The Triangle

Issue date: 10/31/08 Section: Ed-Op

It's hard to say - there's no research on the subject that I know of - how many home buyers fit this model of the rational investor. I know my son didn't; he just wanted a home to raise his family in. When even this market was exhausted, however, the banks hit on sub-prime lending; that is, lending to unqualified borrowers the banks knew would shortly default. At this point, the game shifted from hypothetically rational calculators (banks and buyers betting against each other) to something worse than loan-sharking. There wasn't a name for it before, but we have one now: predatory lending. Sub-prime buyers were seldom if ever sophisticated enough to try to game the system, and in any case they lacked the resources to do so: banks could force foreclosures just by ratcheting up the ARMs.

Few banks, however, bothered to play the game out to the end. They bundled dubious mortgages with other forms of debt into so-called collateralized instruments that could be sold as financial commodities. Homeowners on long-term, fixed-rate mortgages such as myself would notice every so often that the bank that owned their mortgage would change. Vaguely, such homeowners were aware that what had once been a face-to-face relationship between a lender who knew in detail one's income status and general financial condition and a borrower who made monthly payments to that lender for a prescribed term had been replaced by something different. One's debt, owed by a particular person to a particular institution, had become a commodity, to be sold or resold without reference to the underlying creditworthiness of the original loan. There was, indeed, no way of unpacking a collateralized instrument to see how much bad debt it contained. And when ARM and sub-prime mortgages stuffed the sausage with tainted meat, the world economy was bound to get very, very sick. The question of the moment is whether it will recover, and at what - or I should say, whose - cost.

Watching Greenspan's recent appearance before Henry Waxman's House Banking Committee was like watching the high priest, discovered at last to be a heretic, recanting before the high tribunal. But the fact is that Congress shares the blame for the current fiasco, as do legislators and regulators abroad. Everyone was happy to foster the illusion that the real estate bubble could go on indefinitely, and the giant Ponzi scheme built on it.

Continued...

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