Barney Frank, chairman of the House Financial Services Committee tells Emerging Markets how US lawmakers are dealing with the fallout of the US housing crash
Who’s to blame for the sub-prime crisis?
I haven’t really wanted to join the blame game. When you’re trying to deal with legislation you look at systemic factors. Essentially what we’ve seen is an example of innovation outstripping regulation. We used to have mortgages made by regulated entities, banks that were governed by rule set down by their regulators essentially to keep them from lending money imprudently.
Because of technology, because of greatly increased liquidity, there were pools of money outside of banks we began to have a large number of mortgages originated by unregulated entities, mortgage brokers, and they would go to individuals, and they could then go to these pools of money that were outside the regulation and then sell them into an unregulated secondary market. That’s what happened. Innovation grew up and there was not sufficient regulation.What we are going to do going forward is to take the kind of regulations that govern banks that were making mortgages and apply them to everybody who makes mortgages. We will also put some responsibility on the people who package them and sell them onto the secondary market.
More specifically, what regulations are you now proposing?
What we’re going to severely restrict prepayment penalties. We’re going to require that you take into account in a reasonable way people’s ability to repay. If you look at the banks, the mortgages they made didn’t cause problems. We’re going to conceptualize the rules there and apply them, with prepayment penalties. That’s on the negative side. On the positive side, we’re going to increase the role of the Federal Housing Administration (FAJ) in being available to guarantee the subprime mortgages and give people an alternative.
In 2005, some of us in the Congress wanted to [apply more stringent regulation] but the Republican leadership at the time embraced a kind of free market fundamentalism and killed the effort.
There’s a concern that Congress will now overreact and as a result could stymie financial market progress.
That’s nonsense. One, where’s an example of that ever happening? Seriously. Ask those people if they have any example of it happening. It never has happened. There was excessive deregulation. By the way, what we’re talking about now, Secretary [Henry] Paulson and [Fed] Chairman [Ben] Bernanke agree with. There have got to be some rules about this. If you really want to hear this argument that if Congress steps in and the government steps in that you’re going to ruin the market, go back to the debates in the 1930’s about the establishment of the SEC. Those arguments have been made ever since. Yes, you can regulate badly - or you can regulate sensibly. We’re talking about doing it sensibly, and the point here is particularly strong because we’re not going to be inventing these regulatory concepts de novo: they’ve applied to the banks. The fact is that regulated entities – banks and mortgage unions and thrifts – have been making mortgage loans for many years without these adverse consequences and that’s been subject to regulation, to the bank regulators, so the notion that regulation inherently destroys the market is just stupid.
As to putting some rules on the people who package [mortgage debt], that’s pro-market because right now the biggest problem you have is investors not buying any of that stuff. What we’re proposing are rules that guarantee that you’re selling valid paper - that’s market enhancing.
Looking at the explosion of liquidity in the market - the easy money of recent years - some lay blame ultimately at the doorstep of the Greenspan Fed for having relaxed rates too much, for too long.
Wrong, wrong, wrong. The notion that you solve a problem in excessive stock market pricing or too many bad loans by deflating the whole economy is ridiculous. And it comes from some economic fundamentalists. Greenspan was right not to deflate the economy in 2001. The notion that the way to deal with abuses in some industry is to punish workers by inducing recessions and slowing down growth is always wrong in my judgment but it’s particularly wrong now because the fundamental economic problem facing the US and many other countries is the mal-distribution of wealth. The fact that as our economy grows so much of the money is going to a relatively small number of people, the average worker is seeing an erosion in her economic position and of course slowing down the whole economy to deal with a specific problem only makes that worse.
So I do think the Fed should have stepped in but they should have stepped in with some of their regulatory powers. Greenspan himself poses a false choice between macroeconomic slowing down of the whole economy and doing nothing. But precisely what we’re going to try to do is to fashion some more specific tools to deal with this.
There’s nevertheless concern that further easing could create distortions in the market in a way that could engender yet more unhealthy risk taking
It’s nonsense. I mean, unemployment is starting to go up. The notion is that the world revolves around the financial markets. No. The world should revolve around working people, people trying to make a living, people trying to put their kids through college, and the notion that you make their lives harder because people have made imprudent mortgage loans is just wrong, especially when there are other tools to do that.
In terms of making money easy – moral hazard and so forth –I do not know of any program in place now or contemplated which is going to give anybody any money to offset their bad decisions. We’re not bailing out the borrowers, we’re not bailing out the lenders. We’re trying to ease things. In fact, what we’re telling the lenders is that they should voluntarily take a little bit of a hit, loosen the terms of some of their mortgages because they would be better off working out a better, different and less difficult arrangement for their borrowers rather than foreclose.