Man Bites Dog (Federal Reserve Edition)

The New York Times’ Floyd Norris, in “In This Mess, Finger Pointing Is in Style,” discussed who might be responsible for the subprime woes and included this tidbit:

Who’s to blame for the subprime mortgage mess?

It’s the lenders, says William Poole, the president of the Federal Reserve Bank of St. Louis. As he sees it, bankers and mortgage brokers persuaded innocent borrowers to take out ARMs — adjustable rate mortgages — when rates were all but sure to rise. He also blames investors who bought the mortgage securities that are now in trouble.

Bankers should take their share of scorn, but they were not the only ones who encouraged borrowers to take out adjustable rate mortgages at precisely the wrong time. So did Alan Greenspan, the longtime chairman of the Federal Reserve.

In Mr. Poole’s view, it was obvious from 2002 to 2004 that short-term interest rates were all but certain to rise, thus driving up the cost of ARMs. But the bankers did not point that out to their customers.

“Apparently driven by the prospects of high fee income,” said Mr. Poole in a speech a week ago, “mortgage originators persuaded many relatively unsophisticated borrowers to take out these mortgages; then, investors willingly purchased them when they were securitized. Many of these mortgages are now in default, some of the lenders are bankrupt, and the mortgage-backed securities are trading at deep discounts to face value.”

In 2004, however, the Fed sent a different signal. Mr. Greenspan, speaking to Credit Union executives on Feb. 23, said “recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable rate mortgages rather than fixed rate mortgages during the past decade.

Norris focused on the implicit criticism of Greenspan and the barb is well deserved. Security, particularly where most American’s biggest financial asset is concerned, might be worth the tens of thousands of dollars worth of insurance embodied in a fixed rate mortgage.

However, what is at least as interesting is Poole’s criticism of the banking industry. I can’t recall a time when a financial regulatory official has blamed mainstream institutions (as opposed to a few outliers) of taking advantage of customers. Is the Fed finally getting on board with the idea of borrower protection? Or is this simply lip service in the face of recent Congressional pressure?

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