RIGONOMICS:Mortgage woes not taxpayers' problem

This week has seen turmoil for the financial markets. The seeds of this turmoil started right here in Orange County, which is ground zero for the sub-prime mortgage industry.

These are loans to buy or refinance homes for less-than-creditworthy borrowers. The chickens have come home to roost, as many borrowers cannot or will not make their payments. Many of the homes purchased in the last couple of years are worth less than what is owed.

Unlike in the past, these homes were sold with 100% financing. Any drop in value and the loan is underwater.

In Econ 101 you learn very quickly that people and businesses will do what is rational. In the last two to three years what has been rational for lenders is to make what may look like risky loans — zero down payments, bad credit, etc. Because the property that these loans were secured against was rising in value, the lenders were always secure. In case of a default, the lender could always recoup the loan amount from the sale of the property.

In most cases, if a borrower got behind they would sell the house on the open market and put cash in their pocket.

Lending and borrowing have intrinsic risks to both parties. Let's look at the rational decisions each party made at the time the loan was given.

The lenders charge interest and fees for the loans. They enjoy great profits on loaning money at higher rates than their cost of funds. What about the borrower/home buyer? They made a rational decision to buy the home with no money down. They risked nothing because they put nothing down. They also got a tax deduction to subsidize their payments.

Clearly, looking back now, we can see that these buyers, with nothing to lose, bid up property prices.

Part of today's drop in prices is just the lack of buyers who were buying with no money down. Now that these people are out of the market, prices have come down.

Now we hear from presidential hopefuls and other politicians on the left that the U.S. taxpayer should bail out these borrowers because they did not know what they were doing. Their argument is that it is mean-spirited not to help them keep their home.

Don't get me wrong: If a lender wants to negotiate a loan with a borrower for a lower interest rate or payments, I am fine with that. In many cases it is in the lenders' best interest to keep the borrower in the house and get some payments.

But a government bailout would be the worst thing that could happen.