Let's fix this subprime mess

If you want a taste for what life was like inside some of these joints, rent the movie "Boiler Room" and substitute risky mortgages for stocks. The other props would be the same, including young guys running around in expensive sports cars and a relentless pressure to sell, sell, sell -- even if you had to lie, cheat or steal to close the deal.

The brokers arranging these loans didn't care about the fallout, because they didn't have to. The loans were bundled up and sold to investors. If borrowers defaulted because they were given far more mortgage than they could afford to pay, it was the investors' problem.

Stupid products, stupid investors

Investors' willingness to gamble fueled the go-go atmosphere. Wall Street firms kept pushing mortgage lenders to come up with higher-yielding loans to sell to their customers.

Investors "demanded this stuff," said mortgage expert Dick Lepre, a California loan officer who writes a weekly newsletter on the mortgage business. "I blame the overabundance of money and the willingness of people who ran hedge funds to invest in stupid products."

• Talk back: How has the subprime crisis affected you and your area?

It's not as if we couldn't see the end coming. All the way back in 2004, when I wrote "Are there too many homeowners?," there were already clear signs that the mortgage industry was going off the rails. But it was still hard to conceive how far lenders would be willing to go to generate loans -- which is why I agreed with Alan Greenspan at the time that a national decline in real estate prices was "unlikely." Now, it's reality.

"People generally still believe that a lender wouldn't make a loan unless you were qualified to pay it back," said Paul Leonard, director of the California office of the Center for Responsible Lending. "I don't think the shift to this 'buyer beware' market has translated into broad public knowledge or consciousness."

Of course, we can't just blame lenders and Wall Street and let consumers off the hook. Not every borrower was deceived into accepting a hazardous or unsuitable loan. Many walked into these loans with their eyes wide open and simply dismissed the risks.

Others, though, trusted their loan officers and mortgage brokers to do what was right. In hindsight, we know that trust was sadly misplaced. But mortgages are incredibly complex transactions and borrowers typically want a helping hand to guide them. Furthermore, folks who turn to the subprime market for money tend to be the least sophisticated consumers -- and the most easily misled.

4 ways to stop this nonsense

Since we're all going to pay in one way or another for this fiasco, we should all do what we can to ensure it doesn't happen again. Congress would make a good start with the following reforms:

No more "teaser" qualifications.Earlier this summer, federal financial regulators issued a "best practices" guide for lenders that discouraged them from using low, initial teaser rates to determine how much mortgage a borrower could afford.

Well, duh.

No loan should be made unless the lender has taken reasonably steps to ensure the borrower can repay based on the real rate -- the fully indexed, fully amortized rate that would be required to pay off the loan over 30 years (or however long the term). Lenders also should be required to factor in homeowners insurance premiums, property taxes and the borrowers' other debts when determining their ability to repay.

• Video: Is the worst yet to come?

This is common sense, but common sense was in extremely short supply during the subprime mortgage boom. Some qualifications were based on rates as low as 1%, when the borrower had no hope of making the payment when the rate eventually adjusted.

For a realistic look at what you can afford to repay, try out MSN Money's Home Affordability Calculator. It limits the amount of your gross income that can go to monthly debt payments (such as mortgages, credit cards and student loans) to a maximum of 42% -- and that's only if you've got excellent credit.

Continued: Limit liars' loans

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