The Deceptive Practices of Balloon Payments, Adjustable Rate Loans and Bullet Mortgages

ByPrimary Researcher

Executive Summary

  • The banking industry is filled with deceptive practices that make loans unsustainable.

Introduction

Private banks have a long history of creating deceptive loans that are designed to turn borrowers into debt peons. One method is to push borrowers into permanent loans. One such tactic was the bullet loan, which is described in the following quotation. The following quote describes the similarity of the payday loan to the bullet loan.

“We review this history to show that the consumer financial protection problems with financial exclusion and predatory lending in AFS are actually quite similar to problems that the federal government has successfully regulated in the past through the use of public options. Indeed, in concentrating liquidity risk on the borrower, the structure of a payday loan is functionally similar to that of the Depression-era bullet loan. This history also suggests a final note of caution: Absent regulation, financially fragile loan structures tend to reemerge rapidly. Immediately following the deregulation of the financial industry in the 1980s, adjustable rate mortgages (ARMs) reemerged, which redistributed interest rate risk back towards borrowers. Many of these mortgages also redistributed liquidity risk back towards borrowers. These loans came with low initial interest rates that would eventually reset at a higher rate after an initial “teaser” period, thus requiring borrowers to refinance the loan in order to remain solvent.” – The Public Banking Solution

Source: The Public Banking Solution

https://www.amazon.com/Public-Bank-Solution-Austerity-Prosperity/dp/0983330867

A major part of this is to place the risks on the borrower and away from the financial institution. This is covered in the following quotation.

“The creation of a stable mortgage structure during the New Deal provides an excellent case study of how public options can be used to regulate in the public interest by shielding households from risk. Stable mortgages in the U.S. only emerged due to direct government intervention to address the foreclosure crisis, which contributed to the Great Depression. Prior to New Deal reforms, the structure of mortgages concentrated risk on households. These loans typically had terms of 3-5 years but were not fully amortizing, and so they required a large payment at the end to fully pay off the loan. This structure earned these mortgages the nickname “bullet mortgages” because of the large “bullet” payment at the end the loan term. Borrowers typically depended on the extension of a new mortgage at the end of the loan to prevent foreclosure (Levitin and Wachter 2013). The financial fragility of this structure was revealed during the Great Depression. At the height of the Great Depression in 1933, roughly one half of the mortgages in the country were in default, and 10 percent were in foreclosure.” – The Public Banking Solution

However, this allowed the banks to reap the benefits of foreclosure. Private banks like fragile systems that allow them to strip assets from their borrowers. The government should have the opposite incentive, to reduced financial instability. This was the point of creating the secondary mortgage market purchasing entities of Fanny Mae and Feddie Mac. There is a clear pattern at work here and it is duplicated by the removal of Glass Steagall provisions. The US, under extreme pressure from corrupt profit-seeking private banking interests, has increasingly removed the financial reforms of the Great Depression and is now much closer to pre-depression levels of regulation than at any time since The Great Depression. Even the FDIC, which was passed in response to the bank failures of the Great Depression is now inadequate for the job, given the size and concentration of the major banks. The FDIC would be unable to bailout a single bank failure among the largest. However, even though concentrated banks concentrate risks, and make these megabanks virtually impossible to regulate, they have been allowed to consolidate in any case.