The Failed Subprime Clampdown

Matt Apuzzo's excellent article on how the goverment failed to rein back subprime mortgage lenders paints a picture of deregulation run amok:

The administration's blind eye to the impending crisis is emblematic of its governing philosophy, which trusted market forces and discounted the value of government intervention in the economy. Its belief ironically has ushered in the most massive government intervention since the 1930s.

My take however, is that the truth is more mundane: the proposals simply got killed by the fact that there were too many regulators, none of which had the breadth necessary to implement something along these lines. This is only the beginning:

The government's banking agencies spent nearly a year debating the rules, which required unanimous agreement among the OCC, Federal Deposit Insurance Corp., Federal Reserve, and the Office of Thrift Supervision.

More importantly:

The comptroller of the currency, John C. Dugan, was among the first to sound the alarm in mid-2005. Speaking to a consumer advocacy group, Dugan painted a troublesome picture of option-ARM lending. Many buyers, particularly those with bad credit, would soon be unable to afford their payments, he said. And if housing prices declined, homeowners wouldn't even be able to sell their way out of the mess.

It sounded simple, but "people kind of looked at us regulators as old-fashioned," said Brown, the agency's former deputy comptroller.

Diane Casey-Landry, of the American Bankers Association, said the industry feared a two-tiered system in which banks had to follow rules that mortgage brokers did not.

This is worth underlining. Even if the OCC, the FDIC, the Fed, and the OTS had miraculously managed to come to unanimous agreement on curtailing subprime lending, it still wouldn't have helped much -- because between them, they only had regulatory control over banks. Any subprime lenders which didn't take deposits -- and there were hundreds of them cropping up all over the country, originating loans and selling them on to investment banks to be packaged into bonds -- would have remained outside the regulatory reach.

In other words, without major regulatory consolidation, nothing effective was going to happen in any event. There's a general consensus in Washington now that we need a super-regulator with teeth, and the US might be able to learn from the UK's lessons in setting up the FSA. Once we have that, doing things like clamping down on subprime lending might become a great deal easier.

Comments

[john s. gordon:]

yes please regulate before any more disasters occur.
> jack

2008 Dec 03 08:02 AM

[Smarty_Pants:]

Why does everyone concentrate on the origination issue? Why not the ratings agencies slapping a AAA label on garbage? Or the investment banking purchase, repackaging, and resale of obvious junk as 'prime' paper? Or the GSE purchases of same?

There were plenty of points in the chain of events where regulators (or other participants) could have stopped the runaway train. If the unregulated mortgage lenders hadn't had a ready market to snap up the crap they were generating the number of such loans would have been miniscule.

Keep in mind that top level politicians like Blarney Frank WANTED these kind of loans to be made so he could crow about how the underpriviliged had 'gotten ahead' as a result of his efforts.

With power players pushing for ever more home ownership without thought of the eventual consequences, there was in reality little that regulators could do to stop the process without fear of reprisal from above (which is, in fact, a primary driver for the selective enforcement of 'regulations' on a federal level).

Nitpicking over whether there was 'too little' or 'not enough' regulation at this point is like closing the barn door after the horse has run into the highway and been creamed by an 18 wheeler. The horse is dead. It won't be coming back any time soon, nor will "high" real estate prices that everyone is trying to prevent from correcting to sustainable levels.

The economy won't be recovering in earnest until the prior debt is liquidated and someone takes the associated losses. The path we appear to be on is having the gub'mint print so much money that the losses from bad debt are taken via the eventual loss of purchasing power of the public.

2008 Dec 03 09:28 AM

[g7enn:]

SUB-PRIME MORTGAGE WOES ARE NO ACCIDENT

In 1995, a senior Clinton Administration official shared with me the Administration's targets for Fannie Mae and Freddie Mac mortgage volumes in low- and moderate-income communities. We had recently reviewed the Administration’s plans to increase government mortgage guarantees — most of these mortgages would also be pooled and sold as securities to investors. Even in 1995, I could see that these plans would create unserviceable debt loads in communities struggling with the falling incomes expected from globalization. Homeowners would default on mortgages while losses on mortgage-backed securities would drain retirement savings from 401(k)s and pension plans. Taxpayers would ultimately be hit with a large bill . . . but insiders would make a bundle.

I looked at the official and said that the Administration was planning on issuing more mortgages than there were houses or residents. “Shut up, this is none of your business,” the official snapped back.

Recently, we have seen numerous press accounts of bank and hedge fund losses from sub-prime mortgages. Remarkably, these reports imply that the losses are the result of a market downturn or contracting credit cycle. But there has been no mention of the extraordinary profits that were generated or who reaped them. There is no mention of who is poised to make a fortune on the bubble collapse. Even the most sophisticated commentators of our day are describing this financial coup d'etat as the unintentional consequence of "market forces."
solari.com/news/announ.../

2008 Dec 03 09:55 AM

[John Lounsbury:]

g7enn - - -

Good comment. We have had the perfect storm of misguided social engineering, ineffective regulation, opportunistic greed and an economically illiterate populace (including our elected officials).

Free market philosophy? It has been too much free wheeling and not enough free will.

Too much government? Some say too little government. Both positions are wrong. The problem is not the size of government; the problem is the effectiveness (actually, the lack of effectiveness) of government. It is perhaps too idealistic, but, in addition to national security, we desperately need a government that provides an environment for individual and group initiative. We need a government that coordinates social structures needed for societal improvement, not a government that provides all social services. We need a government that does an effective cost/benefit analysis of all tax money expenditures. We need a government with enough intellectual capacity and curiosity to evaluate unintended consequences of all initiatives. You say that would gridlock government? I say not gridlock but well considered actions would result.

We just voted for hope. Is the ideal I describe too much to hope for?

2008 Dec 03 01:17 PM

[axelrod608:]

Keep in mind that there WAS one protection in place. Fannie, Freddy, FHA, HUD, FmHA and banks all required PMI - private mortgage insurance - on all loans with less that 20% of the borrower's money down. There should have been PMI on all the subprime mortgages.

Unscrupulous lenders, mortgage originators and processors and closing agents pushed combo loans - 20% high interest loan for the "downpayment" plus an 80% low interest loan - to avoid the added cost of PMI. They simply did not follow the rules and thereby took away the protection that was required by law.

The single most disturbing thing about the subprime mess is that the Federal and States' Attorneys General are doing NOTHING to the folks who made and closed subprime loans without the required PMI. They should ALL be headed for or in jail and should have reparations requirements for when they get out.

Heck, they are all LICENSED by the states and their licenses haven't even been pulled. They're all still out there, scheming how to get around whatever new regulations may be made. Our governments are BROKE. They can't protect us. They're not even trying.

2008 Dec 03 01:20 PM