WHO SHOULD TAKE THE BLAME?
In March, 2007, a top Federal Reserve Official admitted that the central bank could have done more to prevent the growing crisis in the subprime mortgage sector.1 Some attribute the problems that are arising today to the tenure of former Fed Chairman, Alan Greenspan.2 In 2003, the Fed cut its benchmark rate to 1 percent and kept it there for a year which helped foster a housing bubble.3 The interdependence of mortgage lending and the demands of Wall Street for high-yielding mortgage bonds increased the demand for high-risk loans and thus lending standards declined in order to meet these demands.4 The effects of the low interest rate were tremendous, as subprime mortgages almost doubled to $640 billion in 2006 from $332 billion in 2003.5
Why did the federal regulation industries not foresee the problem or attempt to implement stronger restrictions? Federal bank regulators say their authority extends only over the institutions they oversee and does not extend to the state-chartered mortgage brokers that represent a large share of the industry.6 However, consumer advocates argue that this is not entirely true.7 For example, the Truth in Lending Act gives the Fed rule-writing authority over disclosures for consumers’ credit among all financial institutions.8
RATING AGENCIES
Some are also blaming the rating agencies. House Financial Services Chairman Barney Frank questioned housing industry officials during a recent hearing on how good a job the rating agencies had done considering an estimated 13 percent of subprime loans are now in default and an increasing number of lenders have filed for bankruptcy.9 Although investors are attracted to the higher yielding tranches which contain subprime loans, it is not certain that the investors would have invested in some of the riskiest loans without the rating agency’s backing. The rating industry claims that it had little historical precedent to rank the new subprime loan products that featured the most risky characteristics, such as mortgage loans with little or no documentation or ones that offered a low introductory teaser rate in the first few years.10 In addition, they argue that as the market changed, they adjusted their ratings, so they should not be blamed.11 Warren Kornfeld of Moody’s claims that the rating agency’s job is to express its opinion. “A rating is not a pass/fail. A rating is a probability of potential losses to bondholders.”12
PRIVATE INFORMATION
Another criticism of the current policy is the lack of public disclosure.13 Under the supervising enforcement powers, more than half of the potential actions, such as a memo of understanding and consent cease and desist orders, are confidential and thus never reach the public eye. Proponents of this system claim that there are a relatively low number of formal actions, which is an indication that the supervisory process is working.14 Critics however, argue that the regulators’ private responses harm consumers by depriving them of information that might be necessary for them to take action on their own behalf.15 Consumer education seems to be the problem and not necessarily disclosure. If all of the confidential actions were made public, there would be a greater likelihood that unwarranted scares would exist within the community, which would greatly disrupt the financial institution markets.16
1 Sue Kirchhoff, Fed Official Acknowledges More Should Have Been Done in Subprime Sector, USA TODAY, Mar, 23, 2007 at 6B.
2 Craig Torres & Alison Vekshin, Banking Regulators Fell Off Tightrope, SUN-SENTINEL, March 18, 2007, at 1E.
3 Bill Swindell, Democrats Turning to Credit Rating Agencies’ Role in Subprime Loan Crisis, CONGRESS DAILY NATIONAL JOURNAL, Apr. 18, 2007.
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