Subprime Borrowers: Not Innocents
Consumers who took out adjustable-rate home loans they now can’t repay are primarily to blame for the subprime mortgage crisis. Pro or con?
Pro: Willing Customers
A simple look at the blunt reality reveals that borrowers themselves should assume primary responsibility for the current subprime crisis. Millions of borrowers, all over the country, knowingly signed mortgage contracts they cannot now afford to honor.
Provided that lenders did not engage in force or fraud—and there’s no particular evidence they did so on a large scale—borrowers should do whatever they can to live up to the contracts they signed. The policies of lenders and government certainly helped the current crisis develop—but ultimately, do not absolve borrowers of responsibility for their debts.
And in most cases, the mortgage lenders not only are innocent of the predatory practices borrowers complain about but also are feeling the pain right along with them. These lenders do not revel in the current circumstances. A lender typically loses about a third of its loan value through foreclosure; thus, no lender (or mortgage-backed securities marketer) has an incentive to make or purchase a loan it genuinely believes a borrower cannot pay.
With a very few exceptions, lenders have no desire to serve as landlords or take away people’s homes: A foreclosure causes almost as many problems for the lender as it does for the borrower. True predatory lenders, who engage in fraud or make loans they know borrowers cannot pay, inevitably end up in either jails or unemployment lines.
The government played some role in the crisis as well. Its tax system encouraged Americans to take out very large mortgages to get out of paying federal income tax. And the government’s 2005 bankruptcy reforms meant that rather than having their debts wiped clean, most middle-class Americans who file for bankruptcy have to set up five-year payment plans with creditors.
Not one of these factors, of course, mitigates the facts of the situation. Mortgage borrowers who signed legally binding contracts should have to honor those contracts, or at minimum, renegotiate terms with their lenders. Any suggestion that borrowers should avoid responsibility would undermine the fundamental principles of contract law that lie at the base of any modern capitalist economy.
Con: Collaborative Fiasco
Yes, a few borrowers bear some blame for subprime problems, although not for the whole crisis. These few are the crooks, the ones who falsified their financial statements and obtained loans fraudulently. They should be prosecuted. More numerous are the mortgage salespeople and real-estate brokers who both misled borrowers and falsified the applications to get mortgages the borrowers could not repay. They also should be prosecuted.
The subprime “crisis,” though, is much bigger and more complex. Most subprime borrowers applied for and got mortgages they thought would benefit them. They bought houses they otherwise could not have afforded. They expected that house prices would continue to increase, allowing them to refinance their mortgages or sell the property at a profit. Many guessed wrong, and they and the investors who ultimately provided the funds for the mortgages will take losses rather than gains. These borrowers are not responsible for the crisis. They just took advantage of opportunities offered to better their lives and finances.
Who, then, is responsible? Well, no one—and everyone. The mortgage salespeople and real-estate brokers received commissions. They benefited. But they are not responsible for the crisis; they (the honest ones) just did what people who sell cars or TVs do—sell the product. Indeed, the interest and repayment terms of mortgages must, by law, be clearly stated. It is the present and future value of the house that is hard to estimate. The initial lenders who securitized the mortgages benefited, which does not make them guilty of causing the whole crisis. The agencies that gave the securitizations too-high ratings were responsible, but (at least in retrospect) investors should have been more skeptical. Because investors were not sufficiently cautious, they have taken and—as the crisis unwinds—will continue to take losses. They are not responsible for the crisis; rather, they are the victims of less-than-competent risk managers.
Although borrowers are not responsible for the subprime mortgage crisis, neither are they its victims. They just gambled and lost. Hence, they should not be bailed out by taxpayers. Investors (or their agents, the mortgage servicers) may restructure their mortgages rather than foreclose. They will take a hit as will the many others who contributed to—but didn’t solely cause—the subprime mortgage crisis.Opinions and conclusions expressed in the BusinessWeek.com Debate Room do not necessarily reflect the views of BusinessWeek, BusinessWeek.com, or The McGraw-Hill Companies.