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By Root 730 0

a good chance of paying off the loan: the borrower’s income had to be verified and documented; total housing cost including insurance and fees—no more than 28 percent of borrower’s gross income; total debt (including credit cards, auto loans, etc.) less than 36 percent of borrower’s gross income; the borrower’s payment history could not include too many late payments. The borrower’s money for the down payments and closing costs should come from his own savings, not from, say, a “gift” (which may in reality be a loan) from a relative. The borrower should have a steady job for at least two years, and enough extra cash to cover at least two months of all living expenses and other obligations.This is called prudent lending, and it protects both the lender and the borrower. Prudent lending practices protect the United States economy from mischief makers whose actions, intended or otherwise, could upset the entire U.S. housing market. But as prudence gave way to politics born out of greed, HUD stopped being part of the solution and became part of the problem.

For more than a decade, prudent lending seemed to assuage the fear of losses; but “creative” investment banking ruined even that supposedly safe scenario. If you set up a countrywide system where you overstate the value of an illiquid asset and then lend to borrowers who will have a hard time paying you back, you create bad loans on a massive scale. Cheap money available for loans pushes the prices of homes well above the price of the underlying land and cost to build plus reasonable profit; the prices keep getting pushed upward based on imaginary value and paid for with loans for which few questions are asked. It is as if you created your own third-world country in a bubble.

In contrast, Warren Buffett’s Clayton Homes (through Vanderbilt Mortgage) maintains prudent lending standards—that require a certain down payment, proof of income and employment, a reasonable debt to income ratio—the kind of standards that keep people in their homes and paying their mortgage.

Suppose there is an unemployed man with no source of other income other than his representation that he is a successful Internet day trader. Up until now, he has not been very successful at anything. He has a poor credit history, and he wants to buy a home he could not previously afford. Fortunately, he says he has a flair for gambling—I mean—day trading, on the Internet. He does not wish to provide documents verifying his success, because the key to his successful formula is that is must remain confidential. Furthermore, he does not want to make a down payment on a home since his capital is tied up in his successful Internet day trading strategy, which he says is more profitable than the housing bubble—I mean housing investment. Why tie up money in a down payment when he can use that money to gamble—I mean—increase his fortune?

Fortunately, a mortgage broker, who is completely objective, since his income depends solely on the fees he generates by making mortgage loans, is willing to overlook the absence of documentation. The Internet day trader can state his income, and that is good enough for the mortgage broker. The mortgage lender helpfully informs the day trader that there have been mortgages made to people who apparently cannot afford them other than the fact that they are willing to state an income which suggests they can make the payments—so climb on board.Warren Buffett would likely have asked whether or not the trader can pay him back. He would undoubtedly ask for documentation.

After a few months, the mortgage broker calls the day trader with good news. The appraised value of homes in the day trader’s area has gone up, so the day trader has equity in his home. The mortgage broker asks if the day trader would like to take out a home equity line of credit, which can then be used to make the payments on the mortgage of another home, an investment property.Yes? Great! (In contrast, Warren Buffett avoids investing in any business [in this case the loan from a shaky borrower] that has excessive leverage,