Monday, January 28, 2008
Who is to blame for the subprime mess?
Who is to blame for the subprime mess and what can we do to keep this from happening again? Do we need more regulation of mortgage lenders? Do we need to change the way underwriters are paid? Do we need to change the way credit rating agencies do business? All of the above? Something else? None of the above? -ACSullivan
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9 comments:
Who to blame is a difficult question. It seems as if everyone was gaming the system, from lenders to borrowers to ratings agencies. There do seem to be a couple sensible areas in which to begin looking at reform:
1 - Mortgage lender regulation - In the housing boom, they were able to sell bad loans for more than the actual home value by allowing borrowers to “self-report” their earnings and getting home value appraisal amounts that were necessary to entice homeowners to borrow. I think that any long-term fix needs to start here. I believe that the self-reporting loophole has been fixed, but perhaps there is a way to tie the lender fee into the actual servicing of the mortgage i.e. getting paid commission over the life of the loan. This increase the incentive to work with a lender to make sure the loan will be paid back.
2) - The Credit Agencies - The credit agencies seemed all too willing to offer high ratings on complicated debt instruments. Because of the complexity of the securities they likely garnered a larger than usual fee. Obviously they misjudged, or overlooked, the risk. As long as they are paid by those they rate, there will always be a conflict of interest. The answer here eludes me though; if companies don’t pay for ratings, who should?
I shy away from more regulation - but I do like the idea of changing the incentives for people like brokers who simply get paid on the selling the loan at inception. I think staggering the commissions is one way. Or having lower commissions for say "undocumented" mortgages than less risky loans.
Is it unfair to ask consumers to be smart and take responsibility for their decisions? I simply cannot believe so many people were "taken advantage of" - come on! I don't feel like using tax dollars to bail out people who were too lazy or didn't care to read the fine print. It also keeps buyers who have saved on the sidelines in the current real estate market.
Unfortunately we can't mandate common sense...
Going to Hentges' point about stated income loans. I understand that there is a responsibility for the lender to due their due diligence. However, as a borrower, if you are asked a question about your income, and you then overstate it because you really want the house how can you then come back and say that it was the bank's fault. That is basically an admission that you knew you were getting in over your head but you didn't want to admit it.
By adding regulations to crackdown on this the gov't is taking liquidity out of the market, which is exactly the opposite of what the Fed is trying to do. If the borrower had been honest with themselves and with the bank then they might not be having to go through the foreclosure process.
Well, it's easy to blame borrowers, but often they can't properly assess the value of their own home, especially in a market like we had the past four years. A high school acquaintance of mine who sold mortgages for Ameriquest told me that it was basically a boiler room. They know what their customer needed in order to buy so they made sure they got it. They used every tactic up to and including forgery. Both parties are responsible, but in this case I think that brokers should have a fiduciary duty to sell good loans and they haven't all been working in good faith.
From my own personal experience in the hot Washington DC real estate market, I had "took advantage" of the undocumented loan option for my fisrt house in order to close very quickly (in my case to take advantage of a tx incentive).
However, I had a plan, and refinainced within 60 days on much better terms because now that I had the asset, all of a sudden I was a valuable customer. I think it's OK to give some flexibility to consumers - although I had a thought-out plan.
I am not sure you can legislate saving people from themselves if they are determined to be reckless...
I wasn't trying to imply that lenders were totally innocent. Lenders, Realtors, Borrowers, Ratings agencies all are at fault. People got caught up in the fact that their home was a risk-free investment that would make them lots of money. Lenders and Realtors used this as a reason for people to get in over their head.
It was similar to the dot.com bubble, people didn't want to admit that there was a downside. I think for this reason, it was hard for investors to get a decent idea of what the risks were to buy the CDO's and now we can see what is happening.
There is no such thing as a free lunch.
I blame the FED for artificially lowering interest rates. I'd like to see more (or any at all) accountability for the FED.
I would like to point to the Austrian Business Cycle Theory to support this claim.
It reads as follows.
Austrian economists assert that central banks create the business cycle by inflating the supply of money in a fiat monetary system. The resultant lower interest rates (the price of borrowing) lead to a "boom" during which malinvestments cause resources to be misallocated. A correction—commonly called a "recession" or "bust"—occurs when resources are reallocated to their best uses.
Jesse Hokeness
I believe that the supply of "dumb" money in the market was the culprit. It was the hunger of the lenders that led them to lend to people with not very good credit histories. It is just that the risk has turned sour. How it all began can be seen from:
http://www.bloomberg.com/apps/news?pid=20601170&refer=home&sid=aA6YC1xKUoek
This tells us how subprime started.
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