Reply #60: Interest only mortgages insulate banks from downside [View All]

[1932]

interest + fees = bank profit. Paying down principle = ownership of house transferring away from bank.

With interest only mortgages, banks make sure they get their profit up front, so when people default, the bank not only got its profit, but gets all your house, whatever it's worth.

That's an oversimplification, but I think it isn't too far off from reality.

Anyway, I don't think banks are going to be hurt by this. I think banks are going to own a lot of real property as a result, and that a lot of people who own homes will really be renting their homes from the bank (which is what happens when you pay a lot of interest but never the principle on loans). I saw in the paper that some banks in CA are now creating new interest-only mortgages for people whose old interest-only mortgages are in their balloon payment phase. They're basically another interst-only short term loan with an even bigger balloon payment in a couple of years -- ie, homeowners will be renting their homes from the bank.

I think the economy will suffer not because banks (the richest companies at the top of the pile) will suffer, but because the economy is built on consumer spending and it's not clear how much debt people are willing to go into to fuel the economy with consumption -- and I think it will be small businesses that suffer first. I think the biggest will be able to hold out the storm and perhaps find themselves with more economic power once we come out of it (unless and FDR-like president implements on program founded on the principle that the only way we can come out of depression is to redistribute economic power down to those without economic power, small businessman, and worker alike).