Monday, February 11, 2008

Ideas for Financial Regulatory Reform

I received an email from Vasos Panagiotopoulos recommending an article by Edward M. Gramlich, “Booms and Busts: The Case of Subprime Mortgages,” Economic Review, Federal Reserve Bank of Kansas City, Fourth Quarter 2007, 105-113 [official Summary here]. Vasos provided a brief summary that I have with his permission amplified as follows: "The Monetary Control Act of 1980 ended usury limits for risky mortgages. The subprime industry since 1993 created 12 million new homeowners, raising the total by five percent [106]. It is important to appreciate that the boom and bust has left, besides investor losses, about 88 percent of the homes still solvent [107]. Borrowers had difficulty comprehending the implications of teaser adjustable mortgage rates and their often-onerous prepayment penalties [107]. Moreover, because the debt was immediately securitized, risk was transferred to buyers of collateralized securities. Independent brokers, unlike banks in the traditional mortgage relationship, had nothing to lose when borrowers defaulted. A “giant hole” in financial supervision has existed, exactly where supervision was needed the most. The weaknesses seem concentrated among on state-chartered lenders but joint Fed/Office of Thrift Supervision action, with the support of state banking supervisors, has already started to bring these under supervision without new legislation [109]. The Fed has a predatory lending statute it can use to intervene in some cases [111]. Strenuous efforts be made to prevent foreclosures [112], in part by buying up properties in default for rentals. Above all, weaknesses in supervision must be corrected soon."