Subprime

FDIC Chairman Sheila Bair has struck again-with yet another creative response to the ongoing mortgage crisis. Chairman Bair has a history of being ahead of just about everyone else in Washington with proposals to respond to the crisis in a manner that is doable and fair. This time it's the Home Ownership Preservation or HOP loan, and the FDIC estimates about one million loans-make that one million homeowners in trouble-might be eligible.

A proposal by Gordon Brown's government to up the taxes paid by resident foreigners and demand greater transparency in their offshore dealings has many fearing an exodus of London's international financiers. This comes at a time when increasing numbers of businesses in London are also moving their headquarters to countries with lower taxes. Layoffs by banks in the wake of the subprime crisis are further damaging the City's reputation as a vibrant financial center. A loss of foreign residents and international business would be devastating for a city that has emerged as New York's greatest rival for global preeminence.

Snapshot asks, could New York reclaim the top spot if London falls?

With a sense of irony and amazement that Congress actually might be getting the housing mess right, Sebastian Mallaby's column in today's Washington Post hits the nail on the head. It's interesting that it took a writer whose major beat is international economics to see the point about negative externalities and the collective public good. As several of us, through many forums--I've been working with the Center for American Progress on the Save America's Family Equity or SAFE proposal--have been saying for months, this is not a matter of bailing out either borrowers or lenders or of preventing house prices from falling. This is a matter of cushioning the blow for all the rest of us--the communities that will pay dearly from declining tax revenues and increased demand for services; the homeowners whose mortgages are long-since paid off or who have been paying faithfully and can and will continue to do so; the renters who have lost their homes because their landlord can't afford to pay the mortgage any more.

Mallaby points to the positive steps Congress is taking to enable loan servicers to sell or refinance their loans after taking a substantial haircut and to enable borrowers to get new loans that they can support--with upside to the government to compensate for taking the risk. I wish he'd included the proposal outlined in Congressman Frank's bill for bulk transfers of loans, because I believe that ultimately that will be necessary. But the essential points are there. As is the point that the tax giveaways in the Senate's "housing" bill are outrageous.

It's all we hear about these days: The U.S. subprime mortgage bubble -- created by poor and at times predatory lending practices and lax banking regulation and creative investment products -- has burst. Of the approximately 7.7 million subprime loans outstanding, over 2 million are at risk of foreclosure and 600,000 borrowers are expected to lose their homes this year. The majority of us are left in shock as we watch the devastation unfold, the bubbles aftermath wreaking havoc on the U.S. (and increasingly global) economy, ensuing fears of recession and economic pain to come, and leaving politicians, economists, and regulators all scrambling to pick up the pieces.
However, in the meantime, the 2006 Nobel Peace Prize winner on Tuesday proudly hailed microfinance -- the innovation of providing small loans to poor, traditionally financial excluded individuals, mainly women -- as "sub sub sub subprime" lending. That means that globally, more than 3300 microfinance institutions provide such "super-subprime" loans to over 100 million clients and growing. Just to be clear: I'm a huge fan of microfinance. However, I'm left perplexed by this dichotomy: How can a lending practice that is almost singlehandedly dragging the whole of the U.S. economy in to a hole simultaneously and sustainably end third world poverty?

It has lately become fashionable for conservative pundits (Larry Kudlow, George Will) and disgruntled ex-bankers (Vernon Hill, for example, in his March 7 American Banker editorial) to blame the current credit crisis on the Community Reinvestment Act. This is patent nonsense. The sub-prime debacle has many causes, including greed, lack of and ineffective regulation, failures of risk assessment and management, and misplaced optimism. But CRA is not to blame.

First, the timing is all wrong. CRA was enacted in 1977, its companion disclosure statute, the Home Mortgage Disclosure Act (HMDA) in 1975. While many of us warned against bad subprime lending before the turn of the millennium, the massive breakdown of underwriting and extension of risky products far down the income scale-without bothering to even check on income-was primarily a post-2003 phenomenon. To blame a statute enacted in 1977 for something that happened 25 years later takes a fair amount of chutzpah.

Alan Greenspan wrote in Monday's Financial Times that he was blameless for the development of the real estate bubble, echoing his dismissal of blame during the popping of the tech bubble. Greenspan is right to point out that the ability of regulators to foresee crises are exaggerated and housing bubbles in other countries have risen despite tight monetary policy. However, he is wrong that tighter monetary policy, further regulation over both mortgage lending and complex financial instruments would not have helped slow soaring housing prices. As Martin Wolf points out in his column linked below, a rise in interest rates of 1% would not lead to market collapse if people expected their houses to rise in value by 10%.

Alan Greenspan - The Fed is blameless on the property bubble
Martin Wolf - Why Greenspan does not bear most of the blame
Desmond Lachman - The Economic Consequences of Mr. Greenspan

Steve Clemons, director of the American Strategy Program here at the New America Foundation held a media conference call Friday with George Soros to discuss his new book, New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means. The book is available in electronic form, here. To listen to the MP3 of the call, click here.

In the book, Soros examines the financial roots of the current financial crisis and what to do about it. After the call on Friday, my colleague Sam Sherraden looked at Soros' market analysis and policy prescriptions in this special edition of Global Economic Snapshot. I will take a little more time to examine the geopolitical roots of the crisis, focusing on his concept of the Superbubble and extracting some strategic lessons for the United States.

Bubble of Damocles

The New America Foundation hosted a conference call with financier and author George Soros this morning during which he shared ideas from his recent book, A new Paradigm for Global Financial Markets: The Credit Crisis of 2008 and What it Means. Soros said, albeit with some chagrin, that the current financial crisis "pulled him out of retirement." Apparently it pulled him far enough to write a new book about boom and bust cycles, regulation of credit, and the current financial turmoil. I wonder whether his book was due to some sense of social obligation or he was just drawn by the excitement of the current crisis. Given his philanthropic efforts, I suspect it was a combination of both.

I want to make three comments after listening to the call. First, George Soros came off as charming, self-effacing and brilliant. His analysis of booms and busts are correct and insightful, but not revolutionary. And finally, his prescriptions for policy action are not concrete, but they get at the heart of the problem of our current regulatory structure. There is little need to comment on the first topic, so I'll skip right to the second two.

The first proposal to reform the financial system since the subprime crisis was announced yesterday by Treasury Secretary Hank Paulson. The proposal aims to create a regulatory environment in which "capital can seek out its most productive uses in an efficient matter." Before his time as Treasury Secretary he worked as co-chief executive at Goldman Sachs, where he argued for reduced regulation and consolidation of regulatory agencies. Yesterday's proposal sought to combine regulatory agencies and expand the powers of the Fed.

Snapshot asks, what parts of the Paulson plan will survive?

The upswing in market sentiment after the rescue of Bear Stearns may soon come to an end. Highly leveraged financial institutions, which use large amounts of borrowed money, may still face unexpected losses as the housing market and consumer confidence continue to fall. Institutions have taken more losses on underlying assets, causing them to be even more highly leveraged than before. As underlying assets fall in value, many derivative products will also be written down.