Op-Ed Contributor – Buy the Loans – Op-Ed – NYTimes.com
HERE’S a key reason Treasury Secretary Henry Paulson’s bailout proposal stalled: it had an overbroad definition of the troubled assets the government would purchase. Under the Treasury’s definition, the government could spend much or all of the proposed $700 billion to buy complex derivatives held by Wall Street firms, instead of directly purchasing actual mortgage loans.
Fortunately, there is a compromise. The most efficient means of providing support to the credit markets would be for Congress to limit the definition of troubled assets to actual home mortgage loans. Congress should give the Treasury authority to purchase only the real financial assets at risk — the actual loans — not the derivatives whose prices depend on the values of those loans. If the government takes this approach, and buys and renegotiates mortgage loans directly, it will indirectly support the mortgage-based derivatives that have caused widespread losses at banks. But it will do so without favoring banks at the expense of homeowners.
Here’s a bailout plan I’d support: given that the financial problems right now can be traced to bad loans that have been securitized and placed around the financial market as ticking time bombs (that all go off at once), have the government buy those loans, not the absurd investment vehicles (grade-A securities, we assure you!) that got us into this mess.
From the financial reporting I’ve read, my impression was that these bad loans, made to people who couldn’t afford them (by banks not realizing that everyone loses in the inevitable default), were sliced and diced and combined with other financial flotsam into “securities” with fancy names like “collateralized debt obligation.” (They would then be sold as no-risk investment vehicles, which is why the subprime mortgage crisis spreads far beyond subprime mortgages; pieces of the bad loans have been scattered far and wide in the financial landscape.) I presumed that meant the only way for the loans to be renegotiated, on the massive scale required to right this mess, would be for the government to buy up all these vehicles and piece the loans back together one by one.
The author, here, sets me straight: it’s not that the loan itself was sliced up, it’s that banks met bets on these lousy loans and placed those bets into the securities. That is, these financial vehicles, sold as though they were pure free money, had value partly depending on whether or not the subprime loans were paid back. Since these loans are collapsing left and right, these securities are also shriveling up; and since these financial vehicles that nobody understands have partly taken the place of money, it’s like a whole lot of money suddenly exploded all at once. To make matters worse, nobody wants to lend in an environment like this; if I’ve just been burned by many, many bad loans, I’m not going to be in the mood to lend any more. That means that businesses simply in routine trouble are now in free fall, unable to borrow the kind of money that could be a lifeline; and businesses that could be expanding aren’t, unable to take that bold next step by borrowing for an expansion. That means few jobs and fewer stable ones. Meanwhile, retirement plans indexed to the market are slipping along with everything else.
That’s part of what’s frustrating about this issue: it’s Wall Street’s mess and Wall Street’s problem, but it affects all of us. You need a solution that doesn’t reward irresponsible bankers for making bad bets and then passing them on as airtight securities. I like this idea: don’t buy the bets, buy the loans.
Oh, and next time, bankers: don’t make loans to people who can’t pay them back! I mean, what the banks did—lend to people who couldn’t pay back, then advertise the bad loans to fellow banks as sure-fire bets—was even worse, but I want to address the problem, since I don’t think it gets enough play. These banks were often skirting their own rules for whom to lend money to at what rate. There’s a strong ethic associated with lending to poor people, since poor people can pretty much always pay back, given that their very livelihood depends on good credit. Since banks have greater leverage than the down-and-out, it’s ethically imperative that they respect the situations of poor people and give terms that will encourage and allow them to pay back the full amount, with modest interest, at a reasonable and responsible pace. This all seems like Banking 101, but some people still haven’t learned. Banks lose too in a default, of course, so their bad practices are coming back to haunt them early.
Oh, and all loans ought to be in terms that non-economists can understand, but that should be a given. And, when loans are sold, chains of custody need to be made clear so that loans can be renegotiated in the case of unforeseen trouble. This is all reasonable and all good business for all parties involved, but it seems that the nation’s money men require a schoolin’ from a college girl with a first-year economics education.