"Creditors would be prohibited from … extending credit without considering borrowers' ability to repay the loan."
This is not a joke. It is part of proposed new Federal Reserve Board regulations aimed at stopping banks from repeating the shockingly bad lending practices that led to the still-worsening mortgage mess. Perhaps they could call the new rule "stop me before I lend again."
How did it come to pass that the Fed needs to write a rule barring banks from lending to people who can't repay their loans?
The people who investigate airline crashes often say there is rarely one cause. It is almost always a succession of mistakes, one piled on top of the next. This seems equally true with financial catastrophes.
It is surely so with the mortgage crisis. Securitization and lack of transparency, on top of the too-big-to-fail syndrome, all contributed. So did the markets über alles mindset of former Fed Chairman Alan Greenspan and the Bush Administration's belief that easy money would help create a new class of investors. Add to it all the bureaucratic desire to preserve fiefdoms and the nation's stunning ability to forget Enron and the dot.com bust.
Think about just a few links in this chain. Securitization made it possible to reduce the cost of borrowing by pooling millions of mortgages into liquid, easily saleable investment vehicles. But it also opened the door to a system where mortgage brokers bore no risk for the loans they originated. Banks, the ostensible lenders, became merely loan servicers who did not care if borrowers were credit-worthy. And, the ultimate purchasers of the debt, the investors who bought one pool or another of sliced-and-diced mortgage loans, had not the remotest clue about what they were holding.
It all fell apart, of course, when banks bought back this financial equivalent of mystery meat and stashed it in off-balance sheet investment entities. With no apparent memory of Enron, federal regulators happily looked the other way. Capital requirements were easily circumvented in this new "don't ask, don't tell" environment.
The brokers, of course, knew from the beginning that these loans would blow up once the low teaser rates reset. But they didn't care. They made their commissions as soon as the deals closed. According to The New York Times, at least some government regulators recognized the potential for a collapse, including the late Fed Governor Ned Gramlich. But Gramlich and others were ignored.
Is the solution a prohibition against stupid loans? Perhaps. Honestly, though, I'd rather see more transparency. Holders of securitized loans should have to hold them on their balance sheets and regularly calculate and disclose their value (more often than quarterly would be nice). That way, the Fed won't have a write a regulation that prohibits bankers from being fools.
