Although it hasn’t gotten much attention in the business press yet, the House Financial Services Committee is on the warpath to clean up subprime mortgage lending. Most of their ideas, such as tighter regulation of mortgage brokers, strike observers as reasonable. But one has created a great deal of alarm.
The concept is “assignee liability,” and at least for now, both Democratic committee chairman Barney Frank and the ranking Republican Spencer Bacchus support it:
Spencer Bachus, Mr Frank’s Republican counterpart, has backed an “assignee liability” system that would mean investment banks that repackage mortgages into bonds would be liable to pay compensation to borrowers if loans turned out to have been mis-sold.
Why is this a radical idea? Packagers are currently at risk for the securities they sell, but their liability is to investors, basically to make sure that the securities are what the offering documents say they are. However, Wall Street firms do that by making clear legally how much of the document was provided by them (typically only the offering price and any language that might relate to the offering process, as opposed to the description of the securities or the issuer). The agreement with the issuer also limits the investment bank’s maximum liability to its fees.
The proposed legislation would make packagers like investment banks who acquire subprime mortgages from brokers and banks liable for abusive practices. And it’s almost a given that they won’t be able to limit liability to their fees. (Separately, I wonder how “mis-sold” would be defined.)
This initiative is generally being labeled a Bad Idea, as these comments in the Financial Times illustrate:
….if a subprime scandal erupts again, Wall Street financiers – could face potential class action lawsuits from angry home owners. There is no guarantee that these ideas will ever actually turn into law. After all, once Wall Street wakes up to the implications of the debate, its lobbying machine will undoubtedly go into overdrive….
But it would be naive for Wall Street to think the idea will just vanish….Moreover, from the point of view of US politicians, Wall Street undoubtedly looks a convenient scapegoat on which to put part of the blame for the subprime woes….”Securitisation has not been an unalloyed good thing,” Mr Frank concludes, adding that if the securitisation business now slows, it could help slow some of the excesses of the mortgage sector.
In some respects, it is easy to feel a degree of sympathy for this view…
Yet I doubt that introducing a concept of “assignee liability” to secondary investors will help tighten standards in this industry as much as a crackdown on the mortgage brokers themselves….
Nevertheless, any litigation risk, however minute, tends to make potential investors in securitised products very nervous. If American politicians introduce measures for the mortgage world, where could this end? Will secondary investors in credit card loans, for example, eventually become liable for the sins of that industry too?
The subtext of this comment is, “These politicians don’t know what they are doing. They are going to scare investors away and the capital that goes to this sector will shrink to nothingness.”
Has it occurred to anyone that this might be precisely what Congress wants to happen?
It’s clear that any subprime mortgage lending should be at considerably lower volumes than what we’ve had recently. Just because the majority of subprime borrowers are still making payments does not mean that buying a house was a good investment. Those that bought in the last two years are likely to have negative equity. since housing prices have softened the most in communities with a high concentration of marginal borrowers. Moreover, as we have pointed out, home ownership is not an economic boon for lower income workers. It restricts their mobility, and thus has the effect on average of lowering their earnings. So the idea that it’s desirable for lower income families to extend themselves to buy houses is wrongheaded. It leads to bad decisions and bad policies. It servers realtors, homebuilders, and financiers, not the buyer.
If subprime securitization was largely shut down, what would happen? On a small scale, some banks would offer subprime loans and keep them on their books (what a wonderfully antique idea!). Some Wall Street firms might package and sell loans they originated (some of them bought subprime brokers, which now looks as smart as catching a falling safe). But the biggest impact is likely to be that the Federal Housing Administration, once the dominant force in low-income home lending, will again become a leading, if not the leading, player. The losers would be Wall Street, realtors, and investors in current subprime paper (with a contraction in funding to subprimes, the foreclosure process will result in lower recoveries than if more credit were available). But none of them are likely to get a sympathetic hearing right now. Wall Street has has several quarters running of record profits. Complaining about lost income when people are losing their homes won’t go over very well.
The alarmists raise the specter that assignee liability could apply to other areas of the financial markets, but Frank has indicated otherwise:
Mr Frank himself categorically rules out extending shared liability beyond the subprime world. He also insists he has no desire to undermine the financial community.