An important job qualification for a Federal Reserve chairman is the ability to express oneself in a reserved manner. But even by that standard, Ben Bernanke's official statement today accompanying the Fed's announcement of proposed new guidelines for mortgage lenders is impressive.
As the mortgage market has become more segmented and as risk has become more dispersed, market discipline has in some cases broken down and the incentives to follow prudent lending procedures have, at times, eroded.
With that quote ringing in your ears, I strongly recommend readers interested in learning more about how the subprime mortgage embarrassment blossomed to read an ongoing special report put together by Bloomberg News. Part 1, by Mark Pittman, published Monday, zeroes in on a group of Wall Street investment bankers who designed a new subprime mortgage derivatives contract in 2005. Part 2, by Bob Ivry, gets up close and personal with Quick Loan Funding Corp., a subprime lender in Costa Mesa, Calif. that worked overtime making loans to bad credit risks -- in order to satisfy demand from Wall Street (Citigroup in particular) for high-yielding subprime debt.
One quote from Quick Loan's principal, Daniel Sadek, stands out:
"If the loans were so bad, why did Wall Street keep buying them?'' Sadek says.
Elsewhere, Sadek notes that his company made most of its money selling its loans to banks -- who repackaged them into risk-disguising securities that were then resold across the planet.
This is a point that cannot be stressed enough, but keeps getting lost in the overwhelming media coverage that the ongoing housing bust is currently commanding. Incentives to follow prudent lending procedures did not "erode," as Bernanke put it. Incentives to follow imprudent lending procedures flooded the market. Wall Street is at least as guilty, and possibly more so, for creating this mess as the mortgage lenders who made all the dodgy loans and the speculators looking to make a killing or unwise home buyers who took on loans that they couldn't afford. Wall Street created the demand for those loans.
So on Tuesday, the New York Times has a terrific story by Edmund Andrews detailing how Greenspan's Fed ignored numerous warnings that the mortgage lending industry was out of control, and, simultaneously, the Fed announced its proposed new guidelines for clamping down on bad practices in the mortgage industry. The easy response to the Fed's plan is to call it a classic close-the-barn-door-after-the-subprime-horses-have-gone-extinct strategy. It would have been a terrific plan that could have headed off a lot of trouble if it had been instituted in 2005. But most of the lenders who engaged in the behavior that the new plan would prohibit are already bankrupt. What the Fed really needs to be doing is taking a closer look at the wellspring of "financial innovation" on Wall Street, that has been the bottom-line driver for all this behavior, and figuring out what needs to be done to better regulate that creativity. That's where we need guidelines. That's where knuckles need to be rapped, sharply.
It's all very fun to pour scorn and derision on the housing flippers and the marks who got in over their head. It's also an easy call to talk sternly about deceptive practices in the home lending industry, and to declaim, as Bernanke did today, that:
We are meeting today to discuss proposed regulatory amendments to protect consumers from fraud, deception, and unfairness in the mortgage market. Unfair and deceptive acts and practices hurt not just borrowers and their families, but entire communities, and, indeed, the economy as a whole. They have no place in our mortgage system. Our goal is to promote responsible mortgage lending, for the benefit of individual consumers and the economy. We want consumers to make decisions about home mortgage options confidently, with assurance that unscrupulous home mortgage practices will not be tolerated.
But it's all aiming at the wrong target. The damage has been done in housing, as today's gloomy housing start numbers prove yet again. The mistakes that led to that crash won't be duplicated, at least not in this generation.
But even now, somewhere in Manhattan, or Greenwich, Conn., or London, a handful of whip smart investment bankers are eating takeout and devising a new formula for turning a sow's ear into a silk purse. They're the ones we should be watching.