by Tanta on 4/10/2007 12:03:00 PM

This gem from Bloomberg has popped up in the comments and my inbox. According to “Mortgage Bondholders May Bear Subprime Loan Risk” (yes, that’s what that says):

April 10 (Bloomberg) -- The top Democrat and Republican on the House Financial Services Committee said investors in mortgage bonds should be liable for deceptive loans made by banks.

Democratic Chairman Barney Frank of Massachusetts and Spencer Bachus of Alabama, the committee's highest-ranking Republican, said such legislation would discourage lenders from extending loans to people with poor credit histories by making it more difficult and expensive for the banks to sell the mortgages.

``More money was being lent than should have been lent,'' Frank said in an interview from Washington. Frank, who last month predicted that the House would approve such a bill this year, said growth in the market for mortgage bonds ``provided liquidity without responsibility.''

An agreement by the two lawmakers may increase the likelihood legislation will be passed this year. The cost of borrowing would rise and curb financing for some lenders and subprime homebuyers, said David Brownlee, who oversees $14 billion as head of fixed income at Sentinel Asset Management in Montpelier, Vermont. It would also reduce opportunities for the Wall Street firms that pool the home loans as securities. . .

``There is no doubt that securitization has had an impact on looser underwriting standards we have seen by lenders,'' Federal Deposit Insurance Corp. Chairman Sheila Bair told the House Financial Services subcommittee on March 27.

Investors in bonds backed by subprime mortgages currently face sufficient liability, [David] Brownlee said. The investment banks underwriting the bonds ``aren't idiots, they're already laying off the risk of subprime loans on investors.'' . . .

Bachus said he favors legislation similar to a law enacted in New Jersey in 2003 enabling homeowners whose loans are the result of predatory lending to gain compensation from lenders and investors who purchased the mortgages. The indemnity includes attorneys' fees, the borrower's total loan payments and the cost of terminating the borrower's remaining liability. . . .

Lenders this decade have increasingly relied on mortgage- backed securities to fund new loans rather than tap capital from federally insured bank deposits. Frank called the process flawed, saying that as a subprime financing mechanism, banks' exposure to the risk of default is excessively diluted.

By dispersing risk, the bonds fueled reckless and unscrupulous lending and compromised underwriting standards, he said. ``There should be a decrease'' in the money available for subprime mortgages, he said. . . .

Bachus said there is a danger lawmakers could overreact and cut off financing for too many subprime borrowers.

``It's very important to preserve the liquidity in the subprime lending market,'' he said. ``If you get too aggressive with assignee liability, you dry up the ability of low and middle income families to own homes.''

Reckless investors shouldn't receive any sympathy, Frank said.

``Our job is to continue to have money available for people to continue to buy homes with minimal chance of these kind of disasters,'' Frank said. ``The effect this has on the ability of people in the bond market to make money is simply not a factor.''

You go, Barney. You too, Spence. "No Liquidity Without Responsibility!" I'd put that on my license plates.

Tanta fails to see why bondholders should be allowed to earn all the reward—those fat juicy yields on predatory and reckless subprime loans—while being allowed to shove the risk back down the chain to the originator in the event that someone sues for deceptive or predatory lending practices. Tanta also fails to see exactly why raising the cost of subprime credit has so many undies in a bunch. (OK, well, I see that. I just don’t care.)

The fact of the matter, it seems to me, is that as long as there is almost no real barrier to entry at the bottom of the mortgage food chain—any idiot can get a broker license, and probably every third idiot can get a mortgage banker license and a warehouse line from someone with more money than sense—there is no way to stop predatory and deceptive lending by writing fancy disclosures for consumers or forcing back enough loans to bankrupt the originators. We’ve noticed that the loans just get originated elsewhere.

I’m ready to entertain the notion that if bondholders had to actually hold the bag, there might come some changes to this hideous misallocation of investment dollars. Among other things. I eagerly await being told that there’s something downright commie about making sure the risk is held by the party reaping the reward.