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Saturday, September 01, 2007

Financial Times Editorial Comment: Subprime loans – subprime solutions

Financial Times Editorial Comment: Subprime loans – subprime solutions
Copyright by The Financial Times
Copyright The Financial Times Limited 2007
Published: August 31 2007 18:11 | Last updated: August 31 2007 18:11

The US subprime loan crisis has turned into a morality play. Subprime borrowers – people with bad credit who took out high-priced mortgages to buy homes beyond their means – are cast as hapless victims. Subprime lenders (and the investors who bought their securitised loans on Wall Street) are portrayed as Shylocks preying on the American poor. Now the whole crew is looking to the government to step in, and spare them the consequences of their financial alchemy. Washington should resist.

President George W. Bush on Friday announced some modest measures to help truly needy borrowers, but he ruled out a bailout for the merely greedy (whether borrowers or investors). Unfortunately, Congress will probably not stop there. Millions of Americans could still be about to lose their homes, and millions more will lose money in the markets. That is the kind of crisis politicians cannot resist meddling with.

Presidential candidates are marketing their own solutions: Barack Obama has proposed a fund financed by fines on “irresponsible” lending (whatever that is). The powerful House financial services committee will hold hearings next week that could lead to legislation within weeks. The chairman of the committee, Democratic congressman Barney Frank, has made clear that he thinks the subprime crisis proves US financial markets are under-regulated. He favours everything from new underwriting standards to a new right to sue everyone from brokers that sold the loans, to banks that originated them, to investors that bought them in the secondary markets.

The result could be a stifling new web of rules and liabilities that will choke off lending to the people that subprime loans were originally meant to serve: those who need a modest home, but cannot get a normal mortgage because of credit problems.

That would be a shame: Congress should be careful not to over-react. US markets are already burdened with ligitation risk; the last thing they need is more liability.

Much can be done to save Americans from themselves: mortgage loans should be more transparent, so borrowers know how much they really owe. Borrowers can be educated to make good decisions about their mortgage (life’s most important financial decision).

But if Congress loads on too much litigation risk, mortgage finance for non-ideal borrowers will simply dry up. More regulation and liability is probably inevitable: but those who have done due diligence on their loan should be exempted. Not every subprime loan is a scam.

There is no sense in adding the huge cost of litigation to a problem that is already cripplingly costly. The market has learnt its lesson; do not lend to people who cannot pay. It is hard to see how the legislators can improve on that.


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