It's overwhelming see the government is planning on handing out scads of money to bail out commercial investors. Mind you, it strikes me that it's going to be necessary that we do something if we want to have the economy in good working order. On the other hand, I don't want to see us put a package together the rewards the greed and idiocy that got us here the first place.
As I understand the proposal, the federal government is proposing to get involved in the purchase and sale of mortgage-backed securities. That's not such a simple thing -- when they are turned in to bonds, the Wall Street bond brokers took your standard mortgage and split it up into a whole lot of pieces. Say, for instance, that you had of 30 year fixed rate mortgage. One of the ways it could be split up would be to split the interest from the principal. But that's a really simple split compared to the current options. By the late 1980s, the bond market consisted of mortgages that have been split into a principal portion, the first five to 10 years worth of interest, second five to 10 years of interest, and so forth until all of the interest stream had been sold. Because the mortgage can be paid back early, the farthest out interest streams had the greatest quantity of risk in them. As a result, they were sold at a discount in order to increase the rate of return.
As far as I'm concerned many of the people buying these investment assets really didn't understand what it was they were buying. They made the assumption that because it was underwritten with real property that there was relatively low risk. Unfortunately they didn't take into account the rapid rise in home prices over the last couple decades. While real estate may be a very solid asset, there's only so much the value of an asset can increase relative to the average income. After all, at certain point, you reach a point where there aren't any people in the market who have a sufficient income to buy the property.
And that's how we end up where we currently are. Make no mistake; mortgage brokers, the banks that put together these bonds, and the banks that sold these bonds were all making a substantial profit just by creating them. They didn't have any incentive to make sure that the quality was sufficient for long-term viability because they were getting paid to the short-term process.
Give you an example: I bought a house two years ago. I was a new homebuyer and I had a small down payment. I had done my research and knew that I qualified for an Investment Finance Authority Loan. These are loans which are backed by the FHA but which also have state level support I don't know how many states have them but I believe that several do. In my state they offer two different alternatives: a) no money down or b) 3% down with a reduced rate of interest. Both of these are 30 year fixed mortgages. I had to do a substantial amount of fighting in order to get that 3% down mortgage. The mortgage broker really wanted me to go with two mortgages. The first would have been a 30 year fixed rate at 500 basis points less than the rate of the mortgage through the IFA. The second one, however, would have been an open ended, variable rate loan for the 30% that was not eligible for FHA financing. The terms on that loan seemed really generous on the surface: 1% less than the IFA loan, and repayment other than interest was not due until after the 30 year mortgage is paid off. Now, like I said it seems on the surface that this is very generous. But if you read through the fine print, you will notice that it was a variable rate mortgage. And this is a sort of instrument which is gotten us where we are today. Everything would've been well and good if I taken that, at least until the interest rates went up. The jump would've been to something close to 16% and I doubt I could've paid the resulting mortgage payments, which would've led to me being part of this current disaster.
So now the federal government wants to bail out all those people who profited from making those inadvisable mortgage loans. I don't have a problem with us doing something about a problem of illiquidity in the system. But I think that we need to go about it in a different way. It would make a lot more sense if instead of bailing out Wall Street, we bailed out the people who couldn't make their mortgage payments. Let's spend that money on creating low-cost loans that allow people to refinance and requiring Wall Street takes a hit for the difference between what they can realistically pay for every month and what the mortgage brokers talk them into signing on for. That infuses cash into the system, but makes the losses go to those who bet on the future value of all those mortgage payments.
I'll do my rant about how we administer this In a different post.
