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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
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