A (sub)prime argument for more regulation
A (sub)prime argument for more regulation
By Barney Frank
Copyright The Financial Times Limited 2007
Published: August 20 2007 03:00 | Last updated: August 20 2007 03:00
Reality has broken into our economic programming, with an important message: the subprime crisis demonstrates the serious negative economic and social consequences that result from too little regulation.
In the debate between those who believe in essentially unregulated markets and others who hold that reasonable regulation diminishes market excesses without inhibiting their basic function, the subprime situation unfortunately provides ammunition for the latter view.
The epidemic of mortgage foreclosures is the result of a powerful negative synergy stemming from the large increase in mortgages originated by unregulated entities, and an essentially uncontrolled secondary market into which those originators sold their products. Until recently, the great bulk of residential mortgages were originated by deposit-taking institutions closely supervised by federal and state regulators. If these entities had continued to be the overwhelming source of mortgage originations, we would not be dealing with the subprime crisis.
It is the unregulated sector of the mortgage industry that has disproportionately contributed to the large number of imprudently made loans. A major reason that these originators could make such loans is that soon after they did so, they sold them into the secondary market, which left them free of any financial responsibility. By contrast, entities that make loans and retain ownership of them have a financial stake in the ability of borrowers to pay them off. This analysis yields several recommendations for public policy.
First, all mortgage originators must be subject to reasonable regulation substantively similar to those that apply to depository institutions. This means some form of licensing and the proscription of loans that should not be made because there is no reasonable prospect of their being repaid. Some states have already moved in this direction but others have not, so Congress must act. To those who argue that we should let the borrowers suffer the consequences of their mistakes, there is a two-fold answer. Many loans were accompanied by fraud, deception, inadequate information and other failures of responsible marketing. Additionally, inappropriate subprime loans have not been randomly geographically distributed. They are concentrated in some neighbourhoods, and this has a wholly undesirable and unjustified impact on the majority of homeowners in those neighbourhoods who are keeping up their mortgage payments. Having a foreclosed, vacant home next to your home or four doors down leads to a deterioration of your neighbourhood and the value of your property.
Effective enforcement of any lending standards means that those who package and sell those loans into the secondary market must also have some responsibility. Setting clear guidelines, which securitisers must follow to guard against being vehicles for unsound loans, can be done in a way that enhances the attractiveness of the secondary market to investors and serves as a safe harbour against liability.
Of course, we will be told by some that putting any restrictions on the ability of servicers to package and sell will prevent the market from functioning. (Connoisseurs of the argument that any regulation of a securities market will bring about its demise are urged to turn to the debates over the establishment of the Securities and Exchange Commission in the 1930s.)
These considerations are also relevant to the current debate over the supervision of Fannie Mae and Freddie Mac. The outstanding issue is the insistence by the Bush administration that Fannie's and Freddie's portfolios should be reduced in favour of increased reliance on the secondary market. But loans held in their portfolios are more amenable to the flexible workouts that are important in diminishing the current foreclosure problem, and Fannie's and Freddie's ability to serve as refinancers for existing mortgage holders who are seeking relief from abusive loans would be substantially diminished if they could sell these only into the secondary market.
That brings me to one of the silver linings. Those of us who have a serious aversion to clichés can take comfort that in this debate over regulation for the secondary market, we are unlikely to hear anyone invoke that tritest of conservative arguments, "If it ain't broke, don't fix it."
There are two further public policy debates on which this crisis sheds light. Congressional Republicans have ended most federal programmes in which the federal government collaborates with the private sector to construct affordable rental housing, and have instead held out home ownership as the only valid answer to those seeking decent housing, even for those whose economic circumstances and the high cost of housing in their areas make this economically unsustainable. One goal of the Democrats is to return to public/private partnerships to construct subsidised rental housing, which will remove one of the push factors contributing to the current crisis.
Further, we must now address the questions raised by the instability in the financial markets triggered by the subprime problem. It is clear that updated regulation is required to deal with innovations in the mortgage business. There have been even more profound changes in the broader financial markets. Private and public sector policymakers must also askwhether current regulatory frameworks are adequate to dealing with them.
The writer is chairman of the House Financial Services Committee and is a Democratic congressman from Massachusetts
By Barney Frank
Copyright The Financial Times Limited 2007
Published: August 20 2007 03:00 | Last updated: August 20 2007 03:00
Reality has broken into our economic programming, with an important message: the subprime crisis demonstrates the serious negative economic and social consequences that result from too little regulation.
In the debate between those who believe in essentially unregulated markets and others who hold that reasonable regulation diminishes market excesses without inhibiting their basic function, the subprime situation unfortunately provides ammunition for the latter view.
The epidemic of mortgage foreclosures is the result of a powerful negative synergy stemming from the large increase in mortgages originated by unregulated entities, and an essentially uncontrolled secondary market into which those originators sold their products. Until recently, the great bulk of residential mortgages were originated by deposit-taking institutions closely supervised by federal and state regulators. If these entities had continued to be the overwhelming source of mortgage originations, we would not be dealing with the subprime crisis.
It is the unregulated sector of the mortgage industry that has disproportionately contributed to the large number of imprudently made loans. A major reason that these originators could make such loans is that soon after they did so, they sold them into the secondary market, which left them free of any financial responsibility. By contrast, entities that make loans and retain ownership of them have a financial stake in the ability of borrowers to pay them off. This analysis yields several recommendations for public policy.
First, all mortgage originators must be subject to reasonable regulation substantively similar to those that apply to depository institutions. This means some form of licensing and the proscription of loans that should not be made because there is no reasonable prospect of their being repaid. Some states have already moved in this direction but others have not, so Congress must act. To those who argue that we should let the borrowers suffer the consequences of their mistakes, there is a two-fold answer. Many loans were accompanied by fraud, deception, inadequate information and other failures of responsible marketing. Additionally, inappropriate subprime loans have not been randomly geographically distributed. They are concentrated in some neighbourhoods, and this has a wholly undesirable and unjustified impact on the majority of homeowners in those neighbourhoods who are keeping up their mortgage payments. Having a foreclosed, vacant home next to your home or four doors down leads to a deterioration of your neighbourhood and the value of your property.
Effective enforcement of any lending standards means that those who package and sell those loans into the secondary market must also have some responsibility. Setting clear guidelines, which securitisers must follow to guard against being vehicles for unsound loans, can be done in a way that enhances the attractiveness of the secondary market to investors and serves as a safe harbour against liability.
Of course, we will be told by some that putting any restrictions on the ability of servicers to package and sell will prevent the market from functioning. (Connoisseurs of the argument that any regulation of a securities market will bring about its demise are urged to turn to the debates over the establishment of the Securities and Exchange Commission in the 1930s.)
These considerations are also relevant to the current debate over the supervision of Fannie Mae and Freddie Mac. The outstanding issue is the insistence by the Bush administration that Fannie's and Freddie's portfolios should be reduced in favour of increased reliance on the secondary market. But loans held in their portfolios are more amenable to the flexible workouts that are important in diminishing the current foreclosure problem, and Fannie's and Freddie's ability to serve as refinancers for existing mortgage holders who are seeking relief from abusive loans would be substantially diminished if they could sell these only into the secondary market.
That brings me to one of the silver linings. Those of us who have a serious aversion to clichés can take comfort that in this debate over regulation for the secondary market, we are unlikely to hear anyone invoke that tritest of conservative arguments, "If it ain't broke, don't fix it."
There are two further public policy debates on which this crisis sheds light. Congressional Republicans have ended most federal programmes in which the federal government collaborates with the private sector to construct affordable rental housing, and have instead held out home ownership as the only valid answer to those seeking decent housing, even for those whose economic circumstances and the high cost of housing in their areas make this economically unsustainable. One goal of the Democrats is to return to public/private partnerships to construct subsidised rental housing, which will remove one of the push factors contributing to the current crisis.
Further, we must now address the questions raised by the instability in the financial markets triggered by the subprime problem. It is clear that updated regulation is required to deal with innovations in the mortgage business. There have been even more profound changes in the broader financial markets. Private and public sector policymakers must also askwhether current regulatory frameworks are adequate to dealing with them.
The writer is chairman of the House Financial Services Committee and is a Democratic congressman from Massachusetts
posted by Carlos T Mock at 10:45 AM
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