UPDATE: read this, these are the people getting rich while people lose their homes:
The consumer has to be an idiot to take on those loans,” he said. “But it has been one of our best-performing investments.”
Right now there is a lot of talk going around that the government should somehow bailout people in sub-prime mortgages who are losing their homes. First off, I am against people losing their homes in a situation where they we basically scammed into a loan they could not afford. And no one should be punished with homelessness for what was basically a scam rich people came up with to make more money from middle and lower class people (mortgage-backed securities). But there are better ways to prevent homelessness than this.
I am not a finance guru, but here is how mortgages work, or rather worked (oversimplified). The old way was this: a lender has a lot of money. In the case of a bank this is actually the money deposited by the banks customers. The theory of any loan is that a bank loans money as an investment, because the interest rate guaranties that they the money they invest (the loan) will earn a certain return. The risk is reduced because the bank has the house in case the home buyer cannot pay their mortgage. Still, banks traditionally manage this risk, because it is not certain that house will retain the value to cover the loan. In addition foreclosure usually means that a bank will lose a lot of the potential profit of the loan in lost interest payments. This is way traditionally getting a mortgage was not simple. You needed to prove you could pay the payments now and in the future, you needed good credit and a large down payment, all to reduce the risk a bank takes.
The new way is different. A lender (sometimes a bank) sells a mortgage to a home buyer. They then immediately sell the loan to someone else for a profit. The buyer of the loan then packaged it with many other loans and sold it as a security, like a bond. The risk was then bought by a variety of large investors, mostly hedge funds because they securities were considered high risk. The first tier lender and the bank took no risk because they sold the risk off. As you can see, for lenders it was very hard to see any mortgage as too risky, because the next sucker in the chain would buy it anyway. As a result very aggressive sales took place, because the goal of the lender wasn’t to make sure they would not lose their money, but to make sure that they sold a mortgage. So they started selling them with no down payment, very poor credit and with outrageous terms to get the monthly payments low enough to convince the buyer they could afford a house way out of their range.
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