[The daisies in the meadow are here to help us--me, certainly--remember all that's good in the world, even while critiquing crimes and blunders. Our friend Al has very strong and well-informed opinions on financial practice. As his opinions are at least as strong as mine and certainly better-informed, I asked him if he would be willing to let me post his views on the current financial crisis, and this is the letter he gave me in response. The Traverse City Record-Eagle said it was too long to publish. Al insists there is nothing he could eliminate and still tell the whole story. --pjgrath]
For nearly thirty years I was the president of a savings and loan (S&L) association. During that time I was also a director of two unrelated commercial banks and for a time chairman of the board at one of them. That experience gives me a unique binocular view of the present worldwide financial disaster, which we erroneously refer to as the subprime mortgage meltdown.
I say “erroneously” because this appellation, “subprime,” emphasizes secondary causes that economists and Wall Street gurus identify as “careless lending” and “careless borrowing.” To be sure, these are contributing factors, but they are a long way downstream from the polluted well which is the source of the present epidemic.
There are two root causes. One is the market practice of packaging mortgages and then “securitizing” those packages in the form of bonds. This process widely distributes ownership and relieves the original lenders of responsibility and financial consequences. The second cause is the adjustable rate mortgage (ARM).
Prior to 1983, S&L’s were prohibited from making ARM’s and balloon loans. They were required to make only fixed-rate, long-term loans. These conditions were expressly written into the Federal Home Loan Act of 1933 (a year in which we enjoyed an uncommonly wise Congress).
The ARM is an unsafe and unsound instrument for underwriting mortgage loans because interest rates are unpredictable, and the underwriter (bank or S&L) has no way of knowing whether or not the borrower will be able to make payments in the future. In the present market system, the risk to the lender under the terms of an ARM is mitigated or passed on to others by the process of “securitizing” in the form of bonds secured by large packages of ARM’s. In this way, the risk is passed on from the original lender to the bondholder. A very slick trick!
Another effect of this process of turning mortgages into bonds is that responsibility is so widely scattered that it loses identification. Your mortgage may be owned, simultaneously, in part by a bond trader on Wall Street and in part by a bank in Zurich or Hong Kong or a private investor in Chicago. As the borrower, when the interest rate rises so high that you can no longer make the payments on your loan, you have no one to turn to, no avenue of appeal. Even the banker who originated the loan is powerless: he is left with no authority to re-negotiate the terms of the loan. All he can do is to initiate foreclosure on behalf of the bondholders (unknown to him) when you fail to make your payments.
Fifty years after the Federal Home Loan Act of 1933, Ronald Reagan “deregulated” financial institutions. I will mention a few results of the 1983 deregulation:
(1) The prime rate rose to 21.5%.
(2) Bankruptcies and foreclosures went through the roof.
(3) Jumbo (insured) certificates of deposit earned 15% interest.
(4) The majority of S&L associations were destroyed.
(5) ARM’s and balloon notes became common banking practice.
Now, about twenty-five years after deregulation, we are visited by another wave of consequences following from Reagan’s disastrous folly. He promised to get government off our backs. He succeeded—only to hang the uncontrolled, morally unconscious, “free” financial market around our necks. The people who are paying the most for this cavalier exercise in ignorance are, as before, the least advantaged among us.
What is the long-term cure? It’s simple. We should once again outlaw the inherently unsafe and unsound adjustable rate mortgage.
-- Al Bona, Northport
[Bookseller/editor’s note: putting acronyms into plural form is my bête noire. Though the HARBRACE COLLEGE HANDBOOK tells me I can go with or without the apostrophe, I don’t like either way: the plural looks like a possessive with an apostrophe but clumsy without. This time around my flipped coin came up apostrophe. I am not, however, soliciting comments on the use of apostrophes! Al is hoping for substantive reaction to his ideas.]
4 comments:
While I'm not sure about the prescription (if handled properly, and ARM mortgage can be good for the borrower), I certainly agree with the diagnosis. I am an attorney who specializes in class actions against sub prime lenders. I've been doing this since 2000. As far back as that, it was clear to me that securitization allowed unsafe lending practices to be rewarded by high fees and interest rates, inflicted on poorly-informed or actively misled borrowers who trusted their lenders to look out for them. But he laws regulating lending do not adequately protect borrowers, and are poorly enforced. Add to that the strong anti-plaintiff bias in our court system and getting a fair resolution for borrowers is very difficult, even now.
Al Bona is also absolutely correct about how securitization impedes fixing this problem now that it is finally too big to ignore. Any reasonable workout, from one loan to a hundred, will require investors to give up a little of their expected gains. But whenever such an arrangement is proposed, every investor wants everybody else to take the haircut, regardless of the cost to the borrower and the economy as a whole. Until those who profit from this situation are forced to be more responsible, the costs will continue to mount.
Thank you, d. myers. This is exactly the sort of response Al was hoping for. I will pass it along to him and see if he wants to toss the ball back to your side of the court. Good to hear from you.
Just want you to know that we read Mr. Bona's wonderful post aloud this morning, in a cabin in the Methow Valley in Washington State (Books in Northport reaches everywhere), and loved in particular his Reagan list and his description of the free market!
Al will be pleased to have reached all the way to the Pacific Northwest. I like the touch about your reading his letter in a cabin. Log? Kerosene? Mosquitoes? I’ll be sure to convey your pleasure to him for his enjoyment.
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