Reply #37: Prosecutions not bailouts

[notesdev]

The core problem with the mortgage industry was a pattern of fraud that started with borrowers and included everyone up the chain, including the loan originators, banks, MBS securitizers and the Federal Reserve.

Many borrowers simply lied flat-out. That's why Alt-A loans are typically referred to as "liar loans".

Many loan originators also lied. They put in the numbers into the system that they knew would be approved, regardless of whether they were true or not. The originators got paid based on loans granted and paid no penalty for bad loans, even if they immediately went belly-up.

The banks who originated the loans also bear responsibility. They approved of a practice of issuing loans to people who were very unlikely to be able to meet the terms. In particular, most people had no business getting adjustable rate loans - and the banks knew well that after these loans adjusted, a good many borrowers would be forced into default, then foreclosure. Even worse was the practice of selling option-ARMS (a speculator's tool) to Joe Average, knowing full well that the buyer had no idea what he was getting into. You need a good deal more economic education than your typical homebuyer to understand those products. And the worst of all was the interest-only loan. If any of those actually get paid off, I will be quite surprised.

Then come the MBS manufacturers. They packaged these garbage loans into securities and camoflauged the credit risk by applying their own credit ratings to them. These were then sold to unwitting investors who believed the risk levels presented to them, which were wildly different from the risk levels of the underlying loans.

Finally, the Fed and the policymakers who enabled all this, by requiring banks to make loans to bad risks, and keeping interest rates artificially low to pump up the valuation bubble.