I have been following the efforts in the Congress to enact financial reform. I agree with strengthening regulations regarding increased capital requirements and less leverage.
I definitely agree that the so called "shadow banking" sector must be included in the regulatory scheme.
Frankly, I think credit default swaps should be banned, unless you also hold the underlying asset(the so called naked swaps) or treated as insurance, with reserves set aside like any other insurance. But I'm sure there are decent arguments on the other side of that one.
I'm not sure why we need a separate Consumer Protection Agency other than to make sure bankers do what they should always do which is to make loans based on "safe and sound" underwriting principles.
Of course it's just silly to levy a tax on banks which can only cost consumers and create additional moral hazard ( whatever that really is). I really don't get why you tax banks for TARP losses arising from making loans to car companies and an insurance holding company. They better pass that tax quick before GM,Chrysler and AIG pay back the money they got, maybe even with a profit to the taxpayer.
However, what we really need is a ban, as exists in Canada, on subprime lending of the kind that got us into this mess in the first place.
Why is it that no one talks about eradicating the root cause of the financial meltdown-- abusive subprime loans. How in the world did the government allow subprime lending, especially the kind made with no money down and no proof of income, assets or even a job. The so called "no docs" loans that were made to anyone with a pulse.
As Paul Krugman pointed out it is against the law in Canada to make home loans with less than 20% down. Even with low interest rates and too big to fail banks, Canada didn't have much of a housing bubble problem. The reason was no subprime lending. The same was true of NYC where co-op boards certainly didn't allow subprime financing.
Why can't we just do that in the US? I really don't understand why no one talks about that. Everything else deals with how best to absorb the consequences of future problems. I think we also should do something to actually help prevent future problems. Securitization didn't cause the loans to go bad. Even credit default swaps didn't create those scandalously poorly underwritten loans. What's the old computer cliche "Garbage In , Garbage Out". The subprime loans were mostly garbage and no Volker Rule or other regulatory reform would change that.
All the other catastrophic problems followed from having made crappy loans in the first place. What am I missing here? All the other reforms do not address eliminating this root cause of the meltdown. Who is against eliminating subprime lending and why?
Eric
I'm in agreement with Eric. There should be regulations in place to prevent subprime mortgages. In fact, I think the mover and shaker who gets it enacted should get the Nobel Prize in economics.
ReplyDeleteAfter doing my post I listened to Alan Greenspan testimony before the FCIC. When pressed why the Fed didn't do anything to stop subprime lending , he asid if they had tried to do that the Congress would have stopped them and come down on the Fed like a ton of bricks.
ReplyDeleteI think what he said is right, so now we have to ask why Congress would have acted in that way?
Won't it be ironic (to put it mildly) if the FCIC investigaton determined that the root cause of the Financial Crisis was the The Congress of the United States !
What's that old adage," we have looked for the enemy, and the enemy is us". Of course it would be a pipe-dream to think that the FCIC would ever come to that conclusion.
Eric
"Who is against eliminating subprime lending and why?" As they said in the time of Watergate, "follow the money." What so many defenders of the bankers want to forget is that those bankers and their lawyers, investment banker friends and others in that fraternity made enormous amounts of money by encouraging subprime lending far beyond anything Congress ever imagined. Eric, I hate to be the first to break this to you but Citibank and Goldman Sachs (or, more precisely, the people who made the decisions there) really were not the least bit interested in helping low-income people buy homes. Look at the income distribution data from the decade before the crash. I certainly agree with all of your suggestions, especially eliminating subprime lending. But who benefited from the bubble created by subprimes? OK, lets try this again: Who is against eliminating subprime lending and why?
ReplyDeleteRon
Ron, you've really hit on the issue that has been nagging me all along. Of course I know that Wall St and the Big Banks weren't interested in helping the poor buy houses but they certainly were more than eager to take advantage of a situation that otherwise good intentioned people promoted. The combination of good intentions and greed became lethal for our economy.
ReplyDeleteBack in the day ( as they say) people had to put 20% down when they took out a home mortgage.They also had to have reasonably good credit. However, also back in the day, banks were accused of redlining ( even after they actually stopped red lining) because the poor and minority community was "under served" by the banks. Having advanced beyond outright discrimination , banks being banks, didn't make many loans to those under served communities because they couldn't make much money there and many in those communities had credit that was not up to standards.
Enter subprime-- high interest rate loans made with very little ( later no ) money down to people with less than stellar ( eventually even poor) credit. These are the predatory lenders. Usually not the Big Banks everyone loves to hate today. It's certainly true however that Wall St was more than happy to buy and securitized these loans and makes lots of money doing it ,as you point out. Unfortunately for them ( and us) those same Banks actually bought the securities back by those crappy loans. That's why the Banks lost so much money.
Getting back to who is against restricting this kind of subprime lending, let me relate something that I brought to the attention of my class in the fall of 2008 ( or 2007) . The New York Times had 3 articles about subprime lending on the same day. While they began on different pages , all 3 were continued on the same page, as often is the case with related stories.
Story #1 on the front page-- Subprime Lenders Rip Off Poor and Minority Communities--It was about the huge profits that lenders were making from subprime lending in poor and minority communities.
Story # 2 on page 6. - Subprime Lenders Filing for Bankruptcy Protection In Large Numbers-- Due to skyrocketing defaults, most subprime lenders were going out of business.
Story #3 on page 3. -- Communities Leaders Complain About Placing Restrictions on Subprime Lending -- In this story one leader is quoted as saying "you may think a 30% default rate is a bad thing but I see it as 70% of people in my community who now own homes they won't have had but for subprime lending. Of course the default rates got even worse but the same logic would apply.
As I said all three stories were continued on page 8 , so the Times editors thought they were related. I did too. Something in that the confluence of greed and good intentions prevented the government from doing it's job and stopping abusive subprime lending. The fact that Barney Frank looked the other way leads me to believe that the community side of the equation was just as important as the greedy bankers. Greenspan testified that if the Fed would have tried to restrict subprime lending the Congress would have stopped them. Who do you think he was talking about? Just the bankers?
What do you think? And thanks again for commenting.
Eric
Eric, I completely agree that the promoters of home ownership in both parties went too far. I don't think that justifies Greenspan not sounding an alarm, or brushing off the alarms others sounded. He is just passing the buck, which is disappointing, because I once had a lot of respect for him. It also doesn't let the banks off the hook. They went far beyond anything Congress had in mind and they did it because they were making huge profits and not dealing with risk adequately. Making profits is great, but not dealing with risk, as you well know, is the cardinal sin of banking. (Remember in my first post I said Congress was like McDonalds, but nobody forced the banks to supersize it.) And my point in the last post is that, whatever happened to institutions and shareholders (at least in the short term, which is another issue) as a result of the bust, the individuals -- the real people -- at the banks and all the other places involved in the process made fortunes. They want to make more fortunes, so they do not want Congress to get in their way now any more than they would have wanted it a few years ago. Its not low income people who are flooding Congress with campaign contributions tied to this issue.
ReplyDeleteMy favorite criticism of regulation that comes from Wall Street and the banks is that regulation will stifle innovation. Somebody asked Dorothy Parker if she thought writing classes stifled young writers and she said they didn't stifle enough of them. That is how I feel about financial innovation. I wish somebody had stifled it about 10 years ago. Which is why I think your ideas are exactly right. There is nothing wrong with an 80% fixed rate mortgage and even less wrong with forcing banks that originate loans to keep a large part of the risk, however old fashioned those ideas are. We can help low income people find housing in other ways. But don't count on any of that happening.
Ron