MORTGAGE MELTDOWN: FINGERS OF BLAME

by Brad Keiser

Now Comes The Finger Pointing

It was only a matter of time until we began to see the finger pointing with regard to our current mortgage crisis. This morning I am going to summarize an article I found in Fortune Magazine Online written by Peter Eavis. In this article Eavis attempts assign varying degrees of blame to 7 groups that have contributed to the mortgage crisis. This work is not original to me, as I am using information from the article with an attempt to summarize it. Eavis assigns blame using a scale of 1 – 5 “Fingers of Blame”. Reality as I see it is that it will get worse before it gets better, we will see 100 year old Wall Street firms go under. While we are dispensing blame at some point the only way for us to unwind this mess will be for a certain “measure of amnesty” to be granted to many of the same parties, unfortunately I fear the last ones that will get any amnesty are the homeowners and they will probably need it the most.

Borrowers (3 Fingers Of Blame)

Thanks to low interest rates, getting rich in real estate became a national pastime. As prices soared, the urge to get in on the boom became overpowering. Medical students, hairdressers and other amateurs made purchases planning to flip them for quick gains. People for whom home ownership once seemed out of reach took on far more debt than they could ever hope to repay. These buyers were naive and addicted to easy money. Teaser rates and complicated loan terms insured that homebuyers often had little sense of what they were getting into. Many will pay for their poor judgement. The author weighs belief in individual responsibility against the all-too-human failing of getting caught up in a national frenzy.

Mortgage Brokers (3.5 Fingers Of Blame)

Mortgage brokers were very good at enabling borderline borrowers to get their loans. “The brokers have always been a disproportionately large part of subprime origination, so they were well positioned to help fuel the boom in subprime lending.” says Guy Cecala, publisher of the newsletter Inside Mortgage Finance. Mortgage brokers made millions as pure middlemen, they will feel relatively little in the way of consequences.

Appraisers (2 Fingers of Blame)

Real estate appraisers often buckled under pressure from lenders to overvalue houses. There is no loan without an appraisal justifying the value of the property. In comparison with other participants, appraisers come across as bit players.

Mortgage Lenders (4 Fingers of Blame)

Once mortgage lenders made all the loans they could reasonably make to qualified borrowers, the banks began relaxing the rules and reaching further down the credit scale. Ever heard of the NINJA loan? (No Income, No Job, No Assets). Lenders are paying a large price for their past practices. Dozens of mortgage companies have gone bankrupt. Mortgage providers made billions from the boom. Judging risk is at the heart of what they are supposed to do.

Wall Street (4 Fingers of Blame)

If the banks and mortgage companies would have had to keep these loans on their books, they never would have made the loans. They did not have to thanks to the mortgage machine Wall Street’s investment banks and hedge funds developed. Wall Street profits fueled the situation we now face. For example, Bear Stearns, which recently suffered huge subprime losses in two of its hedge funds, earned $2 billion in 2006. It made $600 million in 2001. 

Rating Agencies (3.5 Fingers of Blame)

Wall Street needs the blessing of rating agencies like Standard & Poor’s and Moody’s. These agencies were often all to willing to comply. Typically, rating agencies react too slowly with regard to questionable trends and innovations. The subprime lending explosion offered far more risk than these agencies expressed.

The Federal Reserve (4.5 Fingers of Blame)

The Federal Reserve has the power to put a stop to the excesses we experienced during this market. The main charge against the Fed is that former chairman Alan Greenspan kept interest rates at very low level far longer than necessary, which in turned sparked the bubble in housing prices and mortgage lending. The rate decisions made, showed that Greenspan had chosen to use the housing market as his main instrument to prop up the economy after the 9/11 attacks. In 2005, Greenspan gave a speech that blessed the creation of new loan products, including subprime home loans.

Senator Christopher Dodd, chairman of the Senate Banking Committee, laid much of the blame for the current crisis at the feet of Greenspan’s Fed. Most believe that the Fed should have tightened earlier. So the Fed has to accept a large slab of blame for the current crunch. 

So it is obvious that there is plenty of blame to go around. The bottom line is that a “perfect storm” of financial conditions all had to come together at once to fuel this crisis. It will be interesting to see the responses of these agencies to the mess they have contributed to.

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