Friday, April 27, 2007

Foreclosures: How the middle class suffers

Isn't it great how one hand of the government can cause a problem, while the other hand is left to clean it up? It's not your representative who ends up footing the bill; it's you, the taxpayer.

Subprime loans are hot in the media right now. A little too hot, but our mainstream media turning a small issue into a hysterical frenzy should be old news by now. Foreclosures in subprime loans have risen almost 50% from last year (source: and while that may make the casual reader frantic let me remind you we are talking about a very small percentage of the total homes out there. Remember a 50% increase to 1% is still only 1.5%. But that doesn't make for a headliner.

Still, we regular consumers have to keep an eye on these subprime loans, primarily because the mortgage companies who issued them are crying foul to the government and asking for a bailout. Whenever an "essential service industry" asks the government for a bailout, you'd better be paying attention...because they're very likely to get it.

Guess who will be paying for that? Yep: you and me.

The problem began when mortgage companies were encouraged by uncle Sam to start writing these loans. A disproportionate number of minorities and low-income families were being effectively driven out of the market because they couldn't qualify for traditional loans. What's the solution? Apparently it was to lower the requirements for getting a loan. Enter the subprime loan, a whole host of new mortgage types that came with huge fees, teaser rates, no deposits and quite often no verification of income.

It was all well and good. Home ownership increased, particularly in the low-income and minority sectors...the problem that I see is that these mortgage companies were so interested in getting people into their homes that they forgot their main goal is to keep them there. Banks earn money by drawing interest for long periods of time. They don't make much by making several thousand dollars and eating the rest of the principle when the house goes into default 2 years later.

What also happened is that consumers who had already fallen for the credit card trap were driven into these loans, sometimes from their stable traditional mortgages to consolidate high interest debt. Money Magazine reported that the largest chunk of these subprime loans (around 30% as I recall) were refinances. Home owners saw their houses skyrocket in value, saw rock bottom interest rate mortgages thrown at their feet, and the dollar signs lit up in their eyes.

Now it's a given that if the government bails out these loans the cost is going to land on the home owners who aren't in this situation. CNN reports the costs will be $120 billion. And if they don't? Interest rates will rise, foreclosures will create a huge surplus of cheap homes and drive down values around them (as if we need more cheap homes saturating the market - thanks KB).

Do I have a solution? Of course not, I'm no economist. Should the government bail out these mortgage companies? I don't know. But what I do hope is that this will be a lesson for the future. Regardless of how good your politically-correct policies may look on paper, it doesn't make sense to give loans to people without any hope to make the payments, let alone pay it off. If our national credit card debt is any indication, consumers just aren't capable of making smart financial decisions with complex loan models. The bottom line: artificially improving the American dream, owning a home, doesn't do anyone any good if it turns into the nightmare we have now.

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