The Bailout

As I see it, the bailout of the financial industry is caused by the deregulation of said industry, and practices involving bad loans to homeowners.  If this is true, then we need to explore the cause more deeply before we can solve the problem.

From the looks of it, it appears that the initial mistake was made by the banks (and other lenders) in writing mortgages for people who truly could not afford to buy a home.  Take an example; John makes $35,000 a year.  His wife stays home to care for their two children.  A family of four making $35,000 a year is not a wealthy family.  After taxes John makes about $28,000 annually, which is $2,333 monthly.  Following the formula that his housing should cost no more than 25% of his income, he needs a mortgage at $583 per month.

Here in Los Angeles, where homes go for huge amounts of money, it's not possible to find such a mortgage.  Let's say he finds a house for $300,000 and gets a 4.5% loan with nothing down, his payments will still be $1,500 a month for 30 years.  If he extends the loan to 60 years he would only lower his monthly payment by $300.

So, the big huge bank loans John the $300,000 he needs to buy the house at 4.5% interest.  His wife takes a part-time job to help pay the mortgage, and for the next two years they struggle to make the $1,500 payment each month, but they manage to get by.  Then the "teaser" rate adjusts and their 4.5% interest rate jumps to 7.5%.  which means over $2,000 a month for their mortgage payment.  This is impossible for John and his wife to handle, and they try to raise the money, but simply can't.

Now, at the same time the house has increased in value from $300,000 to $450,000.  This gives them $150,000 in equity in the home.  If they were to sell the house they could use that equity to either put a down payment on a smaller house, or simply bank the money and have the start of a nest egg for their future.  Unfortunately, like many of these borrowers, John and his wife don't understand the market and didn't realize that selling the house was an option.  Worse, they waited until the foreclosures had started, and now the market is saturated with houses, so no one is buying.

Enter the bank (again).  This time with a notice of foreclosure.  John and his family vacate the property and move into an apartment.  The bank takes over the property, which has now fallen in value (because of the large number of foreclosures in the area) and is currently worth about $200,000.  John bought the house for $300,000 (the original loan) and paid on the loan for two years.  He paid $1,500 a month for a total of $36,000.  If the bank sells the house for $200,000 the bank will lose $64,000 on the deal.

What the bank calculated was a) interest rates rising (which they did) and b) the economy remaining so strong that John would receive raises that would allow him to meet the higher interest payments, which did not happen.  The bank was counting on getting it's $36,000 in the first two years, and then getting higher rates for the remainder of the loan.  Let's assume that it remained at 7.5% for the next 28 years, and the payments were $2,000 per month.  That would be $672,000 plus the $36,000 paid in the first two years for a total of $708,000 on a $300,000 loan.

There is a third possibility.  When the market turned bad, the banks could easily have converted the 4.5% adjustable rate mortgage into a 4.5% fixed rate mortgage.  This would mean that the payment would remain $1,500 for the entire loan (30 years), and the bank would be paid a total of $540,000.  This would show a profit of $240,000 or $8,000 annually.  Granted, not much of a profit, but still better than a loss of $64,000.  The banks chose not do this, however, because they wanted their entire projected profit.  

This crisis was brought about by greed.  As such, it should not be up to the taxpayers to bail out the banks.  Let them work out their own mess.  Sell the houses they currently hold below market value to get their cash flowing.  This would also allow more people to buy homes, stimulating the economy.  If our congress wants to do something constructive, work on keeping jobs in America.  Pass legislation to disallow tax breaks to companies that send jobs oversees.  Deny tax breaks to companies that have automated voice answering systems instead of human beings answering their phones.  Cut tax incentives to companies that outsource their customer service departments to India or the Philippines.

Our Congress needs to work on legislation that would benefit all Americans, and let the banks take care of their own messes.