That response elicited the most surprise from the House Subcommittee on Financial Institutions and Consumer Credit when I testified on Jan. 14.
Rep. Carolyn Maloney, D-N.Y., had just asked, “Do you believe that, if this rule (regulations promulgated by the Consumer Finance Protection Bureau pursuant to the Dodd-Frank legislation) had been in place, flawed as it is, would it have prevented the financial crisis?”
Rep. Maloney expected a positive response because the rules in question attempt to prevent dubious mortgages from being created. I support the Dodd-Frank legislation. I simply don’t believe it is a cure-all for financial speculation. It was speculation in the form of derivatives that caused the bulk of the financial crisis, not the underlying mortgages themselves.
The Republicans repeated a particular narrative during the hearing: Beginning in late 1990s, the federal government pushed lenders into making risky loans in a misguided effort to raise homeownership, particularly among minority populations. The resulting defaults plunged us into financial crisis. Now the pendulum has swung to a regulatory approach which will disrupt an efficient private market and deprive marginal borrowers of credit.
The Democrats repeated their own narrative: Deregulation led to rapacious lenders enticing low-income borrowers into mortgages they did not understand and could not repay. The resulting defaults plunged us into financial crisis which put an undue burden on minority communities. Regulation is needed to prevent future abuse of vulnerable consumers.
The perceived villains are different: overreaching government for the Republicans; immoral opportunists for the Democrats. Ironically, both narratives depend on the same underlying assumption:
Low income families should not have access to credit if there is a risk they cannot repay.
This reductionist view accepted by both parties obscures the reality. As CEO from 2005 to 2010 of a real estate investment trust traded on the New York Stock Exchange, I had a ringside seat for the inflation of the bubble and its subsequent bursting.
The financial crisis finds its genesis in the mistaken belief that risk can be structured out of transactions altogether. While packaging and repackaging loans which were mis-rated and sold to other players in the same industry, the financial engineers of Wall Street believed their own hype and became blind to risk. They were making money not only selling the securities, but they placed lucrative bets called derivatives that increased the risk of any actual default 100 fold.
The fees paid for these structured securities and the associated derivatives seemed like easy money and the demand for mortgages to package accelerated. If they could structure away risk of conventional mortgages, these financial engineers believed they could do it for any kind of loan.
Subprime, no-documentation, and stated income loans proliferated because the packagers demanded product. This dynamic did lead to some fraudulent lending as the Democrats assert. Loan demand also had fuel from actual and implicit guarantees from the federal government as the Republicans allege. But neither of these political answers can account for the scope of the disaster.
There have been approximately 4.5 million foreclosures nationally since the financial crisis began. If one assumes 100 percent stem from bad lending and further that the average amount underwater on foreclosed mortgages was $70,000 (this according to CoreLogic as reported by CNN Money), then every bad mortgage in the country could have been resolved with an investment of $315 billion.
That number is less than half of either the TARP allocation or the stimulus package. Costs of the crisis have exceeded a trillion dollars. The reason is that the derivative contracts between institutions (no consumers were involved) multiplied the problem exponentially. The hubris of financial engineers set the explosives. The greed of small time opportunists on main street and derivative traders on Wall Street lit the fuse. In the end, it was the exponential leverage of derivatives that brought down Lehman Brothers and crippled the financial sector, not the defaulting mortgages themselves.
Both political parties should abandon the scapegoating that is further restricting credit for those struggling in low wage jobs. Low-income working families were not the problem in 2008 and they are not a risk to the system today.
Frank Spencer is president and CEO of Habitat for Humanity in Charlotte.
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