Save some blame for federal officials

By JAY HANCOCK

There are uncountable culprits and dupes in the extraordinary chain of events that finished Bear Stearns, Wall Street’s fifth-largest investment bank.

But at its heart the crisis is a failure of regulation. If not for the Federal Reserve’s and the Bush administration’s refusal to stop crazy mortgage lending, former Bear boss James Cayne still would be chewing cigars in his Manhattan office, counting his money and complaining about regulators.

And the country wouldn’t be headed toward what might be the worst recession in decades.

Mortgage fraud had gotten so bad in 2004 that people at the Federal Bureau of Investigation wanted Washington to intervene and start regulating mortgage brokers, FBI analyst Jeffrey Nun told Origination News late that year.

The administration, as part of its wider promotion of light regulation and freer markets, pooh-poohed the idea.

“It’s not clear there’s a federal role” when brokers were already regulated in many states, Treasury assistant secretary Wayne Abernathy told the housing trade publication. This even though states were obviously botching the job.

Reliable critic

Abernathy was a frequent and reliable critic of proposals to stop the kind of mortgages that have brought the financial system to the brink. It was perfect training for his present job as executive director of regulatory affairs for the American Bankers Association — representing institutions that issued many of the stupid loans and sold them to hapless investors.

Consumer advocates pleaded with banking regulators to take action in 2005. They worried deeply about interest-only mortgages, “option ARMs“ and other complex loans. They were concerned that banks were ignoring borrowers’ ability to repay “stated income“ and “liar“ loans that didn’t require documentation.

Don’t worry, said Washington.

“We don’t want to stifle financial innovation,” Steve Fritts, associate director for risk management policy at the Federal Deposit Insurance Corporation, told The New York Times. “Normally, we think that if consumers have a lot of choice, that’s a good thing.”

Federal Reserve chief Alan Greenspan fretted about subprime and exotic mortgages, too, and he did a great job of describing the danger.

“In the event of a widespread cooling in house prices, these borrowers, and the institutions that service them, could be exposed to significant losses,” he said in a 2005 speech.

But Greenspan did little to stop the poison loans, even though Congress had told the Fed to do just that. The 1994 Home Ownership and Equity Protection Act directed the Fed to write rules banning “unfair and deceptive practices” across a variety of mortgage lenders, says Allen Fishbein, director of credit and housing policy for the Consumer Federation of America.

But the Fed didn’t do anything until December, when under Chairman Ben Bernanke it moved to ban liar loans and require other reforms.

Pressure on Washington to do something became so great that in 2006 banking regulators issued “guidance” on what were cutely described as “nontraditional” mortgages.

Among other things the rules urged lenders to make sure borrowers could repay the money, a radical concept at the time. But they said next to nothing about the worst loans of all — subprime mortgages for people with terrible credit histories. Only a few subprime loans fell under the rules, says Fishbein.

Regulators didn’t get around to issuing guidance on subprime mortgages until the middle of 2007.

Subprime swamp

Bear Stearns was at the heart of the subprime swamp, although it was hardly the only player. It and its partners invested billions in low-grade mortgages as well as better-rated notes that lost value as the market deteriorated.

The end came when financial partners called its obligations all at once and the company couldn’t comply. Mortgages and numskull regulation, however, were the ultimate cause.

Sure, blame Bear for thinking it could manage the risk of junk mortgages. Blame moron consumers for taking loans they couldn’t afford. But don’t forget the government officials who stood by and watched while these folks ushered the country down the garden path.

X Hancock is a financial columnist for The Sun. Distributed by the Los Angeles Times-Washington Post News Service.