Now that the subprime market is imploding, it seems that better regulation a few years ago would have saved us. Even market stalwarts such as Larry Summers concede that the market didn’t provide enough discipline to prevent lenders from pushing lousing loans. But the no-regulation crowd isn’t giving up. Summers, for example, says that the answer to the current crisis is not to regulate because that’s just the generals fighting the last war.
A regulatory moment comes around rarely, but one is nearly upon us. Senator Dodd and Congressman Frank are pushing hard on the lack of regulatory oversight of subprime lending, and folks on both sides of the aisle are beginning to ask the regulators and business people some tough questions.
But the no-regulation crowd hasn’t given up. They want non-regulation in response to the crisis precipitated by non-regulation.
Do they think that pouring more mortgage money into lousy loans will somehow help? At this point investors will be skittish about putting more money into a market that has just burned them, so the point is likely moot for a while. But putting better regulation in place now will serve two functions when the market stabilizes: 1) families won’t get whacked by these really awful products, and 2) investors can have some confidence that they aren’t about to repeat the Implosion of 2007. In other words, sometimes intelligent regulation can help–and now is the moment when we might get it.
In all the back and forth about subprime mortgages, most news reports miss a central fact: Many of the families that have subprime mortgage could have paid a mortgage with less onerous terms. For example, some families who were sold teaser rate mortgages that escalated from 2.9% to 12.9% may be in trouble even though they could have qualified and made payments on 7.9% mortgages. Other families were told they qualified for $400,000 mortgages, which they could not manage once the introductory rates ended, but they could have managed $200,000 mortgages. Practices like yield spread premiums encouraged mortgage brokers to steer others to subprime mortgages that they couldn’t pay when their credit qualified them for prime that they could have repaid. In other words, the loan product itself caused part of the problem, not just the fact that the loan was made to someone with low income or damaged credit.
Sharp businesspeople like Herb and Marion Sandler and Martin Eakes built strong companies lending money to people of modest means, many of whom had credit trouble. But they didn’t put their borrowers into loans they couldn’t afford. The whole idea behind their lending model was to put them in loans they could afford–and to keep the default rates low.
A significant part of the problem in the subprime market is not simply that too many dollars were put into the hands of working families and people with bad credit. The problem is that too many exploding products–products that were designed from the beginning to become unaffordable–were sold around the country. Smarter, more effective regulation can help us avoid repeating that mistake.
