Greed and fear are the two great motivators. However, if greed dominates fear, then we become blind to some obvious dangers.

Recently, something went badly wrong with the US mortgage market. Somehow, people forgot fear and focused on greed. Banks started to give out loans without considering whether people could pay the money back.

Normally, bankers should treat all potential borrowers with the utmost fear. Borrowers can destroy banks. Borrowers can default on loans, delay payment and provide fraudulent information. If I may paraphrase Mad-Eye Moody from Harry Potter, Banks need "constant vigilence" when confronting those nasty potential defaulters and defrauders that go under the name of borrowers.

Here is an article from It sheds some light on how banks stopped fearing borrowers and just handed out cash without any serious consideration of the risks. The answer appears to be straightfoward. Incentives changed. Origination volumes became more important than long term profitability.

Soon, the pendulum will swing the other way; greed will stand aside and fear will take over. Banks will tighten credit, risk premia will again become important, and as credit becomes more expensive, both consumption and investment will fall. When that happens, an old ghost will return to haunt America – recession.

The nonprime mortgage business is in a mess because during the boom years, hardly anyone had an incentive to say no.

The people who take applications, the companies that lend the money, the appraisers who check property values, the investment banks that sell mortgages to investors and the investors themselves -- all had millions of reasons to keep mortgages flowing to borrowers who couldn't afford them. Each reason had a dollar sign attached to it. As long as each participant kept saying yes to risky borrowers, everyone made money.

"It's like we were originating willy-nilly, with abandon, and the consequences be damned," says Christopher Cruise, who trains brokers and loan officers. "As Americans, we're accustomed to not being told no. ... If we want to have a mortgage loan and we want it now, we don't want to hear about the potential consequences down the road."

That goes for borrowers and also for the players throughout the mortgage industry. The siren song of bountiful paychecks drowned out the murmurings of conscience.

"Are there individuals and folks in the supply chain here and there that don't care, or don't necessarily have the borrower's best interest at heart?" asks Jim Svinth, chief economist for "Yes. But that can be said about just about any industry where people are paid on commission."

Make the deal, dump the risk

Much ink has been spilled on the meltdown going on in subprime mortgages, which are home loans for people with flawed credit histories. Analysts believe problems will show up in Alt-A mortgages, which go to borrowers who have so-so or even good credit, but who don't document their income or assets. A lot of interest-only loans can be lumped into the Alt-A category, too. Together, subprime and Alt-A are known as nonprime.

The mortgage industry is set up in such a way that the participants chase after profits while dumping the risks onto someone else. The chain of buck-grabbing and buck-passing starts with mortgage brokers and loan officers -- the men and women who work face-to-face with borrowers.

Brokers and loan officers make their livings by persuading people to get mortgages. There's no profit in telling an applicant that he has no business buying a house. Except in cases of flagrant fraud, brokers and loan officers don't suffer consequences if their customers later fall behind on their house payments.

'We don't really care'

"For us, as frontline originators, there isn't a direct correlation between loan performance and compensation, so we're disconnected from these failures so long as there's no fraud. In a way, we really don't care that much," Cruise says.

If that sounds harsh, here's what two other mortgage men have to say:

"They have no skin in the game. They'll do anything to get a commission," says Bob Walters, chief economist for Quicken Loans.

"The loan officer's incentives are not aligned with the consumer or the lender," says Jeff Lazerson, president of Mortgage Grader, a flat-fee mortgage brokerage where brokers don't draw commissions.

Behind the brokers and loan officers are the companies that do the actual lending. During the nonprime boom years of 2003 to the middle of 2006, lenders had an incentive to approve mortgages to uncreditworthy borrowers because lenders don't hang onto loans for long. They sell most home loans to investors. Lenders thought they were in the clear after selling loans: If the borrower fell behind on the payments, the investor -- not the lender -- would face the consequences.