The subprime mortgage crisis spirals on: Last week, Merrill Lynch admitted that it had lost $7.9 billion on mortgage-backed securities and structured credit products during the third quarter of 2007, a tide of red ink that swept chief executive E. Stanley O'Neal right out of his office. For its part, Countrywide Financial Corp., the nation's biggest subprime lender by volume, reported a $1.2 billion loss. Countrywide has been so shaken by financial problems and bad press about its allegedly predatory lending that it has agreed to team up with one of its critics, the nonprofit Neighborhood Assistance Corp. of America, to renegotiate up to 52,000 loans worth $16 billion.
Sound off on the important issues at
Great news! Well, not really: These developments mean a lot of pain for borrowers, the firms involved and the people who work for them (or are about to get laid off). But the losses at Merrill and Countrywide show that the market economy is working as it's supposed to. Companies that made overly risky decisions are having to pay for them and adjust their business models accordingly. Over the long run, everyone should be better off as firms learn from the subprime mistake.
The question is whether market discipline is enough, or whether government needs to reinforce it. House Financial Services Committee Chairman Barney Frank, D-Mass., is working on a comprehensive bill that would impose legal liability on the "securitizers" of mortgage debt. Frank's proposal would let borrowers sue issuers of bonds that are backed by "no doc" mortgages or other products that do not meet "minimum standards for reasonable ability to pay." To those who suggest that this would chill the mortgage-backed securities market, Frank notes that the proposed penalties are not unduly onerous. The most a borrower could sue for would be cancellation of a loan and court costs; there are "safe harbor" provisions for securitizers who generally follow sound practices or offer to settle with a borrower out of court. And Frank candidly replies that, given the recent excesses, the market could use a little chilling.
Still, we wonder if his cure might hinder rather than help the industry's long-term recovery. The bill does not yet clearly preempt state-law liability, meaning securitizers would have to assume that Frank's proposed standards would be a floor upon which states could pile additional requirements. The vast majority of securitized subprime mortgages are still performing; delinquencies are concentrated among loans that were made in the last two years, when Wall Street's demand for new debt began to outstrip the supply of capable borrowers - and home prices stagnated. Prior to that, securitized subprime debt looked like an innovative way to bring homeownership within the reach of many people who otherwise would have been shut out. The latest estimates of the economic damage from the subprime collapse and the attendant housing slump, while depressing, are manageable: about 1.25 percentage points off gross domestic product growth in the next six months, but no recession, according to the Institute of International Finance, a global bankers organization.
Wall Streeters have coined a term for bills such as Frank's: "legislative risk." And legislative risk has its uses. Along with the clear and present danger of more losses, the threat of federal action can force the financial industry to clean house and move on. If they really want to make the case against federal intervention, that is just what the banks and mortgage companies will do.
© 2017. All Rights Reserved. | Contact Us