Why the Toxic Paper Crisis Will Continue

It started when Congress forced banks to increase lending to subprime borrowers and those who simply couldn't afford to repay loans after the initial teaser rates expired.

The subprime borrowing sunk Fannie Mae and Freddie Mac precisely because no one sought to limit just how much money was extended to those incapable of repaying their commitments.

Now, the same elements that initiated the global crisis are set to break Federal Housing Authority.

As if they haven't done enough damage. Thousands of subprime mortgage lenders and brokers—many of them the very sorts of firms that helped create the current financial crisis—are going strong. Their new strategy: taking advantage of a long-standing federal program designed to encourage homeownership by insuring mortgages for buyers of modest means.

You read that correctly. Some of the same people who propelled us toward the housing market calamity are now seeking to profit by exploiting billions in federally insured mortgages. Washington, meanwhile, has vastly expanded the availability of such taxpayer-backed loans as part of the emergency campaign to rescue the country's swooning economy.

For generations, these loans, backed by the Federal Housing Administration, have offered working-class families a legitimate means to purchase their own homes. But now there's a severe danger that aggressive lenders and brokers schooled in the rash ways of the subprime industry will overwhelm the FHA with loans for people unlikely to make their payments. Exacerbating matters, FHA officials seem oblivious to what's happening—or incapable of stopping it. They're giving mortgage firms licenses to dole out 100%-insured loans despite lender records blotted by state sanctions, bankruptcy filings, civil lawsuits, and even criminal convictions.

This has been the problem with the bailout all along. It never dealt with the underlying causes for the crisis in the first place. The Bush Administration and Congress sought to paper over the mess with lots of cash.

The real problem is that the rules put in place by Congress to increase the numbers of homeowners in the name of affordable housing have been anything but affordable.

It's going to cost the nation and investors trillions of dollars.

The real estate correction should have brought a reckoning on how lenders decide who is a worthy credit risk, but with Congress meddling in requiring more borrowing to minorities - who also happen to be more often than not subprime borrowers - the banks have no choice but to lend. Throw in predatory lenders - those who skirt the rules and push low teaser rates and little or no money down followed by severe increases in the monthly repayment rates, and you've got a recipe for disaster.

Add to that the fact that the FHA isn't exactly policing its own holdings and those that are backed by FHA guarantees:

Similarly worrisome stories are playing out around the country. In Tucson, First Magnus Financial specialized in risky "Alt-A" mortgages, which didn't require borrowers to verify their income. State and federal regulators cited the company for misleading borrowers, using unlicensed brokers, and other infractions. It shut down last summer and laid off its 5,500 employees. But in May, the FHA issued a group of former First Magnus executives a new license to make taxpayer-insured home loans. They have opened a company called StoneWater Mortgage in the same office building that First Magnus had occupied.

If it walks like a duck, talks like a duck, it's a duck. As much as the StoneWater people want to claim that they're not First Magnus, they sure seem to operate just like First Magnus, which is bad news for the FHA and everyone else.

Then there are the companies who are doing business with FHA despite having default rates that are double the national average. All that is doing is diluting the FHA creditworthiness, and undermining faith in the system and the government's ability to stabilize the markets.

Yet, Congress will only see fit to throw more money at the problem, rather than rectify the mess by demanding a tightening of credit requirements. It might hurt minorities more than most, but then again many of those people should never have been extended credit in the first place because they couldn't verify income and lacked the means to repay loans over the long term.