Tuesday, November 27, 2007

Unintended Consequences

Larry Summers (the former Clinton Treasury Secretary and bounced President of Harvard) recently predicted that the odds were high that the U.S. is heading into a recession. This prediction is based on his assessment of the consequence arising from the recent sub-prime mortgage meltdown. In turn, this mortgage debacle, predicted by some to cost U.S. financial institutions as much as $300 billion, has occurred because of both greed on the part of lenders and financial naiveté on the part of borrowers. The specter of this huge financial loss has caused a tightening of monetary flows that is rippling through many other economic sectors and is the reason for Mr. Summers' gloom and doom.

Now, why has this sub-prime mortgage crisis occurred? May I suggest that politician's fingerprints are all over this misfeasance? I distinctly remember a number of years back when bank's lending practices were under the microscope and, if the number of mortgages given in depressed urban areas were not proportional to those in more affluent areas, they were castigated by solons at both the national and state level. The media had a hay day with such lurid headlines. In response, banks and other financial institutions, against their better instincts, started giving mortgages to marginal credit risks … and, in return, jiggered the terms of these mortgages to compensate them for these higher risks. They then would package these mortgages and sell them to third parties at a nice profit. The result was a paving over of the inherent risks that these mortgage packages represented.

Strutting in the background with thumbs in their suspenders were the politicians who cajoled this "best-practices" change on the part of mortgage lenders. And they obviously used this relaxation to garner many votes among those who were then getting these sub-prime loans. Now that this debacle is affecting us all, where are those politicians? May I suggest that you look under their desks? Will those home owners whose houses have been foreclosed on take it out on these same politicians? I doubt it. Most likely they will despise the banks and other mortgage lenders. And now these pols are also deflecting their own guilt by telling lenders to rejigger their rates so that home-owners are not thrown out on their ears (lowering the rate but extending the term of the mortgage). Basically, like politicians since time immemorial, they are kicking the can down the road. They are also ginning up a legal mechanism to make class-action suits easier for such mortgage borrowers. So, those financial institutions, which are not deep-sixed by this mortgage crisis, will, in the longer run, be crippled by our avaricious trial lawyers.


George W. Potts said...

George St. Maurice offers:

Now, why has this sub-prime mortgage crisis occurred?

IMHO, the underwriters. They were missioned to analyze patterns of credit and payment histories, assess the breadth of asset value changes over the term of the notes, and discount the derived collateralized debt obligations. These should have been less-than-junk right from the start. But I don't hear about those companies collapsing now.

George W. Potts said...

"These should have been less-than-junk right from the start."

BINGO!! But then, mortgage providers were pressured to ignore this and write mortgages anyway ... with predictable results.

George W. Potts said...

George St. Maurice again:

BINGO!! back at 'ya ... "Pressured"? The mortgage initiators may been pressured, but the CDO evaluation should have painted a realistic picture for investors, a red herring report that something, um, stinks.

George W. Potts said...

I'm not arguing that point. But then many mortgage initiators held onto these CDOs because investors had started to get wise (and they still wanted to book these mortgage initiation fees). That is why many of these same financial institutions (who otherwise would have slid) are taking huge write-offs. (In a sense they scammed themselves.)