Mortgage Lending Crisis

Washington Post business columnist Steven Pearlstein was online Wednesday, March 14 at 11 a.m. ET to discuss the mortgage lending crisis and credit standards.

Read today's column: 'No Money Down' Falls Flat.

A transcript follows.

About Pearlstein: Steven Pearlstein writes about business and the economy for The Washington Post. His journalism career includes editing roles at The Post and Inc. magazine. He was founding publisher and editor of The Boston Observer, a monthly journal of liberal opinion. He got his start in journalism reporting for two New Hampshire newspapers -- the Concord Monitor and the Foster's Daily Democrat. Pearlstein has also worked as a television news reporter and a congressional staffer.

His column archive is online here.

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Prescott, Ariz.: Right up until the moment he left his Government post, Alan Greenspan was telling us how awesome adjustable rate mortgages were. I heard he wasn't so hot on them now. What made him change his tune?

Steven Pearlstein: Not sure what Mr. Greenspan's position is now. I heard him testify that he thought people wound up paying too much of a premium with a fixed rate -- in other words, they overpaid for stability and peace of mind. In fact, that is really a personal decision as to how much you value it. Greenspan knows alot of markets and rates and is rich, so for him an adjustable rate is probably better.But that might not be true for someone who isn't as market saavy and doesn't have an income or asset cushion to help him ride through a period of high interest rates. I think he was appalled at all the option arm and interest only loans that were being written, which he thinks were simply too risky.

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Manassas, Va.: Greetings Steve,

I believe that George Bush will go down in history as the worst President next to that of Andrew (break the Indian Treaties-Manifest Destiny) Jackson.

George Bush along with Alan Greenspan lowered the prime rate to almost nothing. This artificially created economic environment caused a pyramid affect in which house prices were bidded up way beyond what people could afford. If we would have stayed the course in which buyers needed 20 percent down and qualify at 2 1/2 times their income as it has been for the past 50 years, we would not be in this mess.

Don't you feel that we need a major recession in order to bring things back to basic economic sense?

Steven Pearlstein: Let's not overdo the Greenspan thing. They were wise to lower interest rates as much as they did a few years ago, when there ws a real deflation scare. They waited a bit too long to begin raising them, but that is easy to say in hindsight -- they were no more than a year off, probably less. But it is wrong to blame the Fed for all the liquidity in the markets today. It has a lot to do with the U.S. trade deficit and the fixed Chinese currency, the arrival of lots of non-market, high-savings countries into the global financial world, the shift from bank credit to security market credit, etc.

There will have to be a major market correct to bring the price of risk in line with reality. Not sure that has to cause a recession, but it will be a drag on the economy for the next bit.

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Bowie, Md.: Slightly tangential to today's topic.

My ARM has a fantastic teaser rate locked for two more years, after which it indexes. I know there are such things as interest rate swaps that trade on the futures market. Is there something I can do to "hedge" my mortgage against future rate increases by buying a product that would move inversely with the Treasury constant maturities on which my ARM tracks?

Steven Pearlstein: Not sure you can hedge on an individual loan like that. The way people normally hedge is to take out a fixed rate mortgage, where the cost of the "insurance" is probably less than if you bought it separately.

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Charlotte, N.C.: As usual there will be losers and winners in the market over this crisis. As an investor, where should I be looking

Steven Pearlstein: Well, you can do like Goldman Sachs and decide this retreat from subprime is being overdone, and start to buy into the industry -- either its debt or equity. Or you can bet that it hasn't yet run its course and short those stocks and put money away to buy up distressed bonds and distressed real estate when you think the market bottoms.

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Chicago, Ill.: What do we know about the standards for so called "prime" mortgages?

Is/was it possible for interest-only or no documentation loans or no down payment loans to be "prime" loans? Does the amount of the mortgage, or the mortgage compared to the borrower's income matter?

I'm asking about this because most people think that the subprime mortgages were limited to lower-income people or starter houses, and I'm not so sure.

Steven Pearlstein: Subprime refers to the credit score of the borrower. Alot of the "innovative" products and techniques I wrote about were not confined to subprime, although they were used inidividually and in combination in that market, which really calls into question the underwriting judgment of the banks.

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Rockville, Md.: Could you explain how these new tranched bond products are different from the traditional mortgage-back government bonds. The latter were instrumental in pushing up home ownership rates by making available low-interest loans with no prepayment penalty, so one can always move or refinance at any time, but the rate will never go up.

Steven Pearlstein: Yes, mortgage backed securities were a real important innovation that deepened the liquidity of the secondary mortgage market and drove down interest rates. The Fannie/Freddie involvement also helped to create the 30 year fixed mortgage product in the US that doesn't exist elsewhere in any great abundance. The tranches is a more recent invention that actually involves buying bonds backed by mortgage backed bond, and slicing them by risk tranche. They were used mostly int eh area of subprime loans, since in the prime loans, the chance of default is pretty low so the spread in the interest rates isn't that great, even for the riskiest tranche.

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Laurel, Md.: Did the explosion of real estate prices (generally, not just the sub-prime market) cause inflation by creating new money? If the value of my house increases by $100k, a bank will give me a HELOC of $80k. If I borrow it, then the money supply has increased by that amount without any economic activity taking place yet (no one earned that 80k by fixing a car, planting crops or making a sofa), so I'm free to inflate the economy with it. One effect of an inflated economy is increased housing prices, so the cycle can start over again.

Did increased housing prices help to cause, and well as being caused by, inflation in a reinforcing Ponzi scheme; or is the amount of new money that can be created through new loans on increased nominal housing prices not large enough to significantly effect the overall money suppy?

Steven Pearlstein: This is a tricky question you ask, having to do with big hariy questions like what is the money supply and how is that different than liquidity and credit supply. The answers to those question used to be a lot clearer in the days of largely national economies and financial markets. At this point, I think we can say only this: that by creating many trillions of dollars of new housing credit on easier terms, the financial system contributed to the bidding war for existing housing that drove up prices.

Here's the funny thing about that. The mortgage bankers say their new products were necessary to allow households to afford the higher price of housing. But, in fact, a big driver of those higher prices was the excess credit that was created, that allowed the Jones' to bid an extra $25,000 for a house and afford the mortgage because of these new mortgage features. In other words, it is a bit of a ponzi scheme in which borrowers are always chasing their tails, having to take out more and bigger loans to keep up with upward spiraling house prices. And the only winners in that game are people who sell their houses (and don't buy a new one) and the mortgage industry -- brokers, bankers, investment bankers.

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Arlington, Va.: There may be many reasons why subprime lending flourished, but securitization has absolutely nothing to do with it. Securitization of mortgages began 30 years ago. It hurts your credibility to blame securitization for mortgage trends that appeared 25 years later. That's like blaming the invention of cash, on the theory that the love of money is the root of all evil. Securitization is a tool for pricing risk, and it's worked extremely predictably and extremely well since its beginnings. The proof of this is that failures are rising in the tranches that securitization identified as the riskiest (and priced accordingly). If mortgages identified as safe were failing but those identified as risky were not, then there would be a problem with the securitization mechanism, but that's not what's happening.

Steven Pearlstein: I'm not sure I agree. The securitization increased the amount and reduced the cost of mortgage financing, and the CDOs -- the slicing and dicing by tranches -- greatly increased the supply of money available for subprime lending. If that supply did not exist, it would not have been possible to write so many subprime loans (let me assure you the banks wouldn't be holding them themselves). Moreover, the demand for the subprimes was so great it encouraged the originators to produce more of them, even at the expense of credit quality.

Securitization was a big and important advancement. But it did raise the level of moral hazard because the banks and brokers originating the loans no longer had to live with the full consequences of bad underwriting. I don't see how you say that hasn't happened to some degree. We can have an argument about how much a factor it has been, but that's a different debate.

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Germantown, Md.: If we overreact to the mortgage problems, as everyone seems to be doing, will we cause more harm? By making nonconventional and subprime mortgages suddenly much harder to get, we will hurt the borrowers who already have them. Homes in their areas will likely lose value, preventing them from selling or refinancing, and leading to more foreclosures. This will only compound the problems in the housing market.

Secondly, why all the sudden outrage? All the risks were known to borrowers, investors, regulators. No one really got fooled, did they? The current state reflects an outcome that was a well understood possibility.

Lastly, where do you think we're headed with this -- falling home prices, class action lawsuits, government bailouts?

Steven Pearlstein: This is the argument the mortgage bankers like to make -- that government shouldn't substitute its judgment for fully informed consumers, investors and bankers. Twoi problems. One is that consumers can be pretty stupid about these things and they do need protection from themselves -- sad but true. And its not clear they really do understand all the risks associated with the products they were sold. We don't let individual investors put money into hedge funds. And we probably should have had stricter suitability rules for some of these non-traditional mortgage products, now that we know the originators can't be trusted to be more prudent in whom they sell these things too.

The second problem is the moral hazard created by the secondary market, in which the originators have an incentive to write risky loans because they don't suffer the full consequences of their bad judgment.

As to your first question, won't a tightening of credit standards tighten credit, and won't that be bad for markets. Of course. But the solution isn't to allow them to go on making worse and worse credit decisions. That would be throwing good money after bad, or compounding a mistake. The way to fix the mistake is to fix it, by going back to sound underwriting practices. To the degree that market is inflated by bad credit decisions, it SHOULD correct.

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The Subprime Disaster: The reason that the subprime situation will probably end up spiraling out of control is psychology and motivation.

People with lousy credit that become homeowners have little to lose. They are not going to hang onto a good paying job they hate to pay the bills no matter what. They are not going to make sure that all of their bills are always paid on time--balancing their checkbook and staying on top of their finances.

People with lousy credit see the personal finance world differently than those who have their act together. Again, they have nothing to lose so they accept being a straw borrower, commit fraud, buy a home they cant afford, dont pay r.e. taxes, etc.

And although this latest crisis is probably more of a problem with "cheaper" homes--foreclosures are an issue in all price ranges. I look at the tax records in my city and I am amazed at the foreclosures and lack of r.e. tax payments on homes that cost 250K and up.

A credit report is really a chance to look at someone's thought process. What DO they care about? What DO they value? What strategic steps are they making to position themselves better in the future?

Steven Pearlstein: You make some good points, although I wouldn't want to say everyone with a bad credit history is basically a sleezeball. Some are, some aren't.

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Rockville, Md.: I would like to hear your thoughts on the following.

One issue that has been constantly overlooked in regards to the subprime market is minority lender. I have been originating what are considered "a" paper loans and construction/renovation loans since 1985. What I have noticed is the majority of loans in the Washington metropolitan area are made by specific ethnic groups to members of their own ethnic group.

Foreign speaking loan offices, in many cases, take advantage of their ability to "speak the language" to sell products which offer the highest commissions to themselves without regard to the future consequences to their borrowers. When ethnic real estate agents, on the rare occasion, have insisted their clients speak with me I have been able to shift borrowers out of the typical subprime programs (2/28's and 3/27's) because they have excellent credit, I can verify their income and assets.

I think the problem goes much deeper than providing loans to clients that do not qualify.

Steven Pearlstein: I thinnk you're right about your last comment. Can't speak to the ethnic lenders, but it certainly is something we ought to look into. Thanks for the tip.

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Income Based Lending: Lending decisions should be based on income. There is really no reason for a person to live in a home that costs more than 2 1/2 times their yearly income (unless they use family money).

Such a mortgagee could fall behind on payments and may not be able to properly furnish the home, afford the utilities or fund a 401k.

A family does not "deserve" to live in a 650K home if the husband and wife are making a combined 150K. They dont even need to be in a home that expensive since they will be out of their league.

Home ownership is not a right. It should be a decision that is made when it makes sense and not just when someone is tired of renting or wants a bigger house to "look rich".

Steven Pearlstein: Lots of common sense there.

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Baltimore, Md.: Mr. Pearlstein: Are Americans fated to go through disruptive lunacy in the financial markets every 20 years? The S and L debacle caused by deregulation of those financial institutions cost the country billions. (And didn't the '87 stock market plunge coincide with the S&L meltdown?) Now history repeats itself with these subprime mortgages.

That mortgage brokers, lenders and banks have been able to enrich themselves by getting Americans to buy homes they couldn't qualify for and/or can't even afford is little short of a 3 card monte game. It is tremendously ironic that this is all happening at a time when good old traditional 30 year fixed rate mortgages are running just over 6%.

Some good friends of mine recently bought a condo in the District and, when they applied for a loan, the lender told them, "Oh, you can qualify for much more home than that, based on your credit and income." The female half of the couple said, "No. We think this is all we should budget for." She said the lender looked at her as if she had two heads.

Steven Pearlstein: There seems to be this attitude among loan originators that if you're not leveraged to the hilt, you're leaving money on the table. They don't seem to realize that we all don't want to live like hedge funds.

And, as to your question of whether we've seen this story before, and whether it comes back again every generation. you are exactly right.

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Silver Spring, Md.: Steve - over the past years we've watched with a bit of envy as various co-workers and friends have bought fab houses, some for $500K to a $1,000K in locations like the Kentlands. We're not privy to their bank card statements, but they seem to be stable, two income families, some working for the government. The trick seems to be these "interest-only" loans.

Are these loans, to people with steady jobs and maybe not so much cash down, considered sub-prime? Our acquaintances with these properties don't seem that risky, but they do seem to be sitting in really nice homes on incomes that aren't stratospheric (for this area). Are these the kind of borrowers the market is flipping out about, or are their actually a lot of people defaulting?

Steven Pearlstein: Interest only loans to people with good incomes and credit records are not necessarily bad. The lender should make sure that the borrowers has some equity in the house so that, if house prices decline, the loan is not underwater. Because in an interest-only mortgage, the only equity you are building up in house is the appreciation -- and if there is negative appreciation, its not good for anyone. It means that when you get transferred and you have to sell the house at a market bottom, you might have to bring a check to the closing.

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Bethesda, Md.: Hello, Thanks for taking my question. I bought my home in 2005, after writing contracts on 16 homes, ultimately paid 40K on top of an already bloated asking price. In one case a buyer paid 100K over the asking price and if that buyer was the recipient of sub-prime loan then that idiot deserves to be on the street. Senator Dodd said something that appears to be a bailout at the taxpayers expense, my question is how? and shouldn't the bond holders or the market do the bailout?

Steven Pearlstein: I'm in the no bailout camp. The lenders and originators should be made to feel the full pain of their misjudgements by losing money. The homeowners you're spaking of probably don't have much equity in their houses, so they will simply be losing the house they have "rented" and are free to go rent a new one.

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Arlington, Va.: Understanding that real estate markets are local, what percentage of homes owned in the Northern Virginia area are financed by subprime mortgages or exotic mortgages including ARMs or no money down? Alternatively, how much exposure does NOVA face as a result of homeowners potentially defaulting on these loans or being forced to sell their homes due to the ballooning of payments? Thank you!

Steven Pearlstein: I think my colleague Kirstin wrote an article saying half the new mortgages written in the Washington area have been interest only. I think the majority are also adjustable rate. The subprime share of recent business was probably around a quarter, with much higher rates in PG County. In NOVA, I"m just not sure.

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NW, DC: This is a broad question that may combine your past two columns. Overall on schools you are right, though I take offense to the declaration of DC and PG being the lone burdens in 20-years. Combined with today's column, I find issues in the way America does business. We do not take care of our nation, our country, let alone see the need to concern ourselves with education and schools. We are all for self and do not see the benefit for the whole. Our politics has gone that way in the past 20-30 years as well. Granted many of our industrial pioneers were outright monopolist and their loyalty may have been questionable too. But they had tangible products that they wanted folks to be dependent on. Today, folks make more money in their companies and jobs from mere financial speculation than sales and profits. What are the core issues affecting American businesses? is it lack of ingenuity? Is it the dominant role of finance and Investors? Or is it simply greed by some and apathy by others? one one hand I see people getting paid handsomely, but on the other I only see a society that is getting tougher and tougher for the common guy.

washingtonpost.com: D.C. School Reform: Everyone's Business

Steven Pearlstein: Right on both points. People who run companies no longer see themselves as stewards of companies, industries, communities, etc. Call it paternalism, yes, but it has been replaced by an overemphasis on the things that markets value and can deliver, to the detriment of a sense of community and the things that make communities strong.

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Bowie, Md.: Two questions: Which neighborhoods or counties in this area do you think default mortgages and foreclosures would affect the most? What are the best ways for a home seller to protect himself from a buyer who signs a contract to buy their home, but cannot come up with the loan 45 days later, which would be a lot of time wasted for the seller, irregardless of the deposit amount?

Steven Pearlstein: You'll have to ask Ken Harney the second question -- I'm not sure of the laws on that. The neighborhood that is probably doing to get hit the hardest is PG county.

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Burke, Va. - No money down CAN help: I couldn't tell in your article if you were arguing against no money down loans or just the N$DLs that were also no-docs. But the former can be a great help to couples like my husband and I. We are both attorneys with downtown firms and have great careers. But with law school loans as well as day care costs it just wasn't feasible to save up the 5, 10 or even 20 percent down on a house in the Arlington area where housing costs can easily soar past $750,000. So for us it made sense, we could prove our long term income history and we were able to get a no money down loan.

I just don't see how first time home buyers can be expected to save $100,000+ in a downpayment especially in a housing market like this.

Steven Pearlstein: There are instances, like yours,where a no money down mortgage might be appropriate. But certainly you would'nt want to combine that with no documentation, or an interest-only mortgage. At that point, if it turned out that the only way you could afford the home was to get an interest-only or balloon mortgage, then I'd say you're not ready to buy a house yet. There's no sin in that, by the way. I think we've elevated home ownership in this country way beyond where it needs to be. Remember, if you don't have $15,000 saved for a downpayment, you don't have $15,000 available when the roof needs to be replaced or some such thing. And let me assure you, that day will come.

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Northern Virginia: Six years ago, I got a "no income verification" mortgage because I didn't earn enough to qualify for the loan amount I needed for the townhouse. The loan officer said that I could get the loan, but at a higher interest rate than normal. I shaved off two percentage points by prepaying that amount of the loan's interest for 2 years (from an 8 percent, 30-year fixed to 6 percent). Due to that, I got lower and more tolerable mortgage bills.

One year afterwards, I refinanced my loan to a 6 percent, 30-year fixed, and now have over $120K in home equity. Throughout these six years, I experienced unemployment and medical difficulties, and have always been a single income household. It's been tough, but I never missed a mortgage payment.

Without this (subprime) "no income verification loan" I wouldn't have been able to purchase a house and build some modest wealth throughout the years. Yes, there are many defaulting in their mortgages, but their are also many like myself who could own a home only by using a risky mortgage loan.

Steven Pearlstein: Well, you were lucky: house prices went up and created some equity for you. If they had gone down, or if you had not been as lucky/skilled in your search for work, it wouldn't have turned out as well as it did. So the question becomes: were you really ready to buy a house, rather than continuing to rent? I suppose you could argue that the higher rates you paid reflected the higher risk, and as long as the lender was willing to take that risk, that's between the two of you. And if the originator of your loan actually held that loan, that might be a nice story to tell. But I'm pretty sure your loan was sold to an investor who had very imperfect information about yours and the other loans in the package he bought into. And that's where this market model falls apart. The rating agencies that rveiwed that package had to come up with some rating on the riskiness. But that was really just a wild guess, since many of these mortgage products are so new that nobody knows how they are going to perform during an industry downturn or a bad recession.

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St. Louis, Mo.: In your article, you point out that (former) Fed Chairman Greenspan was among the regulators warning of the "deterioration of lending standards." However, didn't Greenspan contribute to the problem with his earlier comments that same year, touting these innovative lending products?

"Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. . . . With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . .

Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending . . . fostering constructive innovation that is both responsive to market demand and beneficial to consumers."

Seems he's tried to have it both ways! Your thoughts?

Steven Pearlstein: Greenspan was right -- there are now better, more refined techniques to determine the good risks from the bad risks among people with low incomes or bad credit risk. That's good. But I think Greenspan was complaining about other "innovations", like extending those same people no-interest, no doc loans, or balloon loans, or loans that reset in two years at rates the borrower clearly would not be able to afford.

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Washington, D.C.: Easy for "Income Based Lending" to be judgmental, apparently s/he got into the market before it hit the stratosphere, or s/he has a substantial enough income to handle these prices. I am extremely responsible with credit -- never carry balances, put $7,000 down on a $10,000 car, and paid the loan off early. I have saved $90,000 since paying off that car 10 years ago, but by those strict income standards, my limit would be 190k, and the only places I could buy would be Southeast, Baltimore, some not very metro-accessible areas of PG County or a studio apartment. It's not just greed driving creative underwriting.

Steven Pearlstein: That's true. But one reason you can't afford anything else is that the price has been unduly inflated by all that loosey-goosey credit out there. And when that credit dries up, as it will now, you'll see house prices come down -- maybe to the point where you can afford them.

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Alexandria, Va.: The real proof that the mortgage industry's troubles have the public's attention was not in yesterday's stock market dive, but another sign. While walking on Connecticut Ave. in the gorgeous weather Tuesday, I came across some college-age students out gathering petition signatures and handing out leaflets. Normally their 10-second sales pitch focuses on saving the whales, stopping global warming, or ending the Iraq war. But the sales pitch and reason why they were out there yesterday: "Are you worried about the subprime lending market?"

Three months ago, few of us would have known what the subprime market was, let alone been able to describe it or its problems. How times have changed.

Steven Pearlstein: Interesting. And who was paying them to do that?

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Madison, Wis.: Thanks for a terrific article. In your last paragraph, you imply the need for more regulation of the mortgage banking industry. Naturally, mortgage bankers and brokers will disagree. Are the best arguments for regulation that: (1) the mortgage bankers are paying with OUR money, not just their own venture capital; and, (2) the effects of loosey-goosey lending affect all downstream segments of the housing market, including people who did not assume the risks of risky loans or investments?

Steven Pearlstein: Thanks.

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Arlington, Va.: Steven, great article. I'm sure lots of people in the area want to know this: How will the subprime lending crisis affect the DC/VA/MD housing market? More specifically, are home prices in Arlington going to drop? I'm a potential first-time home buyer and I assume this is a bad time to enter the market, but would appreciate any thoughts or advice. Thank you!

Steven Pearlstein: I'm reluctant to give much direct advice. Prices have declined in the region recently, and I don't see any evidence that they have bottomed out yet. Beyond that, who knows?

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Dunn Loring, Va.: For several years, as part of his "life is good" mantra when commenting on the health of the economy, the President has pointed out that there are more first-time homeowners than ever before. Did this administration accomplish this fact by enabling unqualified home buyers to buy homes for zero or next-to-nothing down thus paving the way for a sub-prime implosion?

Steven Pearlstein: Let's not blame this on Bush. I think the regulators could have acted more promptly, but they behaved, frankly, the way regulators do in any administration -- with a great deal of caution. This wasn't dictated by the White House, trust me.

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Steven Pearlstein: I'm afraid that's all the time we have today, folks. I'll print a few more of your comments, without comment.

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Boston, Mass.: I work in Consumer Protection and wanted to get your perspective on two questions.

1. From the borrower end, how can we convince people before they get these mortgages/refinance that they simply cannot afford it? Is there anything in psychology or business behavior on how to make people understand the risk they are taking?

2. From the standpoint of the ultimate consumer of these securities, what options are out there for "responsible investing," i.e. making sure there are no subprime loans in the portfolio, or, even better, finding lenders that securitize fair loans to those with bad credit?

Steven Pearlstein: Thanks.

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New York, N.Y.: In buying a house, is it a good strategy to leverage as much as you can on the mortgage, and use the 'extra' money for investment? It seems like the tax break and the returns will be more than the interest that you have to pay.

Steven Pearlstein: Thanks.

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DC: As "rich" as Greenspan was when he was the chairman, it was disclosed that most of his money was in bonds and tbills, not securities.

Steven Pearlstein: Thanks.

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Rockville, Md.: I beg your pardon, Mr. Pearlstein, but you are incorrect when you say that banks have no risk when a loan goes sour that they originated and sold in the secondary market.

As a mortgage banker, the guarantees that I make to Wall Street, say Bear Sterns, about the quality of a loan we've closed, Bear Sterns makes to its investors when it packages my loan with all the others.

If the investor kicks out my loan because the investor doesn't like it, then Bear Sterns makes me buy back the loan. When I buy back the loan, I go back to the originator and reclaim any money he or she made on the loan. Sorry, but we ALL lose when a loan goes bad.

Steven Pearlstein: I think your responsibility reduces with time. And if you are an independent who makes lots of bad loans, you just close up shop and declare bankruptcy and there is nothing Bear Stearn can do. Most originator/brokers don't have to maintain reserves, like a bank.

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Arlington, Va.: I read your column and I don't see the "moral hazard." The investors that ultimately buy the risky tranches would only buy them if they thought the price justified the risk. Unquestionably the judgment of some portfolio managers was wrong -- they underestimated the risk.

When their clients see their most recent returns, these portfolio managers will likely be looking for new lines of work, and the origination standards will fall in line with the updated risk perception. What is the problem? Don't portfolio managers and their clients have the right to be terribly wrong and to bear the losses resulting from their poor judgment?

Steven Pearlstein: Neither the investment bankers who package the mortgages, nor the rating agency analysts who assign a risk rating, have to pay any money if they are wrong about their judgments. In extreme cases, they may lose their jobs. But probably not.

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DC: Just a comment. Seems like you've given Fannie/Freddie a real pass on their impact on subprime lending. They have been huge players in the purchase of private-label subprime MBS, which they hold in portfolio. Together they've purchased as much as a third of available subprime MBSs. They've added to the funding of these loans as much as Wall Street has, and they should be held just as accountable.

Steven Pearlstein: Not sure about that. Think they buy the AAA tranches. But if they are buying lots of subprime MBS and not setting higher standards, then you are right.

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Renter: As a young twentysomething, and potential first time buyer, is there any reason why I shouldn't be watching the collapse of the real estate market with a sense of glee?

Steven Pearlstein: Thanks.

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Oakton, Va.: Steven, thanks for an interesting column. I have a comment however. It seems you implicate the programs themselves for the sub-prime market, as opposed to the lenders who decide who is qualified to use those programs. While I agree that no-doc loans are pretty dicey, many of the other programs have legitimate customers.

Just an example, I am buying a new home and am looking at an interest only product which will have me pay only interest for the first 10 years, and then amortize the principal over the last 20. However, as a realtor with an irregular commission based income, this allows me to have lower fixed payments, but make "lumpy" payments towards principal when commission checks come in.

My point is simply that the programs themselves often provide a good service to the savvy homebuyer who knows how to use the programs to their advantage. It is up to conscientious lenders to help the buyer make a good decision. Regulate/Police the mortgage banker, not the mortgage program, and I think we'll find a better secondary mortgage market regardless of the lending programs offered.

Steven Pearlstein: Thanks.

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Bluffton, Ind.: Have any of the proposals by regulators considered requiring the originator of the mortgage to keep some of the risk (say 25 percent) to help make them responsible if the loan goes bad? It seems if they were required to have "skin in the game" that they wouldn't be introducing many of these products.

Steven Pearlstein: Thanks.

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Herndon, Va.: Is it now a good time to buy a home. Since there is a lot of bad news and the housing prices are lower than the peak. Or Should I wait for more time for the dust to settle. I live in a rented apartment looking forward to buy my first home. Thanks

Steven Pearlstein: Thanks.

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New York, N.Y.: Steve, I have a related question: To what extent do you believe that the tax deduction for mortgage interest has helped this spiral (e.g. borrow more money, higher home prices result, people take out interest only mortgages)? Is our tax code encouraging risky behavior in this regard? Thanks!!

Steven Pearlstein: Thanks.

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Edgewater, Md.: Certainly the shaky financing options are the major cause of today's difficulties. But I also wonder if a there are not two large often unacknowledged additional factors. The first is that the turnover of residential living space is extremely expensive. For example, selling a 300K house and buying a 300K replacement may have 25K to 30K of associated fees. This is the "elephant in the living room". The second is the expectation (pushed by the realty industry) that a house is an investment. A result is that buyers are encouraged to engage in risky financing because they believe that at any time they can cash in their chips (i.e. sell) and come out ahead.

Steven Pearlstein: Thanks.

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Washington, D.C.: Is it me or didn't everyone see this coming years ago with the explosion of high real estate prices, no money down mortgages, ARMs, rising interest rates, etc. I can recall reading articles as far back as 2005 about this impending "crisis". I don't see why there seems to be so much surprise on Wall Street.

Steven Pearlstein: Thanks.

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Rockville, Md.: Can you tell me the extent of the subprime market problem loans vis a vis the entire mortgage market? Is this a looming problem because the money center banks will be straddled with the foreclosed mortgages and is that the major cause of the distress on Wall Street? Or as one trader said this morning, "this might be a case of someone stepping on a twig in the forest and scaring the life out of everyone within miles" (paraphrased). So the magnitude in terms of percentages is what would be helpful if you have that information from your research. Thank you

Steven Pearlstein: Thanks.

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Tampa, Fla.: You noted that Goldman sees a buying opportunity in the sub-prime industry. But the fixed-income markets have a different view. The credit spreads on Goldman and other major lenders to the sub-prime industry have widened. (The credit spread is the interest rate a borrower must pay over the risk-free Treasury rate.) This has caused the cost of insuring their bonds with credit default swaps to increase. So the markets seem to disagree with Goldman. Who would you trust?

Steven Pearlstein: Thanks.

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Washington, D.C.: Homeownership is the single most likely factor associated with future wealth. While I obviously think it's unfortunate that the rate of sub-prime defaults is rising, the long term benefits to the sub-prime community may greatly outweigh the short term loss. The 4 percent rise in ownership should translate into millions of individuals with greater assets to be used for retirement, health care, or whatever.

When properly used, the loans in your article are highly effective tools to reduce costs. I think it would be a shame to return the old model of 20 percent down, 30 year fixed. The default rate increased when loans went from 100 percent down to 50 percent; and from 50 percent down to 20 percent. Overall society benefited. The focus should be on making the loan terms clear and reducing the overhead associated with loans (origination fees, etc). The current hysteria is group think on the part of financial journalists. Three months from now the TV talking head windbags will be twittering about yet another impending financial disaster.

Steven Pearlstein: Thanks.

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Washington, D.C.: What does this news mean for mortgage brokers? Will there be anything in place to encourage brokers to stop processing risky loans and selling them on Wall Street to unsuspecting people? Are government regulators able to hold brokers responsible if they exaggerate or misrepresent the quality of these mortgage loans?

Steven Pearlstein: Thanks.

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Oakton, Va.: Greetings Steve: In the press, subprime borrowers take quite a hit in that they are said to have blemishes on there credit ratings, sketchy credit ratings and so on. This emphasis entirely misses the point. With this business, the major sin on the part of borrowers is reaching for a loan that is beyond their means. Lenders are happy to oblige. I do not see what poor credit histories have to do with it.

Steven Pearlstein: Thnks.

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Milford, Conn.: Did lenders and borrowers assume ever-increasing housing prices would insulate them from the kinds of problems were seeing now? It's hard to see how this is a surprise to anyone

Steven Pearlstein: Thanks.

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Rockville, Md.: Steve, can you please explain the difference between a prime loan, and alt-a loan and a subprime loan? Isn't there a category of loans that fall somewhere between prime and sub-prime?

Steven Pearlstein: Alt A is in between.

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Alexandria, Va.: Steven, Could you explain the following expression and how it relates to Fannie Mae's executive compensation and now the mortgage brokers that have caused the subprime meltdown that is slowly, but surely, trickling into Alt-A loans and the economy as a whole: "Privatize the profit, socialize the risk" Thanks!

Steven Pearlstein: Thanks.

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Berkeley Heights, N.J.: Subprime lending put a lot of people into homes, and that's a good thing. The old rule of 20 percent down kept a lot of people renting forever. Do you think it's possible to find an appropriate balance between easier credit and too easy credit and if so who would create this balance?

Steven Pearlstein: Thanks.

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Laurel, Md.: From your column today, of the loan options that you mentioned, one stood out as being far safer than the others: the piggy-back loan. Particularly when both the big and small mortgage rates are fixed. I, and others I know, went this route with great success. Obviously, if I lost my job, I'd be SOL, but that would be the case even if I put down 20 percent. This loan option doesn't have the potential for volatility and catastrophic loss that the others have. Or am I missing something?

Steven Pearlstein: Thanks.

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Hyattsville, Md.: As 1/2 of a married couple who bought our house in May, 2005 with a 100 percent finance loan, they do have their advantages. While at the time, we were able to save $1,000/month towards a down payment, market prices were rising faster than we could save, so we did a 80/20 percent mortgage, and had enough saved to cover closing costs. We are able to pay extra on the higher-interest smaller mortgage, and had solid credit and income. Fortunately, we bought in a county where prices lagged behind most other DC areas, and are settling in for the long haul, so any short-term price adjustments won't hurt us.

Steven Pearlstein: Thanks.

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Bethesda, Md.: As a libertarian, I would generally favor allowing the market to find mechanisms to address the moral hazard problem you identify in your article. Traditionally, those who purchased mortgages to service them long term, or securitized mortgages, insisted on rigid certifications and standards being met, validating the creditworthiness of the borrower and the soundness of the collateral.

So the development of a new, higher risk set of products would appear to be just another innovative expansion of diversity in the marketplace. But given the general financial and potential macroeconomic impact of the subprime market collapse, which affects everyone -- including general investors and workers -- and not just participants in the subprime mortgage market who encounter the direct consequences of their apparent lack of wisdom, would you agree that a case can be made for tighter regulation of these transactions?

As I recall, the S and L crisis 15 or 20 years ago didn't generate such spillovers into the broader market, despite its evident regulatory failure and taxpayer bailout costs. Why the difference this time?

Steven Pearlstein: T%hanks.

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Washington, D.C.: In your column today, I disagree with lumping piggyback loans into the evil loan category. Don't some of the more exotic mortgage products make sense for at least some people? For example, a young couple with high incomes, great credit scores, but relatively little savings usually do just fine with a piggyback loan. This is especially true in an area like the DC market where it's very hard to save 20 percent for a downpayment because of very high rent prices.

Steven Pearlstein: Thanks.

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Arlington, Va.: Steven, Nice article on the toxic lending products... you left the 40 and 50 year mortgages off your list. Okay, our economy is getting pounded by the housing bubble bust now... how can I prevent the Banks RESPONSIBLE for this financial mess from securing public funding (i.e. our tax dollars) from Congress to bail them out? This became even more likely after Moody's recently upgraded several large Banks because they were "too big to fail" and enjoy the same implicit guarantee of a FedGov bailout that Fannie has.

Steven Pearlstein: Thanks.

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Woodbridge, Va.: Dear Steven, I am both a real estate appraiser and a real estate Broker. I can tell you 1st hand that this market should be labeled as a "fools market" not a "buyers market". These houses out here are over-valued by as much as 40 percent over what most folks can afford.

This whole market needs to collapse and start over at a level playing field for all involved. How would you go about bring things back into prospective?

Steven Pearlstein: Thanks.

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Springfield, Va.: http://www.gao.gov/new.items/d0624.pdf

GAO warned about zero down mortgages, in the FHA context, a year and a half ago. Does no one listen?

Steven Pearlstein: Thanks.

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