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Monday, August 4, 2008

Dodd/Frank: History Repeating Itself

I have written much about the Dodd/Frank Bill. I have pointed out its corruption. I pointed out its corrosive effect on the economy. Now, I would like to look at what, conceptually, makes this bill so flawed. Now, everyone agrees that the mortgage crisis was caused because underwriting standards were loosened far too much. This bill does the same thing on a smaller scale. What this bill asks FHA to do is loosen their standards in order to include borrowers that would never qualify on their own.

Here is how it would work. The borrowers that would qualify would be those that are currently in adjustable rate mortgages. The borrowers that would qualify are those that were on time when their mortgages were their initial rates but fell behind after their mortgages adjusted. The logic behind this is that most of these folks didn't realize what they got themselves into, and they will be on time as soon as they are put into a fixed and manageable rate. The problem is multi layered. First, the folks that are behind are not monolithic. There are many reasons why these folks fell behind and being duped is only one of them. In my opinion (from six plus years in the business) most of these folks couldn't qualify for the property they wanted with a fixed rate and they bet on the variable rate.

Ultimately though, the reason is not necessarily all that relevant. FHA looks at mortgage history for a reason. There is a reason why FHA so frowns upon mortgage lates. Prior mortgage history is an excellent indicator of future mortgage repayment. FHA frowns upon prior mortgage lates because those with prior mortgage lates are significantly more likely to be late on their mortgage in the future. By ignoring mortgage lates, en masse, FHA is accepting borrowers with a significantly higher chance of being late in the future than the borrowers they normally approve.

In fact, this is what sub prime was meant for. It was sub prime that was meant for those with prior mortgage lates. In fact, the system is supposed to work with a certain amount of logic. If you fall behind on your bills, you are punished with higher rates on your loans in the future. Someone that became late on their mortgage then would go into sub prime. They would pay their sub prime loan on time for a number of years and they hopefully they would again qualify for a prime or FHA loan. This bill is working in the exact opposite direction. Most of these folks are now in sub prime loans for whatever reason. They have fallen behind on their loans, and now, they are being rewarded with brand new loans that are better than the ones they are currently in.

What Dodd/Frank does is bet trillions of tax payer dollars on borrowers that have already proven to be irresponsible. This bill purports to hypothesize that they have learned their lesson and now will be responsible. The reason irresponsible people become responsibe is that their irresponsibility is punished. Someone falls behind on their bills and they pay for it with higher rates. Then they manage those higher rates for several years and then hopefully qualify for better rates again. These borrowers are having their irresponsible behavior with a better loan. What lesson have they learned? In other words, irresponsible borrowers are rewarded. Furthermore, these borrowers are getting loans they aren't supposed to qualify for in the first place. Like I said, this is a recipe for disaster.

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