Last week, Sen. Charles Schumer (D-N.Y.) proposed that the federal government spend hundreds of millions of dollars to help bail out subprime mortgage borrowers who are defaulting on their loans.

A report by the Joint Economic Committee of Congress, which Schumer chairs, estimates that the average cost of a foreclosure - to the homeowner, lender, local government, and neighbors (whose homes decline in value) - is $78,000. By contrast, preventing the foreclosure would cost $3,300 per home on average.

No Good Sense

"It makes good sense to make sure families and neighborhoods are protected from rogue lenders and lax government oversight," Schumer said in a speech last week, adding that he's working on the legislation. "It'll save homeowners from losing their equity, save cities and local governments from losing their tax revenues, and save neighborhoods from taking a big hit."

Good sense? If a bailout is good sense, Schumer should also sponsor a bill funding free cardiac bypass surgery and liposuction for anyone the government failed to protect from eating repeatedly at McDonald's.

Banking on a Tragedy

Unquestionably, bad things have happened in the mortgage market in the last five years. Lenders threw money at people with no income, no assets, and no down payments; people who "stated" their incomes, often falsely; people with terrible credit scores, who had a history of not paying their bills on time, or at all.

Some lenders lied about what would happen when interest rates rose and the loans adjusted. State regulators looked the other way.

Mortgage lenders pocketed their fees and commissions, told the overextended homeowner to have a nice day, and handed the loans over to Wall Street to be pooled and turned into mortgage-backed securities. They were sold to hedge funds, pension funds, and other investors greedy for the high yields.

The Center for Responsible Lending estimates that one in five of the subprime loans issued between 2005 and 2006 will go into default. "The real tragedy here is that 2.2 million homeowners face the real possibility of losing their homes because they were misled, or just plain swindled by modern-day bandits," Schumer said in a hearing in March.

Shirking Responsibility

On the other hand, as far as I can tell, none of these modern-day bandits held a gun to anyone's head and forced them to take out a loan.

"There's a lot of discussion in Congress about how these are predatory loans, and widows and orphans are being thrown in the street," says Keith Gumbinger, vice president HSH Associates, a financial publisher. "But some of the issues we're dealing with today are self-inflicted wounds - people who didn't bother to read applications or documents and signed for a loan."

Moreover, the vast majority of subprime borrowers - more than 85 percent - are paying their loans on time. Gumbinger estimates that subprime loans make up about 20 percent of the market. Within that segment, a little over 13 percent were delinquent in the fourth quarter of 2006, according to a Mortgage Bankers Association survey.

"Borrowers that five years ago didn't have an opportunity to buy have been given that opportunity - and the fact is that with this great opportunity comes responsibility," says Gumbinger.

Foreclosure by the Numbers

The Joint Economic Committee is discussing several policy proposals that make sense: tightening educational and licensing requirements for mortgage brokers and lenders; creating a federal anti-predatory lending law that bans unfair and deceptive practices; enhancing disclosure practices for mortgage products so people have a better idea of what they're getting into; and establishing a "suitability' standard for mortgages, similar to the standards that must be met in the financial services industry, that will assess the borrower's ability to repay. (Some subprime lending was based on a borrower's ability to pay the loan at the low introductory rate, before it adjusted.)

Then there's the bailout piece. The JEC report proposes funding nonprofits who work with troubled borrowers, concluding that the high cost of foreclosures "presents a strong incentive to prevent them."

Schumer's committee says the average foreclosure costs nearly $80,000. Here's how the report breaks out that figure among various "stakeholders":

Homeowner: $7,200
Lender: $50,000
Local government: $19,227
Impact on neighbor's home value: $1,508
Estimated total cost of foreclosure: $77,935

Lenders Take Their Medicine

Some lenders were clearly predatory, and should be prosecuted for swindling consumers. But most were businesspeople looking to profit on vulnerable borrowers. We all know profit has a twin - it's called risk. These financial institutions, and the investors who bought their bonds, knew what they were doing. Now let them pay for it.

Some of them are. Citigroup and Bank of America recently pledged $1 billion to a nonprofit housing group, Neighborhood Assistance Corporation of America, to refinance borrowers who face foreclosure.

Other companies, such as Bear Stearns subsidiary EMC Mortgage, have created teams of specialists to work with troubled borrowers. EMC, which has a $78 billion subprime loan portfolio, has dubbed its 50-person workout group "the mod squad" (since they'll be modify the loan terms to avoid foreclosure).

Who Should Pay?

Clearly, lenders, investors, and homeowners should step up to the plate here - not taxpayers. In a hearing on the crisis in March, Schumer said families were "teased into unsuitable subprime loans."

"Teased into"? What kind of language is this? When did we transform from being a culture of opportunity to a culture of victimization? Taking out a mortgage is a choice, and choices have consequences. If we want to own our financial successes, we also have to own our financial mistakes.

And what kind of message does a government bailout send to Americans who did things the right way? People who had a job, paid their bills on time, built solid credit scores, saved for a down payment, read their loan terms, and scrutinized their budgets to make sure they could afford not only the mortgage payments, but the taxes, insurance and maintenance on their homes?

The Real Crisis

More important, what kind of precedent does a subprime bailout set? Undoubtedly, foreclosures will cause personal tragedy, as well as economic dislocations in the affected communities. But there's a much, much larger crisis brewing: Rising poverty among the soon-to-retire baby boomers who haven't saved for retirement.

When they can't work any longer, and don't have enough to live on, and cause a dislocation in the economy, will Congress bail them out too? Will Schumer be around to go after the "rogue" retailers and "bandits" who "teased" Americans into buying consumer goods when they should have been saving for retirement? Or will the government just put the burden on those of us who have done the right thing all along?

Originally published April 19, 2007 on Yahoo! Finance here.

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© 2007 Laura Rowley

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Posted in Guest Commentary, Housing Bust, Laura Rowley