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EYE ON THE PIE: Subprime mortgages meet subprime plans

February 4, 2008

I'm a clipper. I clip articles from newspapers, newsletters, magazines and Web sites. For example, back on March 12, 2007, I clipped an article in which the U.S. Treasury's undersecretary for domestic finance said, "We monitor the markets all the time, and are hopefully pretty aware of market conditions. It seems to us that the situation [in the subprime mortgage market] is a manageable one, that we're watching."

That was a relief. Treasury is watching and they believe "the situation is a manageable one." Thus if, by watching, they come to believe the situation is a problem, they will take steps to manage it. Whew! A load off my mind. These "subprime" loans to people who ordinarily might not be able to afford house payments were becoming a worry.

The same clip said, "Federal bank regulators, concerned about a spike in delinquencies and defaults on subprime home mortgages ... called on lenders to exercise caution in making the loans and to strictly evaluate borrowers' ability to repay them."

Wow! Regulators calling on lenders to exercise caution means a lot of high-powered people are close to closing the barn door.

Now that the problem was resolved, I was amazed to find a clip from Dec. 7, 2007, (nine months later) that the "manageable situation" had given birth to a financial crisis. President Bush and Treasury Secretary Henry Paulson announced a plan to "freeze interest rates for five years for those subprime borrowers most at risk of defaulting on their mortgages."

With characteristic boldness, Paulson said, "The approach announced today is not a silver bullet. We face a difficult problem for which there is no perfect solution." Hmm. The Lone Ranger would have used a silver bullet.

Now let's understand what this means. Anyone who has already gone through foreclosure is not going to get any help. But if your loan is up for a new, higher interest rate, you may be eligible to have your rate frozen at its current level.

This program aids those in danger of future default because they have an adjustable rate mortgage where they were tempted by a low-interest rate loan, only to find out later that a higher rate is now applicable. It also helps the banks and big investors who own such loans. But it does nothing for subprime borrowers without ARMs who might go into default because of medical bills, unemployment or any other factors that destroy their ability to pay monthly bills.

Since the current owners of subprime loans didn't know which of their borrowers might not be able to pay at some time in the future, they took dramatic action. They assumed all subprime loans were worthless and wrote them off their books. Yes, throw out the whole barrel, if you think some of the apples are spoiled.

The difference between apples and mortgages, however, is that most of the mortgages will turn out to be good and the lenders will get their money at some future date. Writing off such loans as losses today is a dramatic gesture that can lead to future "unexpected" profits.

More recent clips reveal that subprime loans have led to the collapse of the housing market and a recession looms ahead. To forestall that, Democrats and Republicans joined hands with President Bush in a typical political polka. They are going to send money to taxpayers; the checks should arrive in time for the November elections.

What we need instead is a program that helps people avoid foreclosure, that punishes lenders who engaged in shady practices, and that puts worldwide financial institutions on notice to pay attention to what they actually own. We do not need checks sent to you and me so we can buy fancier Halloween costumes. But what would you expect from a Congress and an administration made up of ghouls and children in fancy dress?



Marcus taught economics for more than 30 years at Indiana University and is the former director of IU's Business Research Center. His column appears weekly. He can be reached at mmarcus@ibj.com.
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