Can the Government Fix Subprime Mortgages?

It is no secret that subprime mortgages have caused widespread heartache and financial distress to many people across the U.S. Borrowers were simply not able to handle the jump in mortgage payments once the rate lock was removed.

Now, because of the subprime mortgage market’s enormous potential impact on the U.S. economy (originations in 2006 were around $1 trillion), the government wants to step in and “help.” This worries me not because I believe there is no place for the government in the economy (a.k.a. a 100% free economy), but because they typically hurt more than they help.

Many ideas have been thrown around about how exactly the government should regulate the subprime market, but the following seem to be the most pervasive:

1. Require Better Disclosure

I agree with this type of regulation if it is implemented correctly. Lenders should be required to at the very least show the potential borrower the effect of the rising interest rate on their monthly payment. The average person will understand how a higher payment will effect them financially (or should anyway).

2. Rate Caps

I don’t agree this type of regulation since it will prohibit many individuals from purchasing a home. There are many reasons why a person can become a subprime borrower that are not necessarily related to their recklessness in acquiring large amounts of debt. These reasons include things like expensive medical treatment that insurance won’t cover and a death by the primary income earner. Perhaps the borrower can’t borrow as much, but they shouldn’t be denied if they don’t fit the risk profile for the rate cap.

3. Product Offering Restriction

Again, I don’t like this regulation. ARMs and interest only loans are great financing tools if used correctly. This regulation would throw the baby out with the bath water (so to speak.) Let the borrower decide which financing tool works for them by giving solid disclosure of the negatives for each type of loan.

One thing to remember in all this talk about consumers being the big victim in this ordeal – the lenders (and those who invested in the securitized assets made from the loans) lost too! The loss in itself will cause lenders to further scrutinize potential borrowers and improve their ability to convey the pros and cons of each type of loan product they offer.

Maybe there is no cause for any regulation at all. What do you think?

Read more: CNN Money

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