Not You, Not Me, Blame That Fellow Behind the Tree

If it wasnu00e2u20acu2122t so painful to see new homeowners lose their homes and their dreams, and if it wasnu00e2u20acu2122t so painful to see banks report eye-poppingly disappointing third quarter earnings, it would be funny, sort of, reminiscent of the wrap-up of the television series Dallas, when every character pointed fingers of blame at somebody else, and America asked, u00e2u20acu0153Who shot J.R.?u00e2u20ac

In the case of the subprime mortgage fiasco, everyoneu00e2u20acu2122s again looking for the culprit:

u00e2u20acu00a2 To hear Rep. Barney Frank tell it, guilty parties include the lenders who financed buyers with no reasonable ability to repay, as well as the donu00e2u20acu2122t-ask-donu00e2u20acu2122t-tell buyers of scary paper. What can you expect, wonders Frank, when lenders often provided no documentation verifying the income of a borrower and where debt-to-income ratios often exceeded 50%?

u00e2u20acu00a2 u00e2u20acu0153Maybe the printu00e2u20acu2122s a little smallu00e2u20ac is a common big bank response. Nothing a little disclosure wonu00e2u20acu2122t correct, right? As a senior vice president of JP Morgan Chase wrote in a comment to the Fed, u00e2u20acu0153Borrowers are best served by full disclosures of mortgage product features that allow for flexibility, choice, and affordability.u00e2u20ac

u00e2u20acu00a2 Consumer groups cite prepayment penalties that lock borrowers into unreasonably high interest loans and the proliferation of stated income loans, which tend to encourage borrowers to be, letu00e2u20acu2122s say, a tad optimistic about what theyu00e2u20acu2122ll earn this year.

u00e2u20acu00a2 Washington Mutual, its mortgage portfolio hit hard, implicitly blames third-party brokers, announcing new standards for the companyu00e2u20acu2122s broker network which require brokers to disclose prepayment penalties, whether interest rates and monthly mortgage payments are subject to change, and even how the broker is being compensated for the loan.

u00e2u20acu00a2 Second Curve Capitalu00e2u20acu2122s Tom Brown, whose funds have been deeply committed to the subprime sector, has been consistent in seeing a half-full glass as he assures his investors that the 40% or so free fall of their fundsu00e2u20acu2122 value is a temporary decline u00e2u20acu0153caused by a massive investor overreaction, even panic, related to near-term events.u00e2u20ac

u00e2u20acu00a2 The Economist doesnu00e2u20acu2122t give the Fed a free pass. u00e2u20acu0153Was monetary policy too loose?u00e2u20ac asks the magazine, saying itu00e2u20acu2122s not enough to control near-term inflation, but that central banks should u00e2u20acu0153lean against credit and asset-price booms that appear unsustainable, as a form of insurance against a bust.u00e2u20ac

u00e2u20acu00a2 My friend Bill Seidman, in his column this month, is even willing to take some of the blame, a little too generously, it seems to me, for initiatives taken during his RTC days. Bill rightfully goes easy on community bankers who, for the most part, stuck to their knitting and kept making money the old-fashioned way.

Whoever gets the blame, the GAO and industry groups are now predicting up to 2 million foreclosures over the next few years, the product of aggressive lending tactics and a securitization model that rewarded lax underwriting standards. The upshot of all this, of course, will be exactly what most bankers donu00e2u20acu2122t want: legislation at the national level, drafted by people who are not historically great friends of the banking industry.

I guess the geniuses who created the mess skipped school the first day of Banking 101, when the boring old 4 Cu00e2u20acu2122s of Credit were introduced: Character (the borroweru00e2u20acu2122s standing in the community and history of paying back loans); Collateral (the value, conservatively ascertained, of assets pledged as security for the loan); Capacity (the borroweru00e2u20acu2122s ability to repay, based on simple ratios such as debt to income and debt to value of the asset); and Capital (liquidity after closing that can be readily tapped in case of problems).

Maybe this whole subprime fiasco isnu00e2u20acu2122t so complex after all, is it?

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