Subprime Lenders Enjoying Government Cash

The Washington Post has an article today with a headline that's probably meant to anger and shock its readers: "Subprime Lenders Getting U.S. Subsidies, Report Says." It explains that the Center for Public Integrity has found that of the 25 participants in the government's foreclosure prevention program, 21 specialized in servicing or originating subprime mortgages. I wonder if the Center for Public Integrity has a similar study conducted that concluded, during the day in the absence of clouds, the sky is blue.

How is this at all surprising? The program we're talking about was designed to prevent foreclosures in cases where people took mortgages they could not afford. Those mortgages were largely subprime. The program exists to create an incentive for the companies that originated or services those mortgages to modify them. Did someone expect that two plus three would not equal five? Of course subprime lenders are benefiting from the program -- it was created with that explicit purpose in order to get them to modify loans!

Here's a little blurb from the Post, which quotes the Center for Public Integrity:

Much "of this money is going directly to the same financial institutions that helped create the sub-prime mortgage mess in the first place," Bill Buzenberg, executive director of the center, said in a statement.

I guess I kind of understand the anger, if you believe that all of these firms wrote the mortgages with evil intent. But unless you define making money through originating loans as evil, then I'm not sure that's always the case. While some companies or mortgage brokers might have purposely taken advantage of people, others probably felt they were just like any other mortgage company, but they appealed to a different segment of the population. As a result, even though they might have technically helped create the financial fiasco, they probably weren't more culpable than all of the other parties involved throughout the process.

I would add that some of these 21 institutions are servicers -- not originators. In other words, they never originated the bad loans in the first place and probably deserve little blame. Their job is merely to collect payments and distribute them where they belong -- to the various owners of the mortgages. A huge number of the subprime mortgage companies that once originated these loans have gone out of business, including names like Ameriquest, New Century and IndyMac.

Besides, throwing a little cash at these guys to perform the service of modifying these mortgages seems better than the alternative. If you didn't use a carrot in order to prevent foreclosures, you would need to use a stick. That would likely mean providing a judge with the authority to rewrite mortgages as he or she pleases -- often referred to as the "cramdown" method. I'd rather subprime mortgage lenders and servicers make a little extra money than provide judges with unprecedented power alter contracts in an area where they probably don't have the right background for the job.

However, if the final alternative is to use neither the carrot nor the stick to modify these mortgages and just allow the foreclosures to happen, then I'd be the first to jump on board. I'm highly skeptical that most of these modifications will ultimately perform much better than the original mortgages. They likely just delay the agony of foreclosure. There's no point in giving anyone -- least of all subprime lenders -- cash to arrive at the same result by a slightly longer path.