Efforts to address subprime crisis flawed

The House of Representatives recently passed HR3915 (Mortgage Reform and Anti-Predatory Lending Act of 2007) and the Senate has introduced S2452 (the Home Ownership Preservation and Protection Act of 2007). The Federal Reserve announced on Dec. 18 that it, too, will propose new rules to the Truth in Lending Act to further address the subprime mortgage crisis.

All these efforts are flawed. If the intent is to pass laws and promulgate regulation that will protect consumers and decrease the likelihood that this subprime crisis will happen again, then these proposals are horribly off the mark.

The attempt by Congress and the Feds to address the subprime mortgage crisis fails to address the cause of the crisis and merely addresses the result. The cliche of putting a Band-Aid on the problem is an apt description of the current proposed remedies. The subprime mortgage crisis was caused by improper assessment of the risk by the rating agencies when mortgage bonds were rated and sold to Wall Street. Because subprime-backed bonds were rated as being less risky than they turned out to be, there was far too much demand. This demand resulted in wider and broader mortgage products on the market. These new mortgage products, too, were rated far too leniently by the rating agencies.

Further, the types of financial instruments containing subprime mortgages sold on Wall Street were complex and misunderstood by those institutional investors who purchased them. This further exacerbated their shock when the result was far greater than expected losses.

Finally, large investors in these instruments used leveraging to boost their returns. When the risk in these bonds turned out to be greater than expected, the losses were far greater than was reasonable.

Attempts to address the subprime mortgage crisis merely restrict consumer choice by preventing certain types of mortgages from being made. Consumer choice is good. It helps fuel our economy by offering more people credit. As of April 2007 only 5 percent of borrowers were nonprime and only 1 percent of loans were in foreclosure. The number of loans in foreclosure has risen slightly, but these numbers still belie the fact that subprime borrowers are a small percent of the overall mortgage market. Most subprime loans are performing, which means the borrowers are making their payments.

Congress and federal proposals also attempt to further regulate mortgage brokers. These types of proposals will result in hurting small businesses and our economy. Mortgage brokers should not be held accountable for the type of product Wall Street was willing to buy. Wall Street should have a better rating system to assess risk.

If Congress and the Fed wanted to address the subprime mortgage crisis, they would look at rating agencies and regulate their conflicts of interest that contributed to the lenient rating of subprime bonds.

If Congress and the Fed wanted to address the subprime mortgage crisis, they would regulate the types of products these subprime bonds were sold in, thus enhancing the investors' understanding of the risk.

If Congress and the Fed wanted to address the subprime mortgage crisis, they would regulate leveraging by large financial institutions in subprime bonds.

---

John Norman is the executive director of the Utah Mortgage Lenders Association.