Editorial: Bad Credit Mortgage Bailout is a Bad Idea

Dumb: Buying a house you can’t afford with no down payment and a loan whose monthly payments will explode in a few years.

Dumber: Lending money to people who can’t afford a traditional mortgage, especially when they have lousy credit ratings and don’t substantiate their income.

Dumbest: Bailing out dumb and dumber, especially with taxpayer money.

State and federal lawmakers, community groups and housing advocates are proposing schemes to prevent the victims of the subprime loan crisis from losing their homes. I hate to sound callous, but it’s hard for me to know who the victims are in this mess.

If mortgage brokers or lenders used inflated appraisals or made false or misleading statements, they should be prosecuted or at least forced to restructure the loans. If borrowers lied about their income or assets to get a bigger loan, they too should be prosecuted.

But many people got into the subprime mess because they were willing to believe a fast-talking broker who told them they could buy a home, or a bigger home, or take more cash out of their home than they could with a conventional home loan.

Keeping people in homes they had no business buying is wrong in many ways.

For starters, there’s no easy way to bail out homeowners without bailing out the lenders and investors who were largely responsible for the subprime mess. Many experts say we are in the early innings of the foreclosure cycle. If we bail out people today, will we be willing and able to help people who fail later in the game?

Propping up borrowers who took a gamble on a house and lost reinforces gambling.

“If people think they can take out a bad mortgage and they get bailed out, that’s called moral hazard in social insurance and it’s a very bad thing,” says Thomas Davidoff, an assistant professor in the Haas Real Estate Group at UC Berkeley.

Bailout advocates say they want to help people who were duped, not gamblers. But even if you could separate the swindled from the speculators, there’s no guarantee that people who get a bailout will keep their homes. It could be an expensive form of life support.

Nobody offered to bail out investors who bought tech stocks in 1999. Nobody bailed out Enron employees who lost their jobs and chunks of their 401(k) plans because the company was a fraud. Nobody offers to bail out credit card abusers.

But homes are different, advocates say. It’s shelter, not an investment. Hogwash. The government itself says owning a house is part shelter, part investment.

In calculating the housing portion of the Consumer Price Index, the Bureau of Labor Statistics uses rental costs for leased properties. For owner-occupied housing, it estimates how much homeowners would get if they rented out the house. If the monthly payment exceeds that amount, it is considered an investment, not a cost of living.

The growth in subprime loans made homeownership possible for many more people, including low-income and minority families. Bailout advocates say that door should not be slammed shut because people made mistakes.

The truth is, subprime borrowers could always get mortgage loans, but they had to pay higher rates and make a substantial down payment. If they ran into problems, and many did, the house could be sold and the loan repaid, protecting both lender and borrower.

In 2003, with mortgage rates at historic lows, investor demand for high-yielding subprime mortgages started heating up. To fill the pipeline, lenders started letting subprime borrowers buy or refinance with little or nothing down.

Of course, borrowing 100 percent of a home’s purchase price makes for steep monthly payments. To lure or qualify them, brokers offered rates that were low for a couple of months or years, then shot up to normal subprime rates.

They added other features that kept payments abnormally low in the early years, such as interest-only or flexible-payment options.

These ticking time bombs were bound to blow up when rates and payments were adjusted. If brokers disclosed this fact, they told their clients not to worry because they could sell the house and repay the loan, assuming the home’s value would go up.

If homeowners wanted to keep their homes, they could go through with mortgage refinancing. This also assumes the value of the house would go up or the borrower’s income or credit rating would vastly increase.

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