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.