… you get to keep selling mortgages that are guaranteed by the federal government (and that probably won’t ever get repaid). This from a November 19, 2008 Business Week story: “FHA-Backed Loans: The New Subprime.”
As the government gets ever bigger, there will be more and more situations in which gains are privatized and losses are socialized (paid by us taxpayers). The real question is why anyone starts a business that does not tap into federal guarantees of one sort or another. What kind of fool would take the risk of failure?
“The real question is why anyone starts a business that does not tap into federal guarantees of one sort or another. ”
The answer is potential upside.
You invest in businesses where the rate of return is higher than that guaranteed from some federal program. For example, why did you go and start a company rather than just collect taxpayer welfare (which is guaranteed by the government)? The answer is because the upside potential is higher with the former.
Greed will ensure that we continue to risk failure.
Attikus: It would be nice if every business that operated independently of government guarantees were a Google, but sadly the huge number of startups that don’t turn out like Google mean that we need to adjust any expected return from a new enterprise for risk. The risk of selling FHA mortgages is almost zero. You get paid commissions and fees at the time of origination and if the borrower never makes a single mortgage payment you still get to keep those commissions and fees.
As for the rate of return being higher in some other business, that is tough to imagine. The rate of return on venture capital hasn’t been much better than the S&P 500 and is certainly negative right now. The rate of return of these FHA mortgage sellers is enormous. What is their required investment? A telephone? A desk? An office? If they work from home, they probably already have these things. When capital investment is $0, even a small return generates a very high rate of return.
@philg 2
I’m sure the overhead of being issued a license to grant FHA-backed mortgages is far more than zero (perhaps I should try being granted a license to test this theory), but if the linked BusinessWeek article is even remotely accurate, it’s still probably too easy.
The real problem seems to be one of lack government oversight (a common theme with the bailout), not the fact that the loans are insured. Thus in my mind, the question becomes, is it even possible to have enough oversight for the bailout? Or do we have to accept that certain people will take advantage of loopholes and hope for the best?
More oversight isn’t needed. The best approach for limiting fraud would be to make sure that making the investor whole is in the order of who made the loan. So in this scenario, the mortgage broker would be the first to pay for insurance (up to his spread), then every other insurer between the mortgage broker and investor. In a similar fashion, as the loan is paid off, the same ordering is used to remove liability (i.e. the first bits of interest and principal will reduce the same mortgage broker’s liability on the loan in the event of default)
Yes, in the event of default, a mortgage broker can get screwed, but that’s the correct incentive to make sure that the homeowner can actually pay for the loan and that the mortgage broker (and securitizers) aren’t cheating the system with toxic loans.