The answer to fixing the financial crisis? Restore regulation

MCT News Service
02:41 PM PDT, October 30, 2009

WASHINGTON Why didn't Wall Street firms tell potential investors that the bonds they were selling them were rotten? Why did their business partners, including subprime mortgage lenders, ignore glaring evidence that borrowers weren't qualified and give loans to virtually anyone with a heartbeat?

The answer is simple: Because they could.

In many cases, no law or regulation prohibited these firms from doing what they did. In others, former regulations that might have impeded them had been rolled back.

After 30 years of a national political culture that damned government regulation and celebrated unfettered markets, the lions of Wall Street were free to practice the social Darwinism at the heart of their world survival of the fittest, and the winner feasts on the spoils. Smaller players down the financial food chain played by the same ethics-free ethos.

That's the back story to the U.S. financial crisis. At every turn where regulation was missing in action, the actors did the wrong thing, all along the long, interconnected trail of transactions that make up mortgage finance.

"This crisis started one household at a time. As much as everyone wants to talk about derivatives and shadow markets and rating agencies, it started as one lousy mortgage sold to one family, repeated millions of times," said Elizabeth Warren, a Harvard University business law professor whose thinking has helped shape the regulatory overhaul efforts now under way in Congress.

At the front of the chain were homeowners who took out loans with no documentation or little verification of income, bidding for more home than they could afford and betting that prices would keep rising forever. Mortgage brokers who originated their loans often received legal kickbacks from conscience-free lenders if they got borrowers into creative loans with high and adjusting interest rates.

The mortgage brokers churned volume for big subprime lenders such as New Century Financial and Ameriquest Financial, both now defunct. They exploited a regulatory gap to become nonbank lenders, which were regulated only on the state level, and spottily at that.

To address the "liars' loans" and mortgage-broker trickery, Congress is pushing to create a Consumer Financial Protection Agency. It would regulate consumer credit products such as mortgages, credit cards and payday loans.

The agency would force lenders to offer products with simpler terms and greater disclosure. It would regulate consumer credit in the interest of borrowers, not lenders. This agency, Warren's brainchild, would address directly the weakened lending standards that Wall Street exploited, and which led to the financial crisis.

"This is trying to move that to a world where there is light. One of the necessary ingredients is light, that people can track the terms of a deal, make comparisons among products, and not take on crazy risks," she said. "We've learned the consequence of too much risk aggregated in the system it's brought us to our knees. The CFPA isn't about playing the 'nanny state'; it's giving customers the tools to protect themselves."

Bad lending practices wouldn't have done so much damage, especially in places such as Florida and California, if they hadn't happened on such a large scale thanks to Goldman Sachs Group and its competitors.

Investment banks such as Goldman took possession of the poor-quality mortgages and then, working in consultation with credit-rating agencies, packaged them into a highly rated securities backed by pools of mortgages for sale to big institutional investors.

Many institutional investors state pension funds and charitable endowments, among others were required to purchase only the highest-rated securities. So it was imperative for the rating agencies to help their deep-pocketed investment bank clients attain top ratings for the mortgage-backed securities the banks issued.

As recent history shows, top-rated securities quickly became junk as the housing market tanked and homeowners couldn't make their mortgage payments. The reputations of Goldman, its competitors and rating agencies such as Moody's Investors Service fell along with home prices.

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