THE LENDER SHOULD KNOW THE BORROWER. THE LENDER SHOULD DETERMINE IF A PROSPECTIVE BORROWER WILL BE ABLE TO PAY BACK THE LOAN. (EVERYONE WITH ME SO FAR?)
Risk is involved. The lender is entitled to charge interest in proportion to that risk. Some of those loans will default. If the lender has done his job properly, he (she) will have the principle repaid with interest. If the lender has been astute, relatively few loans will default and he has set the interst rate optimally, he will make a fine profit.
Now that lender is in competition with other lenders. Whichever lender has more skillfully lent money, that lender would be rewarded proportionally. CAPITALISM AND FREE ENTERPRISE AT ITS FINEST!
In 1938, Fannie Mae (FNMA) was established to create a secondary market for mortgages so that banks could sell those morgages to other financial institutions.
The good news was the risk could be spread around. The bad news is that the lender would no longer know the borrower.
Bankers are no different from a barber who is aked “Do I need a haircut?”. If banks can lend money for a mortgage and then sell that mortgage to some other financial institution, that bank can start “selling pigs in a poke” and no longer is kept from making bad loans.
Therefore goverment oversight became necessary to compensate for the effect of the creation of that secondary market.
Under banners of :”The government is the problem”, “Let the market work”, “Get the government off our backs” , “Free Enterpise”, etc, lobbyists descended upon Congress. Most Congressmen and Senators are not PhDs in economics and some of those who are, like Phil Gramm have their own agenda.
If banks that set up mortgages had to assume the risk of that morgage, goverment oversight would not have been necessary.
Imagine if you could lend money to people around town collecting I.O.U.s and then then split them up, rebundling them and selling them to others who in turn would resell them, you would be less concientious of risk assessment.
Does any of this make sense?