Sub-prime Mortgages-A Good Idea Gone Bad
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One of the major problems with the United States Congress is that its members have a very bad record when it comes to encouraging action on the part of third parties, be it by law, intimidation or “voluntary initiatives.” Once a law or regulation is approved, they never seem to go back to see if the impact of their actions actually matches up with the intent of their proposals.
The case of the sub-prime mortgage is certainly a classic example of a good idea gone bad. What could be more American than encouraging home ownership? Giving everyone the opportunity to participate in the American dream? The truth is that it really worked in the beginning and there are a good many homeowners out there who have reaped the benefits that were intended. So what went wrong?
To understand how we came to be where we are it is always instructive to know where we have been. History, as we are supposed to know, is our best teacher (although many of our representatives in government never seem to learn from it, which basically mirrors the attitudes of those who elected them). Once upon a time the United States had a very structured and regulated financial system, which was born of the worst financial disaster the country ever experienced (the great depression of the 1930’s), which was brought about by the institutional and individual financial excesses of the 1920’s. The problems of the 2000’s are not the same but we seem to be doing our best to recreate and update them for the 21st century.
When it comes to mortgage lending, that was once, primarily, the province of the Savings and Loan company and the Savings Bank. Commercial banks provided checking accounts (which did not pay interest) and Stock Brokers and Investment Banks did the securities transactions. There were variations, of course, but this was the basic set up. Each financial activity was carefully in its own box. The world of banking was not a particularly exciting place: everything was predicated on safety, security and predictability. My, how things have changed.
Savings and Loans, since they were involved in lending long term with the loans secured by a fixed asset, a residence, were permitted to offer interest rates (which were closely regulated) to depositors and investors that were a half point more than a commercial bank could offer to its depositors. They were also restricted in the investments they could make with depositors funds. The rational was that this would enable them to attract long term investment deposits to fund long term mortgage loans.
For years the commercial banks pleaded to be let free to compete on equal footing with everyone else (commercial banks were, at the time, restricted by state, city or other in-state regional boundaries). And so the chipping away began and eventually the flood gates opened with the gradual de-regulation of the commercial banking system. As commercial banks were permitted to offer competitive deposit interest rates to consumers the Savings and Loans demanded to be able to invest their assets in whatever vehicle that would provide the best return. The horse was out of the barn. Bank earnings exploded. Barriers came down and the great bank acquisition spree was under way.
The bubble burst, of course. The Savings and Loan industry reached for more and more risky investments. They had no real understanding of the risk of the investments they were buying into; all they knew was that it had a good rating and if a major commercial or investment bank was the manager it had to be safe. Besides, we were now at the end of the 1970’s and interest rates were all in double digits, except, of course, for all those 30 year mortgages sitting on their books at six and seven percent.
Today, although it seems like deja vu all over again, it is considerably different and potentially riskier because of the outright fraud, greed and incompetence that permeates both the borrowing and lending side of the equation. The banks, now run by professional managers, lawyers and accountants rather than experienced loan officers because they are now financial services superstores, kept manipulating what regulations were left in an effort to maximize (both personal and corporate) earnings and increase earnings per share while minimizing risk (they thought) by creating off balance sheet entities and various structured investment vehicles.
Do I believe we need to go back and completely re-regulate the banking industry? Not if it means passing a law or regulation that one assumes will fix the problem for all time because, as we have seen too often, it doesn’t work. Voluntary regulation? That’s even worse – the fox deciding how strong the fence will be, dictated by how hungry the fox is. How about prosecuting individuals rather than the corporations they work for when fraud and deceptive practices are uncovered? How about disciplining managers at all levels who encourage or turn a blind eye to fraud and deceptive practices of their employees for the sake of earnings and personal bonuses? How about enacting regulations that require performance reviews and evaluations on an annual basis? How about fully funding and staffing regulatory and administrative agencies, with the expense being billed to industry members, so that the more violations that occur the more the industry must pay? There’s a solution out there someplace.
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© 2007 Timothy
Holland Originally Published:
Note:
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