Eric Ewanco asked:


The failure of subprime lenders has been in the news recently. One odd article said how people are proposing that the government enact laws or policies to prevent mortgage companies from selling loans that the mortgagee can’t pay back. What I don’t understand is why a mortgage lender would sell someone a mortgage that was likely to be not repaid in the first place. Why would anyone lend someone money if they knew it was not likely to be paid back?

I suspect that the people selling the mortgage aren’t the ones shouldering the risk: They sell them off to investors as mortgage-backed securities, and so they see no downside if the mortgage fails. This seems very bad to me, especially if they make a profit on selling the mortgage — this means that the more mortgages they sell, the more $ they make, even if the loans aren’t sound. But it raises questions: Why would the market buy loans without proof they are sound?
I do understand that there is known greater risk involved, and that some will fail and some will not. This is ordinary lending: Any loan is a risk; you just determine your tolerance to risk compared to the possible return. What I understand happened in these cases was that loans were sold to people who quite obviously could not reasonably be expected pay them back. Normally with a loan there is some calculated hope that they will get paid back, but in this case as I understand it, people were clearly in way over their heads from the beginning. Which makes it sound to me like something fishy is going on.

Louise