Subprime Mess - Who Are The Real Victims?

There is tons of news on the Subprime mess, and most of it is about how people are losing their homes as a result of "Sub-Prime" loans. This story is a huge lie. People are not losing their homes as a result of Sub-Prime loans. What happened is that banks made loans to people with no money down, poor credit, and no ability to pay back the loan. When the value of houses started to fall, the banks who made these huge mistakes were left to pay the price. And they are who should pay the price. It was their mistake in the first place.

So let me describe a sub-prime loan. They come in many flavors, but they are all pretty much adjustable mortgages in some form or another. Nearly all of them involve a teaser rate that fully adjusts to the normal rate in about two years. There are interest only, and payment option loans as well, but at their heart they are all about getting people into houses that they can't actually afford. With house prices getting pumped up by the continued easing of credit standards and more subprime loans, quite a bubble in home prices was created. As long as the bubble keeps expanding people can refinance out before the normal rate hits. But bubbles don't last forever.

So lets look at it from the perspective of a home buyer with poor credit and no money to put down. They see house prices flying up, and they want to take part. They find a house that is not affordable, but they find a loan where the interest rate and payment will be affordable for the first two years. They no damn well that they will have big issues making the payment in two years, but they are counting on the house going up in value so they can refi, take cash out, and I guess make payments with the cash they took out. This is not home ownership by any stretch of the imagination. This is making an investment, and when you invest your money, you can lose.

Now if interest rates were rising it would be a different story. If the fully indexed rate is 6% and you can afford to make those payments when you take out the loan, but interest rates rise to 8% by the time the payment adjusts up you can have unplanned issues. The problem is that interest rates are not rising. Is somebody took out a subprime loan exactly 2 years ago the federal funds rate was 4.75%. Today the rate is 2.25%. Two year old sub-prime loans adjusting today are adjusting to a rate that is 2.5% below what was planned. The fully indexed non-teaser payment is much less today than what would have been planned for when the loan was taken out. How this can lead to massive foreclosures is beyond me. Adjustable Rate mortgages get more affordable every time the fed lowers rates, and rates are dropping fast.

So what is the real story? The people losing their houses to foreclosure could not afford the fully indexed rate. They can't even afford a fully indexed rate that is 2.5% lower than expected. They were doomed to lose their house the second the agreed to buy it. Falling home prices have nothing to do with the problem. If you can afford your loan and plan on living in your home for a while, the underlying value of the home makes no difference. Your house losing value, can't cause you to lose it. Only not being able to afford the payments can cause you to lose your home.

Every horror story from a consumer perspective is based on the premise that they did not understand the loan, or did not know it would adjust up. It like they though you could buy a million dollar home on a $1000 a month payment. You simply can't. If you are not capable of understanding a loan for the biggest purchase of your life, you should not be buying a house. The idea of refinancing out of a high interest rate to a lower one is a pipe dream. Fixed rate loans are always higher than an adjustable one. You can't refi out of an adjustable loan into a lower payment fixed loan. You also can't refi into a lower adjustable rate loan from an existing adjustable, as both are based on the same short term interest rates.

So basically, I have no problems with consumers who can't pay for their homes losing them to foreclosure. Lets say you bought a 50" Plasma TV on a no interest/no payment loan for 12 months. The 12 months expire, and since you didn't pay it off, the interest rate jumps to 20% and you are forced to make payments. If you can't afford those payments, you can't really go back to the store, and demand they lower your payments, or greatly reduce the amount of money you owe on the TV because now you can't afford it. What happens in the real world is you have to give the TV back. You have no equity in it, and can't afford it.

So what about a company like Bear Stearns collapsing as a result of all this? This is simply capitalism at its finest. If you bet your company on something and lose, your company fails. The ones who are smarter than you were live on, and gain market share. The fittest and strongest survive. I will comment on why Bear Sterns failed though, as it is a symptom of a huge problem in corporate America. Too much of a companies profits are syphoned off to upper management and/or traders in the case of Bear Stearns. If you take huge risks to make money, you need to hold on to that money for when times are bad. If you pay out 1/2 of that money in bonuses the money is simply not there to cover a bad year. When these same guys screw up, they don't pay a negative bonus at the end of the year. So they are incentivized to take huge risks with the corp's cash, and are rewarded heavily when successful, and not punished at all when they fail. Its like gambling with the house's money! Until the pay and bonuses for top officers, can be reduced to something reasonable, I think this is just the beginning of more big name collapses. We are also losing our ability to compete globally due to upper management raiding the corporate balance sheets for bonus cash year after year.