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aults and S&L bankruptcies ultimately cost taxpayers more than $200 billion.
In the subprime lending crisis that repeated the pattern two decades later, yet another form of deregulation was implicated -- the invention of "securitization" by investment bankers. That part of the story begins with the privatization of Roosevelt's FNMA.
In 1968, President Lyndon Johnson's housing aides decided to get FNMA off the government's books, in hopes that a private corporation could provide more liquidity for mortgages. Privatization of FNMA, rebranded as Fannie Mae, set the stage for other private players to get into the business of repackaging mortgages, which was no longer the province of a government agency chartered to act in the public interest.
In 1977, the investment-banking firm Salomon Brothers devised a highly lucrative financial daisy chain. Mortgages could be purchased from the originator of the loan, repackaged as bonds, sorted according to supposed risk, and certified by bond-rating agencies, thus allowing any number of investors to buy the bonds.
Securitization enabled subprime lenders to throw away the rulebook. As long as some investment bank could be found to buy the loan, convert it to a bond, and peddle it to someone else, the mortgage companies could still turn a profit.
In theory, this system makes mortgage credit more plentiful by funneling money from capital markets back to mortgage lenders and to borrowers, just as FNMA did beginning in the 1930s. But in today's privatized version, so many middlemen take cuts that home buyers are no better off.
The union of securitized mortgage credit and subprime lending was a marriage made in hell, waiting to be consummated. Once Congress sorted out the S&L mess, reregulating S&Ls in a 1989 law, more and more mortgage companies began doing end-runs around the regulations.
Most of today's biggest mortgage companies are actually subsidiaries of banks, such as Wells Fargo. 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. Other such companies are independent, but financed by big banks.
Many of these new-wave mortgage lenders, which make their profits based on their volume of loans, loosened credit standards far beyond the point of prudence, knowing that they could pass off the risk to some other investor. Between 2001 and 2005, the value of subprime loans soared from $50 billion to more than $600 billion, according to The Wall Street Journal.
Borrowers with poor credit histories were offered loans without a full credit check, often without income verification. Mortgage companies offered loans with no down payments and low "teaser" rates that became unaffordable once they rose to the market rate. About 15 percent of these loans, valued at about $67 billion, are already in default.
There was no government agency to temper these practices, since mortgage companies are exempt from federal regulation. Home buyers and lenders were both betting that appreciation in housing prices would allow early refinancings, or that equity windfalls would allow the borrowers to meet the payments. But when the housing market turned soft, they were blindsided. As super-investor Warren Buffett inimitably put it, "You don't know who's swimming naked until the tide goes out."
. . .
Thus the decline and fall of a once-sublime system of providing reliable mortgage credit for the American Dream. The industry has put a pretty face on its tactics, contending that it was virtuously helping less-affluent people become homeowners. But predatory lenders are a feeble substitute for a national homeownership policy.
Since the Reagan presidency, the federal government has largely gotten out of the business of subsidizing first-time homeownership. In the New Deal and postwar eras, moderate-income people got cheap, government-insured loans. Some veterans got direct loans reflecting the government's own low borrowing rate. In the 1960s, the Great Society directly subsidized mortages with rates as low as 1 percent. But this has all been drastically scaled back. Since 1980, the rate of homeownership among Americans age 25 to 34 has dropped from 53 to 45 percent.
The government should resume directly subsidizing starter mortgages and construction of homes for moderate-income buyers. These programs need to combine careful credit assessment with counseling, rather than relying on the tender mercies of the sleaziest wing of the private mortgage industry. It does no favor to aspiring home buyers when dreams end in foreclosure.
As for deregulation of mortgage lending, it's too late to head off this debacle, but Congress should act now to prevent the next one. Banks and S&Ls are regulated because taxpayer money is at risk through deposit insurance. Though mortgage companies do not take deposits, they too need to be regulated because their antics put the entire economy at risk. Irresponsibly speculative lenders should be prohibited from selling mortgages in the secondary market, even if they can find a consenting adult foolish enough to buy them.
My former boss, Senator William Proxmire of Wisconsin, sponsored the 1968 Truth in Lending Act, to require that interest rates be disclosed to borrowers in clear, consistent terms. The senator, who died in 2005, must be whirling in his grave. Today's mortgages are often convoluted and opaque, explicitly designed to mislead the borrower. We need a new Proxmire Act, to limit the bait-and-switch character of mortgages, and to police the secondary market in mortgage securities.
We've now had an experiment in the claims made for mortgage deregulation, extending over three decades, and deregulation flunked. America needs to restore a system in which government supports home- ownership -- and makes sure that mortgage lenders serve as responsible creditors, not predators.
Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos, a New York-based think tank. From 1975 through 1977 he was chief investigator for the Senate Banking Committee.search Www
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