Government May Punish Subprime Lenders

The government is shocked -- shocked! -- that subprime loans made by subprime lenders are performing subprimely. One of the downsides of a housing bubble is when that bubble bursts (which it will; of course it will; they always do; it’s the very nature of a bubble), there can be repercussions on the economy at large.

Welcome to now.

There has been an alarming spike in in foreclosures, especially among homeowners who took out subprime loans. The government, feeling like something needs to be done, is preparing to punish some subprime mortgage lenders under investigation for discriminatory practices. “Discriminatory” in this case isn’t exclusionary. The government is alleging that subprime lenders targeted the very subbest of the subprimes, leading to the catastrophe currently underway in the mortgage sector.

In the gun-sights of the government? Fannie Mae and Freddie Mac, among others. In fact, the Housing and Urban Development Department has suggested that the largest mortgage companies consider giving strapped borrowers more time to repay their loans.

Categorizing the rights from the wrongs in this scenario is tough. On one hand, the government is right in castigating subprime lenders for aggressively targeting subprime borrowers. However, it’s not like subprime lenders were stealthy in their business model; the government was strangely silent during the bubbliest parts of the housing bubble. Some responsibility also needs to be laid at the feet of consumers who borrowed beyond their means for houses they couldn’t really afford.

For now, the subprime industry can expect further for-the-public scrutiny from the government. Democratic Rep. Carolyn Maloney of New York, is proposing legislation that would impose restrictions on banks and other mortgage lenders. They would be required, for example, to evaluate a borrower's ability to repay an adjustable-rate mortgage over the entire term of the loan, not just at the start, when much lower rates are in effect.

Sen. Christopher Dodd, D-Conn., who heads the Senate Banking, Housing and Urban Affairs Committee, has said he is considering several options to protect consumers.

The rest of us should prepare our faces for more unsurprising shocks.