The Re-Thinking of Mortgage Deregulation

The American dream has always had home ownership at its core. Mortgages have enabled ordinary people to join the propertied class. For most people the prime financial asset they possess is the equity in their home.

Rising defaults in the sub prime mortgage market have uncovered fundamental weaknesses in an economy that was built on speculative borrowing. The past month has seen credit drying up and the fall out has begun to spill over into the wider economy. Many major retailers are reporting softer sales as consumers put off discretionary purchases. All investors will be at risk if the inflated stock market turns out to be a bubble. On top of this, foreclosures are expected to soar this winter as some 2 million mortgages are scheduled for rate increases this fall.

The mortgage companies that offered sub-prime loans blame the investors who made the practice possible. The problem runs much deeper. The sub-prime debacle is not so much a new crisis as a continuation of the saga that began with the 1980's savings and loan scandal. The real problem is the ideology of deregulation.

Free-marketers promised greater efficiency and more plentiful credit, if government regulators would just get out of the way. In each episode of deregulation the result has been increased speculation followed by huge losses and the cost is passed on to the public.

The majority of today's biggest mortgage lenders are subsidiaries of banks. While the loan portfolios of the parent banks are still strictly regulated, their mortgage subsidiaries are not, because the loans don't stay on their books. For the most part, mortgage lenders make their profits based on their volume of loans. Many of these lenders loosened credit standards far past acceptable discretion because they knew that they could pass off the risk to some other investor. The Wall Street Journal states that the value of sub prime loans soared from $50 billion to more than $600 billion between 2001 and 2005.

Borrowers with poor credit histories were offered loans they did not qualify for, often without income verification. Mortgage companies offered loans with no down payments and low "teaser" rates that became too expensive once they increased to the market rate. Many of these loans are already in default.

Mortgage companies are exempt from federal regulation so there was no government agency to temper these practices. Home buyers and lenders were both betting that appreciation in housing prices would allow early refinancing, or that equity windfalls would allow the borrowers to meet the payments. They were blind sided when the housing market corrected itself. To quote Warren Buffett, "You don't know who's swimming naked until the tide goes out."

The mortgage industry has put a pretty face on its tactics, contending that it was virtuously helping less-affluent people become homeowners. Deregulation has flunked its lengthy experiment. America needs a system to support home-ownership while making sure that mortgage lenders serve as responsible creditors, not predators. It's too late to head off the current deregulation disaster, however Congress needs to take steps now to prevent the next one.