Responsible Homeowners - Don't You Just Want to Slap 'Em?

I suppose it was inevitable. It's silly season, and a "housing" (mortgage bailout) plan is speeding it's way through the senate, moral hazard be damned. Knowledge@Wharton (University of Pennsylvania) explains some aspects of the foreclosure problem in detail in 'Subprime Crisis: Could New Rules Avert Another Credit Crisis? Perhaps, but Be Wary'. From a section of this article entitled "Lending Standards Matter":

Fannie, Freddie and the FHA have long operated under federal underwriting standards that minimized risk by making sure borrowers could afford to make monthly payments, and by requiring down payments of as much as 20%. Homeowners who have money tied up in their homes are less likely to default, or stop making payments, if they get into financial trouble. And the down payment assures the homeowner -- or the lender in a foreclosure -- can sell the home for enough to pay off the loan.

But the new lenders did not have legally mandated underwriting standards and they entered a race to offer ever more attractive terms to borrowers. "You compete for market share by competing with your fellow lenders, by undercutting them," Wachter says. "And you can undercut them on [interest] rates; you can undercut them on standards."

Lenders offered subprime loans to people who could not qualify for ordinary prime loans because of poor credit or inadequate income. To help them qualify, lenders offered low teaser rates -- sometimes only 3 or 4% -- to produce a low monthly payment.

Okay, okay, we all know this, and we all know what happened next. But why make loans to people (including lots and lots of flippers) that are likely to stiff you? Well, you see, they had a computer model. Who wouldn't trust a computer model? (Computer models are always right - just ask the global warming guys.) Only this computer model didn't work out so well:

The computer models that were supposed to gauge risk and help reduce it also failed, Herring says. "There simply wasn't enough data over enough cycles to predict" how new types of securities would behave.

The computer models also had assumed that diversification -- collecting many mortgages in a pool -- would offset many of the default risks, just as owning a broad basket of stocks minimizes the damage when a few tumble. But the models had not taken into account the eroding underwriting standards, he says. There were just too many subprime borrowers in the pool.

Well, well. The old garbage-in, garbage-out problem strikes again, as does stupidity. And who pays the bill for stupidity? You already know the answer:

Jeffrey H. Birnbaum, Washington Post: Credit Suisse, a large investment bank heavily invested in mortgage-backed securities, proposed allowing hundreds of thousands of homeowners to refinance their mortgages with lower-cost government-insured loans, relieving financial institutions of the troubled debt.

After the bank proposed this to Congress in January, it became known as the "Credit Suisse plan" among congressional staffers and lobbyists. It later formed the basis of housing provisions in both the House and Senate. . .

. . .Since the new loans would be guaranteed by the Federal Housing Administration (FHA), taxpayers would ultimately pay for defaults. The Congressional Budget Office projected that this could cost $1.7 billon over five years.

So, responsible, tax paying homeowner, there you have it. You pay your bills on time, live within your means, do your best to make smart decisions. But senate approval numbers are down, and it's silly season. So, once again, you are the de facto provider of Stupid Insurance.