By ANDREW JEFFERY

This post first appeared on Minyanville.

Remember the good old days? Back when you and the credit crunch were young, and only those “subprime” people over on the other side of town — you know, the ones living wildly beyond their means, dependent on credit for the very necessities of life — had to deal with the harsh reality of life without free and easy credit?

Those happier times are long since passed, as the malaise continues to seep its way up the economic spectrum. Now, even the most creditworthy consumers who haven’t missed a payment in years are seeing credit lines cut, interest rates raised and finding it increasingly difficult to get a mortgage. They’d better get used to it – the free lunch is over.

Up in Washington, where economic rationale and populist rhetoric seem to be more mutually exclusive than ever these days, the Senate is voting on a widely debated new set of rules for the credit card industry.

According to the New York Times, although the legislation doesn’t cap the rates companies like Capital One (COF) and American Express (AXP) can charge their customers, they’ll be forced to up rates more slowly — and with more disclosure — meanwhile making it tougher to impose late fees on borrowers that can’t keep up. This will reduce lenders’ earning power, not to mention their inclination to give out credit lines to questionable borrowers.

While risky borrowers will bear the brunt of late fees, over-limit charges and slashed credit lines, the well-to-do are in for the biggest shock. Banks are considering curtailing or doing away entirely with rewards programs, grace periods before interest charges kick in and accounts without annual fees. Gone are the days when paying your bills on time was a path to free credit.

The country’s biggest banks, JPMorgan (JPM), Bank of America (BAC) and Citigroup (C) have already told Congress the new rules will force them to limit credit availability and increase fees. While this may bode well for profit margins in the near term, not so for the broader economy.

In light of the financial implosion wrought by too much debt supported by not enough real income, it’s hard to argue credit card companies shouldn’t be a bit less free-wheeling when handing out plastic. But analysts are quick to point out that paring down consumer credit will have a dastardly effect on our consumption-based economy.

For a country whose economy is two-thirds consumer spending, and whose consumer is (still) addicted to credit, the new legislation is like pumping the economy full of Xanex – everything will just slow down.

And while in the long run, less dependence on cheap and easy credit will help prevent the sorts of credit crisis like the one we’re experiencing right now, we’ll likely look back with 20/20 hindsight and say this legislation went too far, constricted credit too much. This is a shame, since before Congress even cooked up the idea of the new rules, the natural deleveraging cycle was already restricting credit on its own.

Debt isn’t in and of itself, bad. As Minyanville’s Kevin Depew wrote today, “real lending and economic activity will only improve when real savers see real value at the right level of risk. That will only occur in the short-run with vastly lower prices, or in the long run with stagnant prices and the benefit of time.” Indeed.

Credit allows a transfer of risk from those who want to take it, but can’t, to those who can take it, but need to be appropriately compensated for putting their cash on the line. This can foster healthy economic growth – when used properly.

That day will come again, but that day isn’t today.

By ANDREW JEFFERY

This post first appeared on Minyanville.

The answer? An emphatic no. This is simply the latest example of legal plunder perpetrated by the federal government against law-abiding, tax-paying citizens.

The Obama administration’s scheme to help troubled borrowers centers on subsidizing interest payments, which would help borrowers make ends meet without angering those investors expecting full payments each month. This marks the first time the government is intervening directly with taxpayer funds to ease the burden of monthly mortgage payments.

Bloomberg reports the plan will be voluntary for lenders like Wells Fargo (WFC), Citigroup (C) and Bank of America (BAC), and will employ many of the tactics previous modification efforts have used (ineffectively), such as loan extensions and principal reductions. Modifications identified as having a net present value will be targeted, where foreclosing would be more expensive than changing the loan terms.

The program aims to establish a standard for loan modifications that can be used industry-wide. That’s an absurd claim, which demonstrates the extent to which lawmakers misunderstand the scope of the problem. It’s a bit like saying every American must cut their hair the same way: It would be laughable it weren’t so sad.

Each mortgage, each borrower, each lender, each home is unique; each situation is different. Individual banks can barely standardize the documents required to close a loan, so the notion that there can be one standard for approving a loan modification — an intensely complicated procedure involving countless interested parties — is ridiculous.

It would be one thing if the plan offered even the remotest possibility of stabilizing the housing market. It doesn’t. The few borrowers who may be helped will have little effect on a massive, disjointed housing market that remains determined to run its course despite government efforts to stop the bleeding.

The societal implications of this program are downright frightening.

Washington cutting checks to borrowers who can’t make their mortgage payments sounds like a benevolent act attempt to reach down to struggling families — and in some cases, it may certainly help. But it also fosters dependency on the federal government and incentivizes bad behavior.

It now appears we’ve reached a point in this crisis where differentiating between those worthy of help and those left to pick up the tab is determined primarily by how poorly one managed their personal finances. The worse the decision, the greater the federal assistance – and it’s true for government bailouts of bad choices on the part of individuals and institutions alike.

The message this sends to the rest of us – those who are still living up to their obligations and trying in good faith to eke out a living during tough times: Throw in the towel.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Unprecedented. Unpredictable. Unparalleled. Extraordinary.

These are the adjectives offered by mortgage industry executives defending their relative innocence in the collapse of the housing industry. Conditions, they argue, deteriorated so rapidly and in such unpredictable ways they couldn’t possibly batten down the hatches fast enough.

As it turns out, that’s not exactly true.

The Washington Post reports that chief executive offers at both Fannie Mae (FNM) and Freddie Mac (FRE) ignored warnings about their firms’ exposure to risky loans. The findings of the House Committee on Oversight and Government Reform are being discussed today on Capitol Hill.

At Freddie, an internal report explicitly warned that certain types of loans might default at a higher rate than expected if borrowers’ true financial positions were to be made known. Furthermore — and troubling insofar as these firms and their Washington backers actively pushed these risky loans on low income immigrant communities — senior executives were told many such mortgages could be particularly harmful for non-English-speaking homeowners, since many didn’t fully understand the confusing loan terms.

At Fannie, no smoking gun was produced, but the oversight committee discovered what it called an “underground” effort to actively buy subprime loans.

For their part, former Fannie CEO Daniel Mudd and deposed Freddie chief Richard Syron are directing the blame elsewhere – not surprising, given their well-documented penchant for obfuscation and finger-pointing. To Mudd and Syron, responsibility for the crash lies squarely at the feet of regulators and Congress: One was asleep at the wheel while bad loans ran rampant through industry as a whole; the other all but forced lenders to give out loans to under-qualified borrowers under the auspice of the Community Reinvestment Act, or CRA.

The CRA, introduced in the late 1970s but used by the Clinton administration to support the now-maligned American dream of home ownership, aims to give low-income borrowers equal access to cheap mortgages and other banking services. Think of it as reverse “red-lining,” which is the outlawed practice of refusing to lend in certain neighborhoods that may be perceived as riskier than others.

Homeownership rates — not to mention political backslapping — surged as the housing market boomed, even as borrowers became increasingly exposed to predatory lending and risky loans. Wall Street and banks like Bank of America (BAC), Citigroup (C) and JPMorgan (JPM) saw loan portfolios balloon as low interest rates, securitization and an influx of foreign money fueled the red-hot market.

A lucky few managed to sell at the top; the rest are now left holding the bag, with everything tenuously held together by an ad-hoc glue of taxpayer money and a ballooning national debt.

And while we now know how the story ends, the future, as they say, has yet to be written.

Mortgage regulations, as much as they’ve been tweaked since the crisis began, will undergo an even further-reaching overhaul by the time we emerge on the other side of this mess. Along with the rest the financial industry, laws regarding borrowing and lending are slated for massive changes in the coming years.

Regulators could choose to punish the industry and homeowners alike with oppressive rules and regulations, which will will push up interest rates and prolong the housing market’s eventual recovery. It will, however, do little to punish those actually responsible, since most have either lost their jobs or are living high off their spoils. Sadly, we appear well along this path.

The other option, however politically inexpedient it may be, is to once and for all remove the government crutch from the mortgage industry and let the free market determine interest rates, borrowing terms, and home prices.

To be clear, this is not to advocate lawless cowboy lending, but simple, prudent rules that protect borrower and lender alike without home loan subsidies in the form of artificially low interest rates.

At the center of any responsible regulatory regime is a realignment of incentives. The current system still rewards housing-market actors like real-estate agents and mortgage brokers for encouraging borrowers to make bad decisions. The higher a buyer’s price, the more an agent is paid; the more the terms of the loan favor the bank, the more a mortgage broker stands to profit. This needs to change.

And until it does, as George Santayana said, “Those who cannot remember the past are condemned to repeat it.”

This post first appeared on Minyanville.

As the debate rages about whether or not we’re finally approaching a floor in home prices, let’s examine the value of another asset: The mortgage.

When considering a home-buying transaction, buyers (and sellers) typically worry most about the value of the house. Lenders, on the other hand, are much more concerned with the value of the mortgage.

From a lender’s perspective, the economic value of a loan is its expected future cash flow in the form of interest payments. The key word in that phrase – and why a loan’s value isn’t purely derived from its rate – is “expected.”

To a bank, a loan is just a product, like an iPod is to Apple or a BlackBerry is to Research in Motion. The value of that product is just how much someone will pay for it. Loans with higher coupons, adjusting for risk, are worth more than those with lower coupons, because they fetch more on the open market.

Mortgages, or debt of any kind, are priced relative to their face value, or “par.” A $100,000 mortgage that’s worth par would cost $100,000. Prices are then expressed as a percentage of par. That is, a loan with a face value of $100,000 that’s worth 102.50 (percent) would cost $102,500.

Subprime loans are often considered “bad,” while prime loans are presumed to be “good.” Many assume, therefore, that high-quality prime loans are worth more than those lousy subprime ones. This isn’t entirely accurate.

“Good” loans are the ones where you’re appropriately paid for your risk, whereas “bad” ones are those in which you’re on taking too much risk relative to return. As Professor Sedacca often says, “If you aren’t being paid to take risk, don’t take risk.”

Consider the following 2 mortgage situations, ask yourself which one a lender is likely to value more highly:

Borrower A has impeccable credit, can make a sizable 30% down payment on her family’s first home, but will have to stretch to make the monthly payments because her husband just quit his job to stay home with their second child. The mortgage carries a low 6.00% rate, or coupon, because of Borrower A’s good credit and the low loan-to-value ratio (loan amount divided by sales price).

Borrower B has poor credit, stemming from medical problems that put him out of work for the past 12 months. Credit-card bills piled up, payments were missed and he had a hard time making ends meet. Healthy now, Borrower B is looking to refinance his existing mortgage on the home he’s lived in for 20 years. He needs some extra cash to finish paying off bills and get back on track, so he’s looking for a loan to value of 90%. The mortgage carries a high 9% coupon because of Borrower B’s bad credit and the loan’s high loan-to-value ratio.

I designed the examples to prove a point, but I would take Borrower B’s “subprime” mortgage over Borrower A’s every time. Even though Borrower A’s perceived risk (by the numbers) is less than Borrower B, Borrower A is probably more likely to default. Despite Borrower’s A big down payment, the low coupon may not cover the additional default risk.

Banks often write mortgages with the intent to sell them on the open market. Whether the loan is sold individually or packaged in a security, the higher the coupon, the higher the potential value for the ultimate owner (provided, of course, the risks are properly measured and evaluated).

Mortgage originators (both banks and brokers) and Wall Street firms used this concept to push bad loans onto borrowers. Whether Goldman Sachs (GS) wanted to issue a mortgage-backed security or Wells Fargo (WFC) planned to park the loan on its balance sheet, both earned more from higher coupon loans, so that’s what they asked for from their salespeople and brokers.

One of the most highly sought-after types of mortgages were those with a high loan-to-value ratio, written for speculative investment properties where borrowers didn’t have to state their income. These loans carried a very high coupon because of the high perceived risk of default.

However, since homeowners in areas experiencing rapid appreciation like Phoenix, Las Vegas, Florida and California could easily sell their way out of a problem during the boom, the actual risk on these loans remained low. Wall Street demanded precisely this kind of loan, and brokers wrote them. Whether the borrower could really afford the payments didn’t matter, since they could just sell the house at the first sign of trouble.

Of course, when appreciation stalled, actual risk shot up, and even high rates didn’t compensate banks for the risk these loans now carried.

Since Wall Street could earn far more packaging and securitizing these high-risk loans than they could on boring, low-coupon prime loans, they paid mortgage brokers and bankers higher commissions to write them. These originators, being good salespeople, aggressively marketed these loans to borrowers that fit these highly profitable criteria.

Homeowners, watching their neighbors get rich speculating on condos in Miami, had little to no financial incentive not to join in. That’s not to say there weren’t some who made responsible decisions - but enough people got caught up in the mania that, well, we are where we are right now.

So this brings us back to your mortgage. How much is it worth?

Remember to think about it from the bank’s perspective.

The next time you hear offers like “no closing costs!” or “low introductory rate!”, think about why the bank would do this. If it’s not charging fees to close the loan, you can be sure it’s making up that lost income with a higher rate. If it’s offering a teaser rate, the higher payments you’ll be making when the coupon adjusts upwards will more than make up for that low payment in the first few months.

The best way to get the best deal is to think about what loan will be worth the least to your lender. Low rate, low fees, low risk… Who wants that boring paper?

The answer: You do.