Interest Rate Roundup

Monday, May 21, 2007

Fed: Trying to cure the subprime market, not kill it

Another Federal Reserve official, Sandra Braunstein, testified today on subprime lending. She said at a House subcommittee meeting that the Fed is trying to cure the subprime mortgage industry, not kill it off. The Fed wants to curb abusive lending but still allow "responsible" lenders to make money giving mortgages to borrowers with bad credit. That echoes comments made by legislators and other interested parties.

All well and good, I suppose. But how do you do that? The problem right now is that the securitization system has incentivized lenders to deliver volume, not quality, in terms of mortgage production. When many of the top quality borrowers were exhausted back in 2005 and 2006, lenders had every incentive to keep churning out worse and worse loans because there were end buyers for the paper out there. It effectively didn't matter to the loan originator whether those loans eventually failed or not. Whatever system we adopt to "fix" this mess should somehow link the originating entity to the loan's ultimate resolution.

Of course, it's worth pointing out the only reason the Fed is being forced to deal with this mess is because it refused to nip it in the bud. It all goes back to the ridiculous, "see no asset bubble, hear no asset bubble, prick no asset bubble" policy I blogged about a few days ago.


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