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Wednesday, December 05, 2007

A Bailout Won't Work

I keep listening to the news, reading the papers, and checking out the lasted plans being hatched to fix the sub prime mortgage problem. The problem with all of them is they are temporary fixes, and in all likelihood will end up being tossed in a few years.

Here's the problem, when the fixes are put into place, we will end up back where we were ten years ago, when people with questionable credit and income couldn't buy houses. Many of them are minorites, and suddenly we'll be having hearings (again) about why they can't get houses.

Congress, directly, and the Fed, indirectly, created the current mess. Congress passed laws that basically mandated that banks and mortgage lenders work out ways to get more minorities into homes. Even before the housing boom of the 2002-2006 that worked. Those with so-so credit, but an ability to pay (at a higher rate due to the credit score) were able to get into houses. Many of them were able to refinance with "A grade" loans after a few years of good payment history.

However, when the Fed dropped interest rates to historic lows to keep a full blown recession from occurring after the 2000 stock market meltdown and 9/11, it created a huge influx of new home buyers. Folks with lower credit scores could suddenly qualify for "sub prime" loans because the rates on them were 7-9%. (By comparison in 1998 those were the best rates for an A grade loan).

Lenders, following Congress's mandates, really didn't have a choice but loan money to folks. Then of course, we all got greedy, and wanted a McMansion. Lenders found creative ways to work that, too. By getting an ARM at 1% below prime for 2 years, and then Prime +2% after that, with questionable credit, and less than stellar income, just about anyone could afford twice as much house as they needed.

Today, though, those ARMS are going from the 3-4% (maybe 5-7% for sub prime borrowers) to their natural rate, 10.5% rate, and even folks with decent credit and income, who didn't refinance out of the ARM, are facing the crunch.

There are a number of proposals to "fix" the subprime problem other than the natural way, home forclosures. Some want to freeze rates on all loans, others suggest limiting how far up they can adjust. Some want the government to guarantee the loans, and not forclose when they have to make the home owners payments.

The problem with all of them is they are going to make those who didn't make a poor choice about a loan to pay for those who did. In fact, just the scare of it already is, as lenders are once again tightening rules on refinancing and purchasing homes.

The worst of the ideas is the government guaranteeing loans that never should have been written in the first place. If you thought the S&L bailout of the 80's was expensive, you haven't seen anything yet.

It would be in most lenders interest to try and find ways to refinance the sub prime loans they've got out there, before Congress "fixes" the problem, again.

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