Friday, July 27, 2007

In This Mess, Finger Pointing Is in Style

High & Low Finance
The New York Times
July 27, 2007

Who’s to blame for the subprime mortgage mess?

It’s the lenders, says William Poole, the president of the Federal Reserve Bank of St. Louis. As he sees it, bankers and mortgage brokers persuaded innocent borrowers to take out ARMs — adjustable rate mortgages — when rates were all but sure to rise. He also blames investors who bought the mortgage securities that are now in trouble.

Bankers should take their share of scorn, but they were not the only ones who encouraged borrowers to take out adjustable rate mortgages at precisely the wrong time. So did Alan Greenspan, the longtime chairman of the Federal Reserve.

In Mr. Poole’s view, it was obvious from 2002 to 2004 that short-term interest rates were all but certain to rise, thus driving up the cost of ARMs. But the bankers did not point that out to their customers.

“Apparently driven by the prospects of high fee income,” said Mr. Poole in a speech a week ago, “mortgage originators persuaded many relatively unsophisticated borrowers to take out these mortgages; then, investors willingly purchased them when they were securitized. Many of these mortgages are now in default, some of the lenders are bankrupt, and the mortgage-backed securities are trading at deep discounts to face value.”

In 2004, however, the Fed sent a different signal. Mr. Greenspan, speaking to Credit Union executives on Feb. 23, said “recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable rate mortgages rather than fixed rate mortgages during the past decade.”

He conceded that they might suffer if rates rose, but that was not the point he emphasized. Instead, he used option pricing theory to conclude that homeowners were paying a very steep price when they took out fixed rate mortgages.

“American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed rate mortgage,” said the Fed chairman.

Rarely has an industry done a better job of following a regulator’s suggestion. The bankers came up with mortgages that took 40 years to pay off, rather than the customary 30-year amortization period. If that was not enough, they offered loans with negative amortization, so that every month a borrower owed more than he had the month before. People could get mortgages without anyone’s checking to see if they had lied about their income.

Mr. Greenspan may have come to regret his 2004 remarks. In the fall of 2005, he told a group of mortgage bankers that the “apparent froth in housing markets may have spilled over into mortgage markets.” He voiced concern over “more exotic forms of adjustable rate mortgages,” but said nothing to indicate banks should stop offering them.

Had Mr. Poole been willing to talk to me, I would have asked if he thought the Fed bore any responsibility.

Now the problems are surfacing. Earnings are down at Countrywide Financial, which as David Hendler of CreditSights pointed out, was “a leader in developing and bringing to the fore many of the innovations that are now adding a certain toxicity to even prime mortgages.”

Angelo R. Mozilo, Countrywide’s chief executive, doesn’t think he should be blamed. Talking to analysts this week, he called Mr. Poole’s comments “unbelievable” and criticized the Fed for first raising interest rates and then forcing banks to tighten their lending standards.

When an analyst suggested that Countrywide, the country’s largest mortgage lender, should not have made those loans, Mr. Mozilo sounded as if he had no more choice than a lemming going over the cliff.

“Our place in the industry would have changed dramatically because we would have arbitrarily made a decision that was contrary to what everything appeared to be — values going up and no delinquencies, no foreclosures — and we suddenly stop the music,” he said.

“Nobody saw this coming,” he added.

Actually, there were forecasts of disaster. But Mr. Poole was not among the Cassandras.

In March of last year, a few months before home prices peaked, he said a housing bubble might be brewing, but that Fed research indicated home prices were not unreasonable.

“So, if you have an academic interest in house prices, I recommend that you wait a few years,” he said. “If you have a direct financial interest, I can’t help much — you’re on your own!”

That exclamation point was in the text released by the Fed.


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