Melvin B. Miller
Editor & Publisher

Too little, too late

When the subprime mortgage problem erupted, the attitude of the White House was to let the rigors of the marketplace resolve the issue. Homeowners were left to be appropriately disciplined for their intemperate financial decisions.

At first, there was little concern that the flawed mortgages had been bundled to serve as collateral for investment instruments on Wall Street. They were attractive because they had a higher rate of interest than was generally available. Sophisticated investment banks borrowed money to invest in these new instruments.

Although home mortgages are usually a fairly safe investment, Wall Street discovered too late that the subprime loans were made without the standard safeguards. Because home prices were rising, mortgage companies did not require the conventional down payment to allow for a possible downturn in prices. To attract a larger volume of buyers, mortgage banks offered adjustable rate mortgages with very low entry rates. However, when interest reset at a much higher rate, many homeowners could no longer afford the cost of debt service.

Many companies that initiated the mortgages were also less than fastidious about qualifying the credit and income of applicants. Since the loans were to be sold to bundlers, there was less concern about their financial quality than there would be if the loans were to remain in the initiators’ portfolios.

The government offered little relief for beleaguered homeowners, but when Bear Stearns, a venerable Wall Street investment bank, found itself on the verge of collapse because of their excessive investments in the mortgage-backed instruments, the Federal Reserve Bank stepped in to provide funds to shore up the company.

Bear Stearns executives had the full-time job of evaluating investments, and they failed miserably. Many Americans, unaccustomed to the ways of Wall Street, were encouraged to buy homes that they ultimately could not afford. The desire to have a home of your own is the most fundamental American dream.

It was appropriate for the government to prevent the bankruptcy of Bear Stearns so that the nation’s banking system would not collapse. However, it would have been even more appropriate for the government to intervene to prevent the home mortgage from becoming such a risky loan in the first place. Now, the government must intervene to prevent families caught in the mortgage craze from becoming homeless.

Private investment has built the American economy, so there is an understandable reliance on the unfettered operation of the market. But conservatives oppose any regulation, even when it seems warranted. There is also a conservative effort to privatize customary government operations. Perhaps the mortgage debacle will make people more understanding of the need for government intervention at appropriate times, and more aware of the risks of privatization.

For example, some Republicans have been pushing for privatization of Social Security. However, if families cannot fathom the implications of adjustable rate mortgages, how can they be profitable investors in more sophisticated stocks and bonds? How disastrous it would be if elderly Americans were left to try to survive with no income because they had lost their Social Security funds on bad investments.

This whole subprime mortgage crisis would have been avoided with government regulation of mortgages. Policy wonks should learn from this disaster.

“When is the Fed coming around to give us a little help?”