"underwater" mortgages

[richlevy]

ARMs were always a most risky thing. Long ago, banks held the mortgages. Therefore bankers shared in the risk and would not make deals that were risky and so stupid. With new financial games (ie mortgage backed securities and CDOs), bankers no longer held risk. They could lie and be believed because once banks were responsible. Once banks did calculate risk and determine who could qualify for loans. No longer. Bankers no longer determined what was and was not a risky loan. He would simply sell that loan to others. And reap rewards by no longer doing what was his job.

I have to agree with TW on the principal of his statement if not on the actual objection to ARMS. This whole mess that we have gotten ourselves into is because of hyper-capitalism. If I collect a bet from you for a horse, our relationship is not investor and broker, it is gambler and bookie. We are not investing in the horse and directly supplying it's owner with capital. While securitization, hedges, and other methods were useful in spreading risk, they were never intended to be primary investments. In the insurance industry, there is also a concept called reinsurance, where an insurance company sells some of their risk in, say oceanfront Maryland properties and takes on earthquake risk in California. This is so that a single catastrophe could not bring down a company. Hedges and the securitization of mortgages were similar in that they allowed spreading risk or betting 'for' risk. Southwest Airlines famously did this by buying fuel hedges. When the price went up, the profits from the hedges offset rising fuel costs.

Banks, however, took it too far. They oversold, securitized, and re-securitized to the point where no bank kept any appreciable risk from any mortgage. This removed their incentive to apply due diligence. Loan officers and brokers, who have a legal obligation to borrowers and lenders, were either untrained or committed actual fraud when dealing with borrowers. Yes, if borrowers lied and knew they were lying, then they were accomplices. But in these dealings the people brokering the loans were the experts.

ARM's serve a legitimate purpose. Interest-only mortgages, however, and some of the more exotic offshoots, are more like rent than mortgages. I can't believe the IRS allows mortgage deductions for them.

Broker: How much did you make last year?
Borrower: Well, I got paid $45,000, but my aunt died and left me $15,000.
Broker: I see. Income $60,000.
Borrower: But I only got the last $15,000 because my aunt died. What am I going to do next year?
Broker: You have other relatives, don't you?