Corporate Madness

One factor that seems to be going overlooked during the current sub-prime mortgage crisis is how badly many of the banks and mortgage companies are behaving in their own right. I’m not referring here to predatory lenders or crooked financial advisors; many of these companies extended high-interest and/or adjustable-rate loans in relatively good faith; some of them have even made a point of explaining the terms of the loan and the consequences of not living up to the requirements of the agreement. But the fact is that many of the home buyers currently facing foreclosure have been sabotaged by unrealistic rates and loans that “adjusted” upwards at a bad moment, and even the companies that have been dealing straight with their customers have generally not done much to prevent this. Unfortunately, those birds are now coming home to roost…

There’s nothing very special about a sub-prime mortgage. Some buyers are not able to qualify for the standard loan terms when buying a house, either because their credit isn’t good enough or because they can’t demonstrate that their income is high enough to guarantee that they will be able to make the payments. Rather than lose their business altogether, some lenders will offer these customers a loan at a higher rate, figuring that the increased profits to be made on the higher loan rate will compensate for the fact that more of these customers will end up defaulting on the loan…

An adjustable rate mortgage (ARM) is a loan that does not have a set (or “fixed”) rate determined at the onset. Thus, if the prime rate rises (or other factors change) the lender can “adjust” the rate of interest on the loan, and increase their profits. Loans of this type tend to start out with lower interest rates, and some people will take them in the hopes of selling the property again before the rate goes up. Unfortunately, this will only work if the real estate market continues to rise, and the prime rate doesn’t…

In the current crisis an unprecedented number of buyers have been defaulting on their loans, and an unprecedented number of houses have been foreclosed on. This is causing problems for the lenders, since as the market continues to cool, many of these houses are not selling for enough to cover the outstanding loans, and an increasing number are not selling at all. Even worse, a mortgage that gets paid off will bring in between two and three times the face value of the loan (depending on the rate and terms) over the course of 30 years, to take the obvious example. If the lender forecloses, the best they can hope for is 100% of the sale price, and if the loan was for more than the purchase price (the infamous 105% and 110% loans) there is no way to even recoup the loan through a sale.

Now, in fairness, a lot of the people being caught up in the Sub-Prime crisis are small-scale speculators; people hoping to make money on the “Bigger Idiot” principle who figured they’d just default on their loans and walk away if things didn’t work out. But a lot of those victims are ordinary people who saw the chance to buy a house they normally would never have been able to qualify for. And while it’s true that the financial institutions have a responsibility to foreclose on deadbeats, it’s also true that if they would make the effort to work with some of these marginal customers, they might be able to recoup more of their losses and keep more people from being turned out of their homes – a clear win-win situation.

Of course, this would require quite a lot of additional work on the part of the lenders. They would have to devote significant resources to working with their customers, raising loan payments only in those cases where the customer can afford the increase, and restructuring loans where necessary to prevent foreclosures. It might almost be easier to just make better loans and build better relationships with their customers in the first place…