Lessons of the subprime crisis
By Barney Frank | September 14, 2007
ONE ASPECT of the subprime mortgage crisis that deserves special attention is that it was in large part a natural experiment on the role of regulation. And the results are clear: Reasonable regulation of mortgages by the bank and credit union regulators allowed the market to function in an efficient and constructive way, while mortgages made and sold in the unregulated sector led to the crisis.
At every step in the process, from loan origination through the use of exotic unsuitable mortgages to the sale of securities backed by those mortgages, the largely unregulated uninsured firms have created problems, while the regulated and FDIC-insured banks and savings institutions have not. To the extent that the system did work, it is because of prudential regulation and oversight. Where it was absent, the result was tragedy for hundreds of thousands of families who have lost, or soon will lose, their homes and for those who invested in shaky and untested, even though highly rated, securities, and have been forced to take large losses and, in many cases, shut their doors.
In the coming months, Congress needs to apply that lesson - to adopt for all of the mortgage industry, both origination and secondary market sales, the sort of rules that served us well in the regulated sector.
Beyond that, a second major aspect of the subprime crisis demands attention: the unanticipated impact it had on financial markets in general. Indeed, that lack of anticipation is a danger sign: None of the entities charged with supervision of the economy predicted that the crisis would have broader negative effects. And this leads to a second and more difficult task that the Financial Services Committee must undertake: examining whether or not in the broader financial markets we have the same pattern that we saw in the subprime market; namely, a massive increase in innovative financial activity that brings a good deal of benefit to society, but also poses serious dangers.
In part because of massive intervention by central banks the crisis that caused global capital markets to seize up in the first three weeks of August appears to have moderated - at least temporarily. However, it did not work as expected, and we must retool regulatory and oversight apparatus to ensure that we are not caught so woefully unprepared again.
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