The Politics of Subprime Mayhem

♠ Posted by Emmanuel in at 3/26/2007 02:33:00 AM
Let's face it: For the most part, politicians are reactive and not proactive. Exhibit A is the recent shakeout in the US subprime mortgage industry. As nearly all the mainstream media and economics blogs stateside provide nonstop coverage of the ongoing saga concerning debt, deceit, and disclosure, there is little need for me to go over the story. Suffice to say, lawmakers in the US have begun to understand the implications of this subprime debacle. There is indeed a large political opportunity here; with election season 2008 gearing up, votes are up for grabs.

Take Senator Christopher Dodd (D-Connecticut), Chairman of the Committee on Banking, Housing, and Urban Affairs. To get where he is, he clearly must have some political skills. There are tricks of the trade to be learned in his modus operandi. In the wake of the housing debacle, he hauled several guilty and not-so-guilty parties to appear before his committee on March 22:
  • Regulators: A game of political dodge 'em requires pinning blame on someone else for lack of government oversight. Dodd requested representatives from the Federal Reserve, Federal Deposit Insurance Company (FDIC), the Office of Thrift Supervision (OTS), and the Office of the Comptroller of the Currency (OCC) to testify. Unsurprisingly, they feigned previous unawareness of the magnitude of the problem, and said they would do better in the future;
  • Industry Representatives: Every decent tale needs bad guys. Cue up patsies sent by HSBC, Countrywide, WMC Mortgage, and First Franklin. (New Century declined as it appears to be in its death throes.) For the most part, these guys had nothing to do but act sheepishly and explain that, actually, they were quite diligent in making these loans;
  • Consumers: Sob stories need hapless victims. Dodd invited two of those who fell prey to vile predatory lending practices to share their tales of woe.

Naturally, the hearing garnered a lot of media attention. In particular, Dodd made an accusation that the Federal Reserve practiced "bait-and-switch" tactics which led to a "perfect storm". From Dodd's opening remarks:

Regulators tell us that they first noticed credit standards deteriorating late in 2003. By then, Fitch Ratings had already placed one major subprime lender on “credit watch,” citing concerns over their subprime business.

In fact, data collected by the Federal Reserve Board clearly indicated that lenders had started to ease their lending standards by early 2004.

Despite those warning signals, in February of 2004 the leadership of the Federal Reserve Board seemed to encourage the development and use of adjustable rate mortgages that, today, are defaulting and going into foreclosure at record rates. The then-Chairman of the Fed [Alan Greenspan] said, in a speech to the National Credit Union Administration, said:

“American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.”

Shortly thereafter, the Fed went on a series of 17 interest rate hikes in a row, taking the fed funds rate from 1% to 5.25%.

So, in sum: By the Spring of 2004, the regulators had started to document the fact that lending standards were easing. At the same time, the Fed was encouraging lenders to develop and market alternative adjustable rate products, just as it was embarking on a long series of hikes in short term rates. In my view, these actions set the conditions for the perfect storm that is sweeping over millions of American homeowners today.

Where this depressing story ends nobody knows. Needless to say, more coordination of oversight between state and federal authorities of the subprime market as well as better disclosure of terms will be required. In the meantime, announced Democratic candidates for the US presidency are jockeying for position. As you would expect them to imply, excess Republican laissez-faire led to this fine mess. Hillary Clinton calls for a time-out on mortgages about to go bust; Barack Obama asks Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson to convene a "homeownership preservation summit"; and Dodd uses his chairmanship as a high-visibility platform for Dodd for President 2008. There's a good chance that the public purse will be opened up to bail out these "hapless victims" as election season 2008 kicks into gear. Public choice theorists should be squealing with delight. Politics is fun, eh?