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The Mortgage Crisis: Predators Who Bite Their Own Backsides

By Dan Ackman

Updated on: July 14, 2008 / 7:54 PM EDT / MoneyWatch

As the banking/housing crisis has progressed, there has been much talk about "predatory" loans. What's a predatory loan? There is no universal definition. But the term seems to involve loans that the borrower is eager to take, but will be unable to repay. In other words, it's a loan that is less likely to be paid back.

Normally, the lender would be the victim in such a scenario. But we are taught to believe that the lender is no victim, but a predator. This obviously makes no sense. But new regulations, such as those approved by the Federal Reserve yesterday, are best sold when they are said to protect consumer victims or prey.

Here is a summary of the new rules by the AP.

Bar lenders from making loans without proof of a borrower's income.
Require lenders to make sure risky borrowers set aside money to pay for taxes and insurance.
Restrict lenders from penalizing risky borrowers who pay loans off early. Such "prepayment" penalties are banned if the payment can change during the initial four years of the mortgage. In other cases, a penalty cannot be imposed in the first two years of the mortgage.
Prohibit lenders from making a loan without considering a borrower's ability to repay a home loan from sources other than the home's value.

In fact the new Fed rules simply enshrine traditional banking practices that any prudent bank would impose on itself -- that is if it cared about being paid back. But at the heart of the banking crisis is the fact that many banks (and even more mortgage brokers) did not care at all about being paid back. Their business was collecting fees up front -- and some of the so-called predation does involve heavy fees. As for the loans themselves, they could be sold in the secondary market.

Traditionally, it was harder to sell subprime loans in the secondary market. But in recent years, the mortgage securitizers have found ways to package most anything. The people who bought these securities (or the banks that got stuck with them) bore the brunt of the defaults, which were rather predictable given the lending practices.

So the Fed is really just protecting the buyers of mortgage securities going forward. The preyed-upon consumers will only be hurt in that the high-risk (to the banks) loans will not be made, or made much less frequently.