Ben Bernanke is closing the barn door that Alan Greenspan left open to allow fraud to run wild in our mortgage system. If he's lucky, Greenspan will be able to see how well Bernanke's plan works in about a decade when the mortgage market starts to heat up again.
What Bernanke has done, according to the New York Times, is to propose that mortgage companies must show that customers can realistically afford their mortgages. He also proposed that lenders be required to disclose the hidden sales fees often rolled into interest payments, and he'd like to ban certain types of lender advertising that encourages people to take on mortgages they can't afford.
Since 47% of the $1.3 trillion subprime mortgage market was made up of no documentation loans -- e.g., liar loans -- Greenspan's policy of turning a blind eye to deceptive practices was institutionalized. He was so enamored of the idea that securitization would diversify away all the risk of people who could not pay back their loans that he ignored warnings from the likes of the late Fed governor Ed Gramlich.
Bernanke's plan is a good first step. I think one of its flaws is that it asks the banks to tell the consumer whether they can afford the mortgage. If a banker needs to close the loan to get a bonus, that affordability calculation will be skewed to close the deal. I would change the bankers' incentives so that their bonus is linked to the long term profitability of the loan; rather than how big a contract gets signed.
Greenspan was wrong and Gramlich was right. As the fates would have it, Greenspan will be around to see just how wrong he was and will see his reputation heavily dented as a result. Wherever Gramlich is now -- he died in September -- he must be shaking his head that it took a global economic crisis to get the Fed to propose the simplest of fraud protection for consumers.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.
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Reader Comments (Page 1 of 1)
12-19-2007 @ 11:20AM
Chilla said...
Well, well, well. So, it turns out Alan is not the
infallible economist he was touted as all those years. And now we are paying a VERY heavy price for HIS "irrational exuberance" regarding sub-prime mortgages. How about a mea culpa Alan?
12-19-2007 @ 11:34AM
James S. Carter said...
The sub-prime loan problem is a matter of consumer safety, and is an outstanding example of how legislation is needed when consumers can't - or don't - protect themselves. Ralph Nader, where have you been? Were you so discredited that you couldn't take up this matter before it got out of hand?
12-19-2007 @ 10:53PM
JB Matthews said...
Let's see..... I know you can't repay me the quarter I loaned you, but I'm hoping you can pay me the forty cents it will inflate too, so I loan it to you anyway. But, I'm clever because I know I don't have to worry about collecting since I've bundled your loan and lots of others together and passed them on to greedy brokerage firms.
Let's face it, this is one of the biggest pyramid schemes ever foisted on the American public and the people now currently in default on their mortgages and the small investor on Wall Street are the ones paying the price.
This is economics 101. If you can't afford to repay a loan today, how can you afford to repay a larger loan tomorrow?