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Suppose someond said to you, "I'm going to give you a loan. It's more than you should borrow -- in fact, under normal mortgage terms, you could only just barely make the payments on your current income, and you probably wouldn't have enough money left over for groceries, much less car payments, or utilities, or anything else.

"But that's okay. This is a special loan. For the first year, you can pick your payment amount. That's right, you can pay whatever you want, as long as it's at least a few hundred bucks a month.

"Of course, after that first year, the payments go back to more conventional terms, and if you haven't been paying enough to cover the interest in that first year, the amount you owe will have actually grown. You won't be able to afford it unless you get a big raise, and you'll probably lose your house. Hopefully housing values will keep going up so you can refinance!

"Oh, and the interest rate will 'reset' -- meaning it will go way up at some point, which will make your monthly payments even higher. But I don't care about any of that, because in just a few days I'll have sold the loan to someone else, and as long as you make the first six payments I'm off the hook forever. Enjoy your new house -- while you still can!"

Would you take that deal?

A lot of people did. Of course, it wasn't presented to them in quite that way.

You'd think those people would have known better
Some would call those borrowers "stupid," but I think that many of them were just poorly informed. They didn't really understand what they were getting. In my experience, most "stupid" people turn out to be pretty smart -- once you get them away from peer pressure and emotional stresses, and explain things to them in clear terms.

The people who really should have known better were those at places like Morgan Stanley (NYSE: MS  ) and Lehman Brothers and the rest, who were -- there's no other way to put it -- overwhelmed by greed. In this case, greed for the fat fees they were generating by securitizing all the loans they could buy, which led them to buy some -- here's that word again -- pretty stupid loans. Or at Moody's (NYSE: MCO  ) , which gave AAA ratings to those big securitized piles of stupid. Or at Wachovia (NYSE: WB  ) , which elbowed its way into the booming West Coast mortgage market via acquisitions, and ended up with a giant and scary mortgage portfolio -- much of which consisted of "option-ARMs," the kind of loan I described above.

A lot of those loans have yet to reset. I don't know about you, but I think I'll hold off on adding Wachovia acquirer Wells Fargo (NYSE: WFC  ) to my portfolio for a while.

A 16-course meal of stupid
Of course, if we're going to call names, there was plenty of stupid to go around -- mortgage brokers, banks big and small, and builders like Toll Brothers (NYSE: TOL  ) , Hovnanian Enterprises (NYSE: HOV  ) , and Pulte Homes (NYSE: PHM  ) , who kept building and building until supply totally outran demand.

There's a Pulte development in my town, full of those great big glitzy houses on tiny clear-cut lots that have sprung up everywhere in recent years. When they first started construction a few years ago, the sign at the development's entrance said something like, "Luxury Homes Starting In The $700s." Later that number became "$800s," and I think it briefly read "$900s." Now it's "$600s."

I don't think the houses are getting smaller, if you get my drift.

I don't feel bad for Pulte, or Wachovia, or Morgan Stanley. But I do feel bad for any poor folks (if they weren't poor before, they will be soon) who bought one of those houses for $900,000 by stretching beyond their financial limits with something like an option-ARM.

They needed a clue. Want to help us give them one?

Help us wield the clue-by-four
Here at the Fool, we've made financial literacy our mission. It's the essence of our business, of course, but it's also our philanthropic -- or rather, Foolanthropic -- passion. Our long-term goal is to ensure that every single young person in the world gets a basic financial education. As the events of the last year have proven, universal financial literacy is in everyone's best interest.

As we kick off Foolanthropy 2008, we need your help. Not by sending money -- there will be a time for that in a couple of weeks, if you're so inclined -- but by helping us choose the organization we'll be partnering with for this year's efforts. We've selected four worthy candidates, and we're asking everyone in the Foolish community to check them out and vote for your favorite, using the poll at the bottom of this page.

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Fool contributor John Rosevear has no position in the stocks mentioned. Moody's is a Motley Fool Inside Value pick and a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletters free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 31, 2008, at 4:26 PM, infoplease wrote:

    I think you are being a little dishonest when you say the borrowers didn't understand and they were poorly informed. Get real we are all responsible for making our choices. I worked at two different banks for 30 years and I do know you give all this info to people before they make the loans. There may have been some unscrupulous lenders but there were a lot of stupid borrowers who didn't care what they were going to pay in a year or two as long as they had a big home now. And if you want to pass blame around let's look at Congress who forced banks to make loans that they would not have made because of CRA and other government programs for the low income. If they have low income and do not understand about buying a home, making payments and keeping it up then they should keep renting. That again was the big government idea that everyone should own a home. It took my husband and I about 6 years before we could buy a home and then we bought within our means. Now the government wants us to help these people after we worked and did without to buy our home. Also now because of all this greed and dishonesty on Wall Street and Congress I am looking at my retirement that has been reduced by about 80%. I am furious and would like to see the free market decide who survives and who doesn't .

  • Report this Comment On November 01, 2008, at 12:21 PM, jrj90620 wrote:

    As long as the punishment for stupid decisions isn't borne by those who make them the problems will continue.Personal responsibility is not practiced in the U.S.Big govt socialist policies caused this mess and I only see govt growing.I'm not too bullish on America or it's common stock,the Dollar.I don't think we can print our selves out of all problems.Look for a Dollar crash down the road that will make current problems look minor.There has never been any,not one,country with a 100% fiat currency,operating in bankruptcy that didn't see it's currency crash.

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John Rosevear

John Rosevear is the senior auto specialist for John has been writing about the auto business and investing for over 20 years, and for The Motley Fool since 2007.

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