Screwing the pooch

Closing the mortgage barn door

An important job qualification for a Federal Reserve chairman is the ability to express oneself in a reserved manner. But even by that standard, Ben Bernanke's official statement today accompanying the Fed's announcement of proposed new guidelines for mortgage lenders is impressive.

A highlight:

As the mortgage market has become more segmented and as risk has become more dispersed, market discipline has in some cases broken down and the incentives to follow prudent lending procedures have, at times, eroded.

With that quote ringing in your ears, I strongly recommend readers interested in learning more about how the subprime mortgage embarrassment blossomed to read an ongoing special report put together by Bloomberg News. Part 1, by Mark Pittman, published Monday, zeroes in on a group of Wall Street investment bankers who designed a new subprime mortgage derivatives contract in 2005. Part 2, by Bob Ivry, gets up close and personal with Quick Loan Funding Corp., a subprime lender in Costa Mesa, Calif. that worked overtime making loans to bad credit risks -- in order to satisfy demand from Wall Street (Citigroup in particular) for high-yielding subprime debt.

One quote from Quick Loan's principal, Daniel Sadek, stands out:

"If the loans were so bad, why did Wall Street keep buying them?'' Sadek says.

Elsewhere, Sadek notes that his company made most of its money selling its loans to banks -- who repackaged them into risk-disguising securities that were then resold across the planet.

This is a point that cannot be stressed enough, but keeps getting lost in the overwhelming media coverage that the ongoing housing bust is currently commanding. Incentives to follow prudent lending procedures did not "erode," as Bernanke put it. Incentives to follow imprudent lending procedures flooded the market. Wall Street is at least as guilty, and possibly more so, for creating this mess as the mortgage lenders who made all the dodgy loans and the speculators looking to make a killing or unwise home buyers who took on loans that they couldn't afford. Wall Street created the demand for those loans.