Thoughts on the Subprime Mortgage Bailout

“If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.” – J. Paul Getty

Unless you’ve been living under a rock, you’ve no doubt heard that the White House has plans for a subprime bailout. In order to stem the tide of foreclosures, the Bush administration has unveiled plans to freeze the ultra-low teaser rates that were dangled in front of borrowers that shouldn’t have been lent money in the first place.

The simple fact here is that people who couldn’t afford to buy houses bought houses, and lenders that shouldn’t have loaned them the money to do so did just that. Now that these rates are resetting, many borrowers can’t afford the payments, and lenders are facing staggering losses.

Obviously, this is bad for everyone involved. The White House’s proposed solution is to freeze these teaser rates for five years for borrowers that fit certain criteria. But will this really help? As far as I can tell, a temporary rate freeze of this sort will just drag out the inevitable. Given that the affected individuals didn’t have good credit in the first place, and that credit standards have tightened up, they won’t be able to refinance to a more competitive rate in the interim, and this entire mess will just play out in slow motion.

To me, this is a bit like removing Band-Aid. We can either peel it off slowly and prolong the pain, or we can give it a good rip and get the pain and suffering over with. Yes, I realize that sounds insensitive, but… Things have gotten way out of hand, and the people who got us into this mess (on both sides) are in for some rocky times one way or another.

The other thing that really, really bugs me about this “solution” is that it smacks of an administration trying to push the worst of these problems off onto someone else. These loans will ultimately reset, but… That’ll be someone else’s problem at some point down the road. I pity whoever winds up being our next President, as this whole mess is likely to unravel in their lap right as they’re going up for re-election.

So what do you think? Am I being naive in thinking that we should just suck it up and weather the storm right here and right now? Will spreading this debacle out over time help to minimize the damage to our economy? Or will it just prolong the pain?

38 Responses to “Thoughts on the Subprime Mortgage Bailout”

  1. Anonymous

    Well, i posted way up above as a dissenting voice to what appears to be the consensus view here, and I think this string of posts may be dead, but I still think it makes sense to issue a quick correction. There is no invalidation of any contracts, nor is there really any manipulation of the market in any non-voluntary ways. To represent the “bail-out” plan (and it isn’t really a bail-out) as such is, I think, a misunderstanding of what is happening. I would characterize what is happening/has happened as the government helping banks coordinate a standard for when it would make sense for them to renegotiate terms of a loan (something they are well within their rights to take up with consumers) and when it probably wouldn’t make sense. This is advantageous to banks for two reasons. First, they can save a lot of overhead by having a general guideline to follow, speeding up processing. Second, they can relax some concerns about competitive consequences of when to renegotiate and when to not do so, which should help grease the wheels on the process. Since neither of these costs are constructive to the process that banks fulfill in the market, I think casting this as “avoiding the costs of risk/failure/bad decision making” is incorrect. Keep in mind that the bank doesn’t want to own your house – it wants you to pay back the mortgage.

    The larger point, also, is that if consequence of bad lending becomes so drastic that good lending (lending that is healthy and necessary for the economy to function) is undercut, then it is appropriate for a governmental body to set up some solution where the good lending is supported again. If the cost of that is to soften the blow of the bad lending (and you have to be careful there – i fully agree that it has to hurt or it will be repeated), that may be the best of all possible actions (including inaction), even if it isn’t exclusively relying on the invisible hand.

    I think coordinating the banking response to calm the market and get normal, healthy lending practices back up and running in the global credit markets is well worth the costs of freezing 10% of the distressed loans interest rates – especially when it is the issuing banks and not the government making that call.

  2. Anonymous

    The administration has made a suggestion which is a nice way of saying we are not officially going to do anything. The people who are truly helped out by this is the corporations who need to hide the fact that their stockholders are not going to get the returns they were promised when the borrowers start defaulting. We were young when we bought our house 5 years ago and thought that interest rates couldn’t sink much further. While we were offered other deals we made sure to lock in below 6%. Anyone who seriously signed the contract without noticing that fact probably has a lot of other problems besides not being able to pay their mortgage.

  3. Anonymous

    “But many people on these kinds of forums don’t seem to realize that the average American (who makes less than $45k a year) 1) cannot afford a house and therefore 2) will do all sorts of gambles if that possibility became a reality”
    A house isn’t a necessity. I live in Westchester county, NY where an average house is worth over 600K. So, even high paid professionals would be hard-pressed to afford it. But, guess what. There are condos that cost less. There is no reason a family of four cannot fit in a two-bedroom townhouse-style condo. My neighbors fit into this category. I even see families living in much cheaper co-ops. Additionally, when you live in a period when it is cheaper to rent than to buy, there is a high probability of prices coming down. Hence, there is nothing wrong in renting, saving and waiting. The 90s showed to all of us that real estate prices don’t always go up.

    Having said that… While I don’t have much sympathy for those who buy more than they can afford or the banks who give these mortgages, I don’t want my 401K and my stocks to go down in price. I don’t want my home value to drop even if I own it outright and don’t plan to move. I also don’t want the technology company I work for to suffer because banks don’t have money for new technology. When my company suffers, I don’t get raises; there may even be layoffs. I am not sure if this bailout will help, but if there is a chance I don’t have a problem with it.

  4. Anonymous

    RE: “You may be a financial guru, but most people in American are not. Their primary fault is being gullible.” — Therefore, let’s use the government to shift some of the expense of those poor choices to those who acted more responsibly? Is THAT what really how you want to use the power of the State — to backstop those who gamble and lose? How about the flip side — that we all get to share in the gains when you win? Break it down friend; you don’t have to be a “guru” to read before you sign mortgage documents, and if you don’t understand it, spend $100 to pay a financial advisor to spell it out to you, OK? And quit trying to prey on our collective sympathies for our otherwise heroic members of our armed forces; we honor and greatly appreciate our heroes overseas, but we demean them by treating them like children and absolving them of basic responsibility for the basic financial choices that they make in a free marketplace. Nanny gov’t is not the cure here, individual responsibility is. THAT is what made America the greatest country in the history of mankind.

  5. Anonymous

    You’ve got a good point about gambling and losing. But many people on these kinds of forums don’t seem to realize that the average American (who makes less than $45k a year) 1) cannot afford a house and therefore 2) will do all sorts of gambles if that possibility became a reality. Owning a home is generally seen as a huge milestone in becoming independent and prosperous (whether it really is or not). Variable rate or not, it’s still very tempting.
    Yeah, they did make mistakes, but the financial institutions set THEMSELVES up for failure when they agreed to loan to these poor fools. First off, they are losing tons of money due to the foreclosures. Secondly, they are losing more money due to the fact that foreclosed (and in many cases bankrupt) families now have crap for credit so for many years, the banks will be short on customers.

    Unfortunately, we investors may be paying the price for it as well. I primarily invest overseas — but with so many European and Asian corporations investing in OUR real estate, the whole world is hurting from our greed.

  6. Anonymous

    NOBODY was “suckered” into a subprime loan with a low initial rate. These loans where sought by people who knew full well they either didn’t qualify or they weren’t going to have the money to pony up when the rates rose. They GAMBLED that either the rates wouldn’t rise or they could sell (At a profit) the house before they had to pay the increased rate. They lost their gamble. Tough sh&@. Go back to living in an apartment. This “crisis” smells like the Florida voters who where (once again according to Democrats)too stupid to vote for whom they intended. Now all these “homeowners” where too stupid to know the interest rate could go higher and thus increase their payment.

  7. Anonymous

    OK, I’m kind of tired of people bashing all the people who got suckered into these loans. You may be a financial guru, but most people in American are not. Their primary fault is being gullible. Don’t you remember, about 5-6 years ago, EVERYONE was suddenly an expert and told everyone else to buy houses. I was told by no less than 3 of my supervisors “You’re stupid for renting! You’re wasting your money!”

    Unfortunately, a lot of my fellow servicemembers were suckered in, too. “Military discount!” “0% Down!” etc. Anyone who knows what we get paid knows the majority of servicemembers cannot afford a house payment on their budget! Our Housing Allowance just isn’t high enough. But 5 years ago, the prices were low enough that it was….

    I agree with Andy’s comment. The economy doesn’t always fix itself — remember the Great Depression? It took some pretty hardcore socialist reforms to fix it. Granted, I think many of the reforms have had negative affects to this day, but that’s another forum. The Constitution charges the government with *regulating* the economy, and sometimes that means interference.

    I figure the 5 year plan may work out. It’ll teach the banks not to make such greedy offers because many people will still tank. And 5 years is a long time to advance in your career — Hell, I might even be in the market for a house by then!

  8. Scott: Just to clarify, the government isn’t proposing to use taxpayer money to help those in trouble. Rather, they’re proposing to temporarily freeze rates. The people who will directly pay the price are those holding the mortgages (banks as well as investors who’ve bought mortgage-backed securities). This is something of a double-edged sword…

    Those investors bought into these mortgages expecting high returns due to the high level of risk. Clamping down on the rates hurts these returns. Then again, doing so *might* help reduce defaults (at least in the short term), so it’s arguably reducing the risk.

    My main concern is that I think this situation should be allowed to resolve on its own. As I stated above, temporarily freezing rates is probably going to do little beyond prolonging the pain.

  9. Anonymous

    Nickel —

    BTW, I agree with you — I would have preferred for nothing to happen. I agree that people made poor decisions and they should be allowed to suffer the consequences. But what is happening is about as close to nothing as any elected official (the president and congress) could allow politically.

    And as far as finding ANY politician who doesn’t play games, good luck with that one. 😉

  10. Anonymous

    I agree with the post of “Let the market work it out”. The government should not involved in an effort to use taxpayers money (from you and me) to bail out individuals that should not have been allowed to obtain a loan in the first place. Why encourage this type of behavior? What would happen if the people that were careful with their finances and did not get into trouble were rewarded? Wouldn’t that encourage a responsibility? Is anyone listening?

  11. FMF: I’m perfectly aware of who and how many this plan will affect, but that still doesn’t make it a good idea. And I’m certainly not impressed by a president who want to play games of this sort to appear as if he’s doing something simply to improve his image. Yes, I realize that’s what pretty much any politician would do, but still…

    Honestly, the effect being “close to” what would happen without intervention just because some the president wants to make himself look good isn’t good enough in my book. A bunch of people made bad decisions (on both sides), and we should let the market deal with it.

  12. Anonymous

    I’m in favour of whatever will reduce the credit crunch. In the UK there is no sub-prime lending crisis, but banks are affected by the lack of credit. I’d prefer our economy not to punished by the actions of those in the US.

  13. Anonymous

    Well, it is annoying to those of us who had better sense than to buy bad mortgages. And no question of it, the Bush plan is a self-interested scheme that sets up some smoke & mirrors to make it look like the government & industry are addressing a problem brought about by self-interest and greed.

    The problem with doing nothing is that ALL of us will suffer, not just the morons who got into these mortgages and the crooks who sold them. I for one do not want to watch my retirement savings go down the toilet over the next five or ten years because of a wave of greed, stupidity, and corruption unloosed by an administration I did not vote for and a bunch of thieves who got away with everything they could.

    If rates are to be frozen for five years, then the affected loans have got to be made, by law, refinanceable and prepayable at no cost to the borrower. Many of the bad loans–maybe most of them–stipulate that the borrower may not refinance, and that prepayments trigger large extra costs.

    Delaying the inevitable rate increase for five years won’t do most of these folks any good, because they can’t get out from under the loans: they can’t refinance and they can’t pay them off. Nor are they (or any of us) likely to be able to sell their houses, many of which are now worth less than they buyers paid for them. In my area, for example, there’s two years of inventory on the market–and it’s growing every day. Five years is not long enough for the market to turn around. So, people have got to be able to refinance to 30- or 40-year fixed-rate instruments so they can stay in the houses until the market improves enough for them to sell without losing their (and, ultimately, our) shirt.

  14. Anonymous

    I totally agree with you. We should be pulling the band aid hard and making sure America learns a lesson. Otherwise it severely hinders US investments for foreigners because the government can at whatever time decide that people’s investments are worth nothing.

    This is not capitalism.

  15. Anonymous

    My take on the deal is closest to Andy’s. If you all would read the details of the actual “bailout”, you’ll see that what’s really covered in it is not the same as the one-line headline analysis seen in USA Today.

    As such, I think the president gets to appear as if he’s doing something (which helps his image) but he’s not really doing that much (which allows the market, for the most part, to handle the correction itself.) The effect, therefore, is fairly close to what most of the people here say they’d like to see happen.

  16. Anonymous

    This is just an insult to the honest, hard-working people that did not get in over their heads.

    The people that took on mortgages that they could not afford have to be accountable. If that means losing their house and becoming a renter for a few years, so be it.

    This is not “putting people on the street”. These people will have their credit ratings destroyed, but they can still go out and rent a place and get back on their feet.

    The government just needs to let this pain run it’s course so we can move on.

  17. Anonymous

    Double Journey,
    I caught a report that covered that same thing.
    The report mentioned that there was a Prop that passed on the ballot in California limiting insurance rate hikes. The Prop passed but was striken down in court because it violated the contract clause in the Constitution. The govenment has no standing in getting invloved as a third party when the other 2 parties have a signed contract.


  18. Anonymous

    It’s a tough one. On the one hand, I’m glad it’s not a pure bailout. For the last few years I’ve been a renter dreaming of owning a house, doing the “right thing”: avoiding other debt, saving, and educating myself about home ownership. So I’ll be really frustrated if it turns out that all the idiots who bought houses they couldn’t afford wind up getting a free ride, since that would effectively be punishing me for being responsible.

    Any time you bail people out from a crisis they could have prevented, there are silent victims: the people who made sacrifices to avoid falling into the same crisis themselves.

    On the other hand, this solution seems to just be putting the problem off until later, specifically when the next (likely Democratic) president is in office. It sure would be nice if I could push all my problems on to the next guy.

  19. Anonymous

    I wrote about the same topic last night. For those interested on my take you can read it here.

    To summarize, the biggest problem I see is the fact that the government seems not to care that they are going to void a legal and valid contract between two parties. This is what government is supposed to protect. Not only allowing, put proposing this solution creates moral hazard in the future and means everybody will pay more for loans.

  20. Anonymous

    Agree. Many of those losing their homes now were never really owners, just renters by any other name (i.e., they were not only financially unqualified, but getting 0% or 1%, 2% or 5% down mortgages, if not also borrowing via 2ndary mortgages on top of that, which means lenders owned the home in all but legal title). So what are these erstwhile homeowners “losing” by being forced out of their home and now having to resume formal renting of a home or condo or apartment elsewhere? They were renting all along. Meanwhile, history reveals that once the government takes the pain out of bad choices, bad choice-makers will feel free to keep making bad choices (e.g., signing lengthy, trap-door-laden documents they were too lazy to read, etc.). The Basic Human Operating System (seek pleasure, avoid pain) that drives all human conduct thus gets upended. What’s next? Bailing out those who run up too much credit card debt because the Mastercard “priceless” commercials were simply too alluring? Of course Bush wants to exploit the “Compassionate Conservative” playbook here, and thus do so at our considerable (and collective) expense. I’m guessing that of all of the presidential candidates, only the supposedly anti-nanny-government Ron Paul would publicly oppose this (has he?).

  21. Anonymous

    I think it definitely makes things easier for Bush to push them off to a future administration. He’s got enough on his plate, this would probably make him look even worse (even if he didn’t have anything to do with the subprime problem).

    The bandaid may work for some who got shocked enough to pull themselves together and do their best to be financially responsible and pay their mortgage. For the others, well they got a reprieve and had time—if things fall apart for them in 5 years, at least we can say they had a warning.

  22. Anonymous

    The idea that the government does not already influence, manipulate or alter the “market” is silly. We do not have a capitalistic economy. It is a hybrid with the governemnt’s tenticles all in it.

    The market can not “take care of it itself” because it is not independent.


  23. Anonymous

    This problem should be worked out in the market. Taking control from the market and shifting it to government is generally not a recipe for success. The bill for stupidity (on both sides) has to be paid some day!

  24. Anonymous

    I’m not sure I agree with your analysis. While I agree that it is important that banks that were relaxing their lending standards (read: all of them) need to be financially punished (through default) when those loans fail, there are two points that I think you gloss over.

    First, there is real benefit to prolonging the pain if the shock to the system by “giving the band-aid a good rip” would substantially harm the overall economy. There is a very real harm to banks when the loans fail – Bill’s comment about banks not holding paper that is internally originated is simply not true. For example, Wells Fargo was one of the most recent banks to write down billions in loans and they are known for keeping a high volume of their originated loans in house and being comparatively minimally exposed to the sub-prime markets. The truth of it is that if the shock is too great, that drys up credit for everyone, not just those with bad credit, and when credit-worthy individuals and businesses can’t get money, that tanks the whole economy. While things are starting to stabilize a bit, that was a very real fear even a month ago – and it remains a risk.

    The second thing to consider is that the proposals I’ve heard (and I’m not familiar with the white house plan in detail, but I know that it is based on the plan in California) do not give a blanket free pass to lenders. Rather, they tend to target those individuals who were not struggling with the teaser rate. This means that lots of loans will still fail and the value of those loans, in accounting terms, still often comes off the books as real default rates rather than overly optimistic projections are calculated in. That said, if you give people who were making payments a few years to look for other options, improve their financial position so they can make higher payments, let the real estate market stabilize so they can get out of their home without taking a staggering loss, or let the credit markets stabilize so they can refinance (all of which are reasonable propositions over a five year time horizon), that can make a meaningful difference.

    The one thing I do like about this is that it isn’t a bail-out – the banks still pay the price for making bad loans, but by making what amounts to a class-action settlement, it removes tons of overhead and (bad) competitive risks from renegotiating the loans – and that is a win-win.

  25. Anonymous

    I completely agree to get the pain over with now. A recession is a recession and playing political games and interfering with natural market forces correcting seems kind of contradictory. Commentators I’ve heard on the radio agree that the bailout plan doesn’t help enough people and it just pushes off the problem onto the next administration. Why delay the mess? I’d rather have a corrected market now than face a second volatile market again in the future. There will be enough of that for other reasons, you know?

  26. Thanks for all of your feedback guys. Glad to know that I’m not crazy (or at least that I’m not the only crazy one). Besides, I have about 30 years until I hit the traditional retirement age. If the stock market is going to tank, then the sooner it happens the better.

  27. Anonymous

    Another agreement here. Let the blood flow until it clots itself. The body has it’s own way of healing itself and economics has it’s own way of fixing itself, even if it may not be fun. Adam Smith can tell you all about it.

    I feel sorry for the people who got into bad deals, but it was their money, they need to pay more attention to what they are doing with it.

  28. Anonymous

    The whole point of this is to set up the next president, who will likely be a democrat, to be voted out after one term because “they screwed up the economy with this whole housing business”…

  29. Anonymous

    I agree – rip the bandaid quickly and lets start putting it behind us. I also agree that its not all the bank’s fault. Hard to feel sorry for a home buyer if they were shopping for something they couldn’t afford in the first place. I’m tired of people not being responsible for their own actions. The home buyer picked up the pen and signed the paperwork – all without a gun to their head. As an aside, aren’t republican administrations supposed to be for “less government”.

  30. Anonymous

    I think we should suck it up. Of course, I don’t have any pity on the subprime borrowers. They should have known what they were getting into. Maybe they could refinance through NACA.

  31. Anonymous

    But ultimately it’s not the lending institutions that are holding the balance right now, its bond investors. You’re probably holding some sub-prime loans bonds in your 401k right now.

    So if the government freezes the rate reset, you won’t make the return that you expected on those bonds. If the government doesn’t freeze the rate reset, you might not get any of your money back. Either way, you, as the investor, loses. Banks almost never lose. How many banks do you know that actually keep the mortgages that they sell in house. They sell those suckers off before the ink is even dry on the paperwork.

  32. Anonymous

    Exactly on the money. Let the greedy lending institutions that promoted this lost propisition go down and the people that wanted something for mothing go with them.

  33. Anonymous

    It is a tough situation. Yes you do not want to screw over all the people that got themselves into their mess. However, there should be some accountability on behalf of the consumers for getting themselves into their mess. But I guess on the other hand I try to relate to my own situation. I am not financial/mortgage expert by any stretch of imagination, but I am a wizard with all things ‘computer’ so hence I get asked by family and friends all the time about fixing their crap. So I shake my head and pretty much say the same thing ‘How and why did you click on that pop up because it said you would get 50 free iPods and you thought that was a good idea?!’

    Lets face it, people can be pretty dumb sometimes.

    Finally I leave us with this as I think its the most appropriate to this conversation and the Greatest American Problem.

  34. Anonymous

    I agree with you. Just rip the band aid off and get it over with. I think all this bailout crap is a slap in the face to people who pay their bills on time and did not buy more house that they could afford.

  35. Anonymous

    Have to agree with you on this one. The financial institutions were greedy and loaned to people that they knew could not afford the mortgage. What happened to the days of 28% and 35% ratios for house payment and house payment plus other debits?

    It is a very simple concept to buy what you can afford and save if you can’t to one day buy what you can afford.

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