At the height of the housing bubble, subprime mortgages flew out the door at a dizzying pace. Independent mortgage companies, operating under minimal regulations, took the lead in pumping out loans, many granted without income documentation or proper evaluation of a borrower's ability to pay. The companies cared little about loan quality; they had no responsibility for overseeing the mortgages' success or failure.
Ultimately the mortgages, along with some good loans, were packaged into securities and then sold to investors around the world. The firms hawking the securities were able to boast about a top-drawer, AAA rating usually assigned to rock-solid investments. That rating was pure fiction; it reflected the desire of various rating services to do business instead of providing realistic evaluations.
Eventually, thousands of homeowners were unable to make mortgage payments, resulting in foreclosures, financial trouble for those who bought mortgage-backed securities and an undermining of the US economy. Congress approved a $700 billion bailout to bolster the banking industry and supposedly stimulate lending.
What have we learned from the financial crisis? First, regulation is less of a curse word in political discourse. There were economists and analysts who warned about the hazards of subprime mortgages; those warnings drew scorn from free-market apostles arguing that government must not be allowed to strictly regulate the financial industry.
That's not to say that stringent rules are now a given. Congressional hearings on financial regulations are scheduled to be held before and after the November 2008 elections, but there's no guarantee significant reforms will be passed. Lobbyists for major banks and credit card companies are still major players in Washington, DC and skilled at blocking reforms.
Next we found out that the national media's view of financial institutions is fairly narrow. There were dozens of reports about the troubled state of Wall Street investment firms and banks. In the meantime, thousands of credit unions and small community banks across the country continued to operate as they always have. They made prudent loans, refused to invest in mortgage-backed securities, and didn't need a bailout. They received scant media coverage.
We discovered that US Treasury Secretary Henry Paulson is a man with a small circle of friends. When asked about homeowners facing foreclosure, he said the government response should be very limited, indicating that people who take financial risks should suffer the consequences. Just weeks later, he initiated a series of moves including the $700 billion package for banks.
What's at stake here is much more than one official's hypocrisy. It's currently estimated that one out of six homeowners is having trouble making mortgage payments. This is a recipe for economic disruption and social chaos, with urban and suburban communities dealing with a slew of vacant houses and declining property tax revenues.
Moving Forward: Challenges
Crafting a plan to help homeowners is very complicated because people having mortgage problems are a diverse lot. On one hand, they include elderly people duped into taking out a second mortgage, folks battered by the high price of housing in some regions and people financially impaired by medical bills or job loss. On the other hand, there are homeowners who bet on a continuing housing bubble, assumed real estate prices would keep climbing and took out a mortgage they couldn't afford. Basically, they played a speculator's role.
A number of analysts and columnists have called for a three-month moratorium on foreclosures. That's only a short-term measure, but it would provide some breathing room, an opportunity to study a range of options.
After that, it's time to move on to a program with several key objectives. For starters, regulators and legislators must restrain "casino capitalism." Around 2004, there was an orgy of lending designed to generate more and more mortgages for the purpose of wrapping them into securities. The loans served as raw material for financial gaming.
Second, governmental efforts to mitigate a recession have focused far too narrowly on influencing jumbo-size banks to trust one another and resume loan making. Other measures should be on the table: expanding unemployment benefits, encouraging lenders to renegotiate with homeowners, increasing employment. Various institutes have called for a big-time financial commitment to infrastructure, such as fixing roads and bridges, school construction and national parks. This is an ideal time for such expenditures.
Third, consumer education, during high school and afterward, merits a serious reappraisal. Reportage on the mortgage crisis has turned up dozens of instances in which borrowers had little understanding of a mortgage's terms. When a low introductory interest rate, known as a teaser, shifted upward, the homeowner couldn't afford to make payments.
Lastly, we need to concentrate on an important proposition. The excesses uncovered during the mortgage crisis shouldn't be viewed in isolation. We live in an age of financial exploitation: payday lenders; rent-to-own stores charging exorbitant fees; credit card issuers utilizing sky-high interest rates and fees. Yes, some companies specifically target people who have already declared bankruptcy and offer them additional credit cards. That's a symptom of larger problems.