America’s bank bailouts: They did not have to be so unfair | The Economist
The Federal Deposit Insurance Corporation (FDIC), which Ms Bair ran, did a study showing that the “teaser” rates were often slightly higher than the interest rates offered to other subprime borrowers with similar credit scores for thirty-year fixed-rate loans. In other words, many of the borrowers who got hybrid ARMs were eligible for better deals but did not receive them. Why, then, did so many people obtain mortgage financing through these toxic products? According to Ms Bair’s account, the lenders who originated hybrid ARMs deliberately misled borrowers—precisely the sorts of financially unsophisticated households who could least afford the risks and obscured fees presented by them. This might not have been illegal but it was definitely distasteful.
By late mid-2007, the incipient financial crisis had made it nearly impossible for borrowers to refinance these loans before getting crushed by the higher interest rates. While some might have been driven into default irrespective of the interest rate because they had been betting on future home price appreciation that did not materialize, many others, according to Ms Bair, could have afforded to keep paying their mortgage at the level of the teaser rate. Preventing a wave of defaults, foreclosures, and short sales that would depress the broader housing market and weaken the rest of the economy would have been in almost everyone’s interest. Investors generally make less money liquidating a foreclosed home than they do from restructuring a mortgage to make it more affordable. In this vein, the FDIC tried to work with investors to renegotiate the terms of these mortgages so that the scheduled rate hikes would not take effect. But these efforts failed.
Fannie Mae and Freddie Mac, the government-sponsored mortgage insurance companies, had bought about one-third of all the toxic securities issued during the height of the bubble. As a result, the government should have been able to exert leverage over other investors to come to a deal. Few seriously expected to earn anything above the teaser rate on these products, since they were designed mainly for creating churn fees. Yet Ms Bair reports that Fannie and Freddie were particularly resistant to any modification of the loans in their securities portfolio. While they were “government-sponsored” and capable of borrowing without limit at a cost similar to that of the federal government, they were nevertheless private corporations. Ironically, it is entirely possible that Fannie and Freddie would have lost less money overall had they done more to ameliorate the collapse of the subprime real estate market in 2007.
In October, 2007, Ms Bair gave a presentation to a group that had been involved in bundling together subprime loans into toxic securities. She asked them why they were refusing to do something that was fundamentally in their interests. Subprime borrowers were deadbeats, they said. Give them a gift like this and they’ll blow it on a new flat-screen television. In that case, Ms Bair wanted to know, why had these Armani-clad dealmakers lent out the money in the first place? “Bad regulation,” she was told.