I just learned that the Federal Reserve will hold a public hearing on subprime mortgages so the Fed can assess whether it should revise its regulations to address some of the terms and conditions of these loans that “consumer advocates” have called misleading or abusive.
The hearing, scheduled for June 14 at the Federal Reserve offices in Washington, DC, will first have invited panel discussions and then an “open mike” period for short comments from attendees. Written comments are also invited — the comment period is open until August 14, 2007.
Problems in the subprime mortgage market have affected home sales and, hence, the economy. But the underlying causes of the problems remain somewhat elusive. Some blame lenders for providing mortgages to people they know can’t make the payments; others fault the explosion of adjustable rate and “low documentation” loans; while still others criticize the supposed lapse in mortgage lenders’ underwriting standards.
Others have looked at the huge and continued increase in home prices over the last decade that looked like it would never end, with consumers over-committing themselves yet confident they could resell their homes at substantial profit. Some speculate that the secondary market contributed to the problem. Since the primary lender’s loans are sold, bundled, and offered to investors as mortgage-backed securities, the original lender doesn’t have a strong financial incentive to ensure high underwriting standards.
I don’t have an answer, even though I worked in the banking and financial services industries for 20 years. I do know, though, that lenders don’t want their borrowers to walk away from their loans — they use sophisticated credit-scoring systems to try to assess who should get a loan and at what rate. As one very successful finance executive told New York business media when asked about the secret of his company’s 20-plus years of earnings increases: “I make loans and I collect on them.” Sometimes lenders err — by not giving a loan to someone who should have gotten one or by providing a loan to someone who should not. Either way, a lender would lose out.
Also, secondary markets are a way to spread risk — a pool of mortgages over different geographic areas, at different rates and risk levels has lower risks than, say, the mortgages made by one institution in one town. And investors in those mortgage-backed securities have a lot of experience in risk analysis.
Even though I don’t have the answers to the reasons for the subprime market’s meltdown, somehow I don’t think the Fed will find the answers at the public hearing either.