Mortgage Reform — Getting Back To Basics
Given the huge profits on Wall Street, we seem to have quickly forgotten that financial reform is necessary if we’re to prevent or less the next financial meltdown.
Sen. Ted Kaufman (D-DE) is now proposing systemic financial reform. One part of that reform — a big part — would clearly involve changes in the way mortgages are originated, underwritten, bundled, sold and re-sold. The impact on borrowers and the housing marketplace would be significant.
From the Senator’s speech, Wall Street Reform That Will Prevent The Next Financial Crisis:
“On one end of the securitization supply chain, regulators allowed underwriting standards to erode precipitously without strengthening mortgage origination regulations or sounding the alarm bells on harmful nonbank actors (not even those within bank holding companies over which the regulators had jurisdiction). On the other, securities backed by risky loans were transformed into securities deemed “hi-grade– by credit rating agencies, only after a dizzying array of steps where securities were packaged and repackaged into many layers of senior tranches, which had high claims to interest and principal payments, and subordinate tranches.
“The non-banking actors — investment banks, hedge funds, money market funds, off-balance-sheet investment funds — that powered structured finance came to be known as the shadow banking market. Of course, the shadow banking market could only have grown to surpass by trillions of dollars the actual banking market with the consent of regulators.”
Kaufman also looks at how companies on Wall Street sold mortgage-backed securities — and then bet that those securities would fail:
“t has also become known that some firms underwrite securities — promoting them to investors — and then short these same securities within a week and without disclosing this fact, which any reasonable investor would regard as adverse material information. In the structured finance arena, investment banks sold pieces of collateralized debt obligations — which were packages of different asset-backed securities divided into different risk classes — to their clients and then took proceeded to take short positions in those securities by purchasing credit default swaps. Some banks went further by shorting mortgage indexes tied to securities they were selling to clients and by shorting their counterparties in the CDS market. This is how a firm like Goldman Sachs could claim that they were effectively hedged to an AIG collapse.
“Unfortunately, the use of products like CDS in this way allows the banks to become empty creditors who stand to make more money if people and companies default on their debts than if they actually paid them. These and other problematic practices that place financial firms’ interests against those of their clients need to be restricted. They also completely violate the spirit of our seminal legislation from the 1930s, which insisted — for the first time — that the sellers and underwriters of securities disclose all material information. This is nothing less than a return to the unregulated days of the 1920s; to be sure, those days were heady and exciting, but only for a while — such practices always end in a major crash, with the losses disproportionately incurred by small and unsuspecting investors.”
For the full speech, see: Wall Street Reform That Will Prevent The Next Financial Crisis
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