Unscrupulous lenders who deceptively sold subprime mortgages to millions of Americans should be fined and the proceeds used to help bail out borrowers facing a wave of foreclosures, according to Barack Obama, the Democratic senator running to be his party’s presidential candidate...
Writing in today’s Financial Times, Mr Obama blamed lobbyists working on behalf of lenders for obstructing tougher regulation of the subprime industry, adding: “Our government failed to provide the regulatory scrutiny that could have prevented this crisis.
“While predatory lenders were driving low-income families into financial ruin, 10 of the country’s largest mortgage lenders were spending more than $185m (€136m, £92m) lobbying Washington to let them get away with it,” he wrote, citing figures from the Centre for Responsive Politics.
Obama's harsh rhetoric is shallow and ill-conceived by most economic standards. Foreclosures are painful, not profitable, for lending institutions. These businesses have very little incentive to repossess on shaky subprime mortgages. As painful as it sounds to those struggling to make payments, the unwise consumer who borrowed more than he or she could afford, and poor planning on the part of the lender, are the principle financial villains in this story. Yes, some people were probably not fully informed on the ramifications of these adjustable rate mortgages. Nonetheless, "learning the lesson" of mortage marketing doesn't come easily. Bailing them out or punishing a business that is losing out does little to rectify potential future crisis: will this happen again? Certainly, no one wants perpetual problems with subprime lending. People need to learn their lesson, and a painful one at that. The Economist confesses that, "The retreat to a new level of risk was never going to be orderly or free of casualties. Neither should it be. Bankers and investors need to suffer precisely because the methods of modern finance have been found wanting. It sounds Darwinian, but the brutal demonstration that you pay for your sins is what leads the system to evolve. Markets learn from their mistakes. Only fear will spur investors to price risks better and get them to put more effort into monitoring their counterparties."
Several facts should be remembered before we take wide scale legislative action. While the economy suffer to some degree, CATO pointed out last week that new home construction is still growing, albeit much slower. The economy outside of the housing market remains strong. The loans in "crisis" represent about one in one hundred mortages in the US, the scale of these foreclosures is marginal, modest at worst. Jim Cramer and his cadre have little justification to berate Mr. Bernake's "academic" explanation and words of comfort about "Armogeddon." Scare mongerers do little to improve consumer confidence.
Many businesses messed up. Politicians like Mr. Obama needing to capitalize on the situation at the expensive of the consumer and economy are daft and unethical to scream, "curse you for messing up!" As The Economist explains:
But there is a price that is only now becoming apparent. Because lenders expected to be able to sell on the risk of default to someone else, they lent too easily. After all, they would not have to pick up the pieces. In theory, that risk should have been borne by the people best able to carry it. But with everybody having sold on the risk to everyone else—and the risk often being carved up, repackaged and sold again—nobody is sure where the losses are. The fear is that some risks ended up with those who least understood what they were getting into, and fear is a potent force in this disintermediated world. In the interbank market, every counterparty was potentially vulnerable. Even small amounts of bad credit can drive out good.
In theory, ratings agencies and mathematical models help investors price the risk they are taking on, even if the securities they are buying are scarcely traded. Yet when some supposedly good-quality assets proved to be worth little, people lost faith in the models and the ratings. Across the board, investors had failed to take account of how fast and how far asset prices fall when everyone wants to sell at the same time. Hard-to-sell long-term securities had been bought with short-lived debt, which left borrowers vulnerable to a change in sentiment every time the debt fell due. It does nothing to restore confidence when the biggest model-driven hedge funds had to get in new money. The people at Goldman Sachs lost a packet when something happened that their computers told them should occur only once every 100 millennia.
Politically, something will have to happen. No "tragedy" can avoid it. We can only hope it's a mild course of action that doesn't excessively bind the individual or businesses, such as President Bush's proposal for FHM loans or, at worst, other policy prospectives such as allowing homeowners to stay in their homes and pay ordinary rent instead of payments. We can then pray radical populists like Mr. Obama have their plans shown to be, well, radical.
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