Who Should We Blame For The Mortgage Meltdown?

According to Alan Blinder, a former vice chairman of the Federal Reserve and now a professor of economics and public affairs at Princeton, there are six factors which caused the current foreclosure mess — a list which curiously excludes, ahem, the Federal Reserve.

Let me explain.

Writing in the New York Times, Mr. Blinder says the fault lies with:

___ Households that spent too much.

___ Lenders who sold inappropriate mortgage products.

___ Regulators in general who failed to regulate.

___ Investors who did not carefully examine their investments.

___ Investment bankers who created risky securities backed with mortgages. And,

___ Ratings agencies which supposedly determined the risk of mortgage-backed securities.

According to Mr. Blinder, the government failed “to do anything large and serious to limit foreclosures is tragic.” But let’s get real: It wasn’t the “government” in a general sense that failed, it was specifically the Federal Reserve.

Under the Home Ownership Equity Protection Act (HOEPA), since 1994 the Fed has had the right to ban “unfair and deceptive acts or practices” — what folks in the know call UDAP. Had the Fed used its authority in 2003, 2004 or 2005 and prohibited option-ARMs, interest-only mortgages and stated-income loan applications we would not have today’s foreclosure levels and therefore the massive losses associated with mortgage-backed securities, bank stocks and credit-default swaps.

Moreover, Mr. Blinder says “the broad contours of the foreclosure tsunami were clear more than a year ago” by some in Washington. A year ago was too late because millions of additional toxic loans were added to the problem since the risks of toxic lending became commonly known.

“Nontraditional” loans and the risk they obviously represented have been known to the public for at least five years. In fact, let’s be clear, does it make ANY sense to issue large numbers of mortgages without requiring that borrowers verify their income and assets? Does it make sense to issue loans where the monthly payments do not even cover interest costs and where loan balances actually grow? Does it make any sense to believe that real estate values always go up?

The Federal Reserve is a bank regulator. It is independent of the President and the Congress. It doesn’t matter who is in office. The Fed had the legal authority to act and the lawful obligation to protect the American people.

The Fed, by itself, could have prevented the mortgage meltdown by declaring in 2002, 2003 or 2004 that toxic loans and weak underwriting were simply “unfair and deceptive acts or practices.” If we had good loans we would also have good mortgage-backed securities, good credit-default swaps (because there would be far fewer defaults) and banks with fewer losses or no losses. There would be no credit crunch because banks would have money for prudent loans.

Instead of pointing a finger elsewhere, Mr. Blinder — and other Fed officials past and present — ought to do what’s right and specifically tell the public that the Fed failed.

For the full story in the New York Times, see: Six Errors on the Path to the Financial Crisis, January 24, 2009.

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1 Comment on "Who Should We Blame For The Mortgage Meltdown?"

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  1. David Reed says:

    Peter- That’s the BEST damned analysis I’ve ever read. You nailed it.

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