Subprime Borrowers: Not Innocents

A simple look at the blunt reality reveals that borrowers themselves should assume primary responsibility for the current subprime crisis. Millions of borrowers, all over the country, knowingly signed mortgage contracts they cannot now afford to honor.

Provided that lenders did not engage in force or fraud—and there’s no particular evidence they did so on a large scale—borrowers should do whatever they can to live up to the contracts they signed. The policies of lenders and government certainly helped the current crisis develop—but ultimately, do not absolve borrowers of responsibility for their debts.

And in most cases, the mortgage lenders not only are innocent of the predatory practices borrowers complain about but also are feeling the pain right along with them. These lenders do not revel in the current circumstances. A lender typically loses about a third of its loan value through foreclosure; thus, no lender (or mortgage-backed securities marketer) has an incentive to make or purchase a loan it genuinely believes a borrower cannot pay.

With a very few exceptions, lenders have no desire to serve as landlords or take away people’s homes: A foreclosure causes almost as many problems for the lender as it does for the borrower. True predatory lenders, who engage in fraud or make loans they know borrowers cannot pay, inevitably end up in either jails or unemployment lines.

The government played some role in the crisis as well. Its tax system encouraged Americans to take out very large mortgages to get out of paying federal income tax. And the government’s 2005 bankruptcy reforms meant that rather than having their debts wiped clean, most middle-class Americans who file for bankruptcy have to set up five-year payment plans with creditors.

Not one of these factors, of course, mitigates the facts of the situation. Mortgage borrowers who signed legally binding contracts should have to honor those contracts, or at minimum, renegotiate terms with their lenders. Any suggestion that borrowers should avoid responsibility would undermine the fundamental principles of contract law that lie at the base of any modern capitalist economy.

This column originally appeared in The Debate Room in BusinessWeek.