a mortgage, because should the borrower default, the lender gets hurt. When the borrower defaults (misses enough mortgage payments) the lender seizes the house. Unfortunately for the lender, the repossessed house rarely sells for enough to make the lender whole again. In many cases the house doesn't sell for years. The lenders all know this, it's been true since Shylock's time, and so they used to make sure the mortgage was less than the price of the house, so the borrower had to put a significant sum into the house. This weeded out a lot of destitute buyers. They also checked for inflated house prices and insisted that the borrowers income be 4 to 5 times the mortgage payments. Best to avoid doing a shaky ("sub-prime") mortgage than risk the losses from a default.
Now that the issuers no longer care should the mortgage default (no skin off their nose) Congress proposes to outlaw the granting of mortgages that the borrower might have trouble repaying. Boy what a lawyer's delight. Prosecutors and defense lawyers can have a field day (and collect handsome fees) arguing about the soundness of this or that mortgage deal.
Better would be to outlaw the sale of mortgages. Make sure the man granting the mortgage has a real stake in the soundness of the mortgage, i.e. his bank gets hurt when the mortgage defaults. Presto, end of problem, the banks go back the the lending standards they used before the "mortgage backed security" was invented.

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