Subprime lending fueled a real estate bubble that later collapsed. It had to do so eventually, as prices outstripped what buyers could afford to pay.
Bubble-inflating lending was fueled by loan originators packaging and selling their loans to other people, offloading their risk to other people. The ability of originators to offload all of their risk removed any incentive to accurately assess borrower creditworthiness and loan viability.
Shouldn't we try to revise the system to insist that loan originators of most sorts must retain some substantial portion of the risk they create by originating the loan?
Or at least ensure that such risk is not obscured in a haze of complexity? I am not arguing that we repeal caveat emptor. But if you look at the chain of custody of this risk-selling, you see that ratings agencies gave high investment-safety marks to a swath of investment vehicles which not only collapsed, but were loaded with packages of high risk loans. If entities which set themselves up as experts are this dumb and or compromised, what hope is their for the rest of us.
I think we either need to make the risk-makers keep some of their risk, or reform the system so that bullshine salesmen are penalized when their bullshine proves to be just that.
Not so simple, though moral hazard underlies many of the intersecting causes of the crash. The banks overall did keep the risk, just some of it in different forms. Check out the number of banks going under. That's not happening because they sloughed off all of their risk.
ReplyDeleteIt's somewhat germane to note that the securitization of mortgages in tranches DID reduce certain forms of risk. But it's the kind of risk it reduced and the kind it didn't that's key. Securitization enormously reduced the credit risk, rate risk, and prepayment risk faced by individual lenders on loan portfolios.
But what securitization didn't do was reduce systemic risk, the risk of the whole market getting whacked or undergoing significant volatility, which happened when the real estate bubble burst. And banks had not swapped off their systemic risk by securitization, as they generally bought into the same securitized markets they sold into. The systemic risk remained.
IOW, it's more complicated than you might think, involving a whole bunch of factors. The Wiki take is a good start. Note the remarks by Buffet and Volcker, especially #3, which may sound kinda familiar ...
Bernanke's remarks on the problems of Freddie and Fannie are also very germane. His tune has changed a bit since he joined the admin, of course.
And no matter how much the Democrats may wish to deny it, the CRA played a huge role as well.