Business

Commonsense Regulatory Ideas Ignored Prior to Mortgage Meltdown

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What continues to bother me about the financial crisis is that so many people saw the warning signs and yet so many others refused to pay attention to the risks.

A new AP report reveals the extent to which the Bush administration ignored the danger. Here’s a list of what the administration could have done but refused to do in early 2006:

  • Regulators told bankers exotic mortgages were often inappropriate for buyers with bad credit.
  • Banks would have been required to increase efforts to verify that buyers actually had jobs and could afford houses.
  • Regulators proposed a cap on risky mortgages so a string of defaults wouldn’t be crippling.
  • Banks that bundled and sold mortgages were told to be sure investors knew exactly what they were buying.
  • Regulators urged banks to help buyers make responsible decisions and clearly advise them that interest rates might skyrocket and huge payments might be due sooner than expected.

Banks told the Bush administration that such regulations would inhibit innovation and assured everyone that the risky mortgages were not risky at all. To be sure, the Bush administration was not alone in falling for this line of bull. Most of Congress and Wall Street also slipped on the rose colored glasses.

Obviously, 20/20 hindsight makes regulating easy. In the aftermath of a crisis, we can see where the levies should have been stronger. But the suggestions above weren’t exactly audacious. Even in my little corner of the real estate world (I do a lot of multifamily advertising), most everyone knew the lending practices were getting out of hand. What we didn’t know was how those outrageous ARMs were laced through the entire financial system like metastatic cancer.

I’m no regulatory reactionary. In fact, I think we should treat new regulations with suspicion. But there’s a difference between government control (which many regulations seek to achieve) and crisis prevention (which the above regulations were geared to achieve).

We would do well to recognize the difference in the future.