Did Lack of Regulation Create the Subprime Mortgage Crisis? 22 comments
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I’m asked this all the time. The short answer: Of course not. Nowhere close. Not a chance. Here’s the long answer.
What regulations have we had? The mortgage originator—your local bank or mortgage broker—was under regulations not to discriminate and to inform you of your interest rate. Those papers you signed without reading? Many of them were “Truth in Lending” disclosures designed to protect you from getting into something you didn’t understand. However, if you didn’t read them, maybe they didn’t protect you.
But you were not the one lending money to a borrower incapable or unwilling to pay the money back. That was your banker. He was not regulated because he didn’t have any risk. He immediately turned around and sold your loan, along with a thousand other loans, to a Wall Street investment bank, which formed the many mortgages into a mortgage backed security or a “collateralized debt obligation.”
There were no regulations protecting Wall Street investment bankers from lending deadbeats money. The idea is that they are smart enough, sophisticated enough, to take care of themselves. (That turned out to be a bad idea, but it was the idea behind the lack of regulation.)
How did these rich, sophisticated investors make such a huge mistake? First they experimented. They tried small variations from the old traditional loans. Variations like adjustable rate mortgages. Low-down-payment mortgages. No documentation mortgages. (How else would strippers who make their living from tips be able to borrow money?)
These experiments worked well. Surprisingly well. Why? Because it was a rising real estate market. Borrowers who were unable to make their payments simply sold their homes at a profit. No big deal, and no default or foreclosure on the mortgage.
The crucial mistake that Wall Street made was extrapolating from the good times to the bad times. They assumed that these subprime mortgages would be good all the time because they had been good in the rising house market. Oops.
Would more regulation have helped? Maybe we could have protected Wall Street investment bankers from themselves. Maybe with good regulations they would not have to give up their summer homes in the Hamptons. Maybe.
In reality, regulatory policy has worked in the opposite direction. The government wanted more risky loans made, not less. For example, the Community Reinvestment Act pressured banks to make loans in poor neighborhoods. Banks (and I was a banker under the CRA) figured that making some bad loans was just another tax, a cost of doing business as a regulated company. In 1995, the Clinton administration revised the CRA to increase pressure on banks to make more loans to risky borrowers. In 1997, the first pool of subprime mortgages was securitized (by Bear Stearns!)
The law regulating Fannie Mae (FNM) and Freddie Mac (FRE) was rewritten to reduce their capital requirements, meaning they would become riskier. Some critics were concerned about the risk, but here’s what the distinguished Congressman Barney Frank had to say at the time:
''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''
New York Times, September 11, 2003
At the height of the real estate boom, the United States set record home ownership rates. Politicians, including President Bush, bragged about their success at getting Americans into their own homes. As recently as August 2007, the President bragged that he was helping Americans get homes with lower down payments and higher loan limits. He also signed a law making it easier for homeowners to walk away from their mortgage obligations.
Would more regulation have reduced the number of bad loans made? Most likely, more regulation would have increased the problem.
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This article has 22 comments:
may be the elimination of the CDO itself - where the loan is sold individually. this would improve transparency. a bank would not issue a loan they could not resell.
predatory lenders (collecting big fat fees from uninformed buyers) created the problem.
> jack
Banks that loan money to people who can't repay the loans are poorly run businesses that should fail if they make too many bad loans.
And, people who take out loans they know there is a good chance they can't repay (they don't have reliable jobs) should go to debtors prison.
I'm joking, of course, about debtor's prison but the fact that debtor's prison is still part of our vocabulary even though it was abolished more than a hundred years ago, tells you something about the propensity of people to borrow a lot more money than they can ever hope to pay back.
"Eat, drink and be merry, for tomorrow you may die" is part of human nature, just as other human weaknesses are. We have laws to protect ourselves from these kinds of excesses and cops and prisons to enforce the laws.
But these moralizing details are boring until everything falls apart. Then they are just common sense.
offer, I shook my head, by the time I received my second such offer I
felt someone would end up in trouble. Too, bad it proved to be us along
with the rest of the world. Greed and stupidity don't make for healthy
economies.
If I were king and had to assign blame (in order to know who to hang) for the current mess, it would go like:
1. Alan Greenspan (kept rates way to low, way to long)
2. Congress (who collectively lived up to Mark Twain's assessment)
3. The ratings agencies who let fees get in the way of honest ratings
4. This last one would be a bundle of dishonest buyers who wanted a quick flip, bankers who (as pointed out above) had little incentive to make a good loan, and investment bankers who created financially engineered products that could not withstand the stress test.
Someone (or many someones) will make a bundle writing post-mortem books on how this all happened.
I'm so glad you explained it for us economic illiterates.
You kind of breezed passed the whole subject of "dirivatives" a monster created wholly by the financial industry. Of couse these were completely UNREGULATED and everybody was so busy collecting a commission on "credit default swaps" that nobody checked to see if the people who were selling this "insurance" could actually pay up if things went sour. OOPS!
It's the dirivatives and the off balance sheet garbage that has every body soiling themselves. AIG was on the hook for a bunch of these and when they had to pay up they didn't have the cash. That's why they went bankrupt and we now own 80% of their sorry rears.
Then there is the whole question of "transparancy". This garbage is so convoluted and slip shod that few if anyone understands them. Nobody knows how much of it is out there or who has it. It's kind of a grizzly version of Old Maid.
The banks know this, it's a big part of the reason they won't lend to each other.
You also fail to mention that our fearless leaders in Congress are idiots and whores. Fannie and Freddie were throwing obscene amounts of money at them to get them to loosen lending standards and let them increase their leverage to insane levels. Congress didn't FORCE them to do anything.
Ditto every other Financial institution on planet earth.
These same idiots and whores are now falling all over themselves to dish out $700 billion of taxpayers money to them.
I'm puking in my wastebasket.
The core problem was and is subprime lending combined with the housing bubble (which subprime lending helped foster).
The seed of this crisis was planted by ACORN and their push for sub-prime lending with the CRA. CRA led to massive increases in subprime lending, and massive increases in subprime lending is at the root of this.
ACORN was represented by Barack Obama when he was a leftwing community activist. Barack Obama was the attorney representing ACORN in their effort in the 1990s to loosen lending standards. The efforts by ACORN worked. An enthusiastic Fannie Mae Foundation report in 2003 singled out one paragon of nondiscriminatory lending, which worked with community activists and followed “the most flexible underwriting criteria permitted.” That lender’s $1 billion commitment to low-income loans in 1992 had grown to $80 billion by 1999 and $600 billion by early 2003. That company was Countrywide Financial, which also gave sweetheart deals to Democrats in Congress like Sen Chris Dodd for political cover.
Bad underwriting was getting hidden by corrupt CEOs like Franklin Raines and Jim Johnson at Fanne Mae and hackles were raised. But Democrats turned back the efforts to reofrm Fannie Mae. In 2005, Obama protected Fannie Mae when McCain and Republicans wanted better oversight of them. Fannie Mae underwrote close to a trillion in subprime loans in the past 4 years, inciting the current mortgage crisis.
Putting leftwing activist Obama and his fellow Democrats Dodd etal in charge is rewarding incompetence, corruption and bad intentions. It’s like putting an arsonist in charge of the fire department. The pro-Obama media will not tell the truth about Obama’s links to ACORN and CRA, and will not point out the serious links that tie him to left-wing extremists or to the corrupt insiders to incited this crisis. They will continue to lamely and falsely blame "deregulation" when in fact GOVT INTERVENTION AND LEFT-WING ACTIVISM is the real problem.
It's a travesty.
I am poor, so are 60% of the United States, but I did not borrow money to buy a house in the last three years.
ACLU, ACORN and a lot of demeneted and apeasing liberals demanded poor people get loans to buy houses in the this fraudelent booming economy.
Banks and Wall Street found the answers to these potential discriminating lawsuits.
Now, the United States suffers and some poeple blame the Federal Reserve, including Greenspan; blame the apartheid and appeasing liberals. This far side force these loans and conditions while people with greed help the booming economy grow through fraud.
Fraud; realtors and developers blackmailed appraisers to increase the value of the house geometrically or lose their jobs.
Arrest them all!!!
I hate how clearly by-partisan caused financial problems are used as political fodder. I'm not going to argue with your specific points (almost every politician has a closet full of skeletons), but you're blinded by ideology if you don't think our current crisis could not also be easily and factually blamed on screw-ups on the right. And your boy McCain has looked like a buffoon in his statements, actions, and 180-degree reversals during the past 10 days (I'm not talking about the debate, which seemed like a draw). I don't know how anyone could be RATIONALLY excited about either candidate right now, unless your they type to "rah rah" your party, no matter what the situation.
I get so frustrated with McCain and Palin not just BATTERING Obama and Biden on this garbage about de-regulation being the cause of this crisis as opposed to the REAL cause... the Democratic policies forcing these lenders to give loans out to people who could not afford them or didn't care to. Thanks Barney Frank, Chris Dodd, and Chuck Schumer, just to name a few of the biggest culprits.
I think it is a joke that Obama and Biden say that this crisis is the result of "8 years of failed policies"... please. The policies that DID cause this crisis began in the late 90's under Clinton. Bush, Snow, McCain Greenspan and others expressed great concern in the early 2000's... but Frank, Dodd, Schummer, and their buddies in the "D" party blocked the legislation intended to address the problem. There you have it. Not to mention...I seem to remember everyone feeling pretty good about the economy up until about... oh, 2006. Hmmm.... I wonder what changed around that time... Oh, that's right... the House and the Senate went to the Democrats.
regulation makes people believe they are safe when in reality they are not.
On Sep 28 05:47 AM The hand wrote:
> there has to be a solution to prevent it happening again - because
> it will happen again as soon as the market recovers, the housing
> prices start their rise again, and all the people involved in this
> process are retired.
>
> may be the elimination of the CDO itself - where the loan is sold
> individually. this would improve transparency. a bank would not issue
> a loan they could not resell.
>