The subprime story: the right policy questions
Amidst the welter of stories regarding the subprime loan shakeout — sad tales of first-time homeowners facing financial ruin, tut-tut post-mortems of defunct lenders, who’s-to-blame fulminations by officials and editorialists — lost is the unvoiced yet essential question, first posed by Tolstoy: What then shall we do? What is the appropriate policy response?
Brain not required
This is an enormously difficult question, which I promise to address in future posts.
In the meantime, to make my commentary and recommendations worthwhile — for that matter, to make anybody’s recommendations worthwhile — it helps to break the problem down into a series of other questions whose answers will form the boundary of our policy options around the subprime story.
Answers within
1. Who has a problem?
Media anecdotes are easy, and visual, and emotionally gripping. They are also infinitely variable, individual, and readily at hand. But stories, as everyone knows, are not statistics. For slow-moving government to act, the problem must be large, widespread, and systemic (see below). Before we leap to help a sympathetic subgroup, we need to know there are enough of them to represent a genuine epidemic, not simply a pattern that we find from self-reported stories.
2. What kind of borrowers are hurting now?
Borrowers come in all shapes and sizes. Families change income, location, composition, and happiness.
All paying borrowers are alike.
Each defaulting borrower defaults in its own way.
One does not stand for all. So even if we sympathize with borrowers — and there are many it is impossible not to care about — we need to distinguish the different categories and groups of borrowers, because they differ in prospects, options, assistability, and worthiness of being helped.
3. Who deserves our sympathy?
To hear them tell it, borrowers in trouble are always blameless. They tend, in the manner of Brigid O’Shaughnessy appealing to Sam Spade, to paint the narrator (usually a new homeowner who can’t pay his or her mortgage) as the timid helpless victim of Wily Evildoers.
“I was duped, duped I tell you, into taking out that Maltese loan.”
Perhaps so; perhaps not.
Additionally, a policy intervention should examine the whole ecosystem, not just one customer group like borrowers, even if borrowers are the most visible, numerous, and sympathetic.
4. Who will fail without our help? How harmful might that failure be?
As I’ve discussed in the housing market’s crumple zone, the ecosystem as a whole distributes pain across three dimensions:
· Space. Some markets hurt much more than others.
· Time. Damage happened in a rolling sequence, much like a multi-car accident, some being hurt early, others late.
· Role. Damage is distributed among different participants, some of whom are much more able to bear it and respond to it. The dramatis personae of the lending universe are the borrower, originator, correspondent, underwriter, mortgage company, investing lender, securitizer, secondary market buyer. Beyond them are the interested bystanders — current homeowners, potential new home buyers, capital markets, taxpayers, even the economy itself.
Careful, it’s a mess in three dimensions
Some of these participants are grownups who can and should look after themselves. Some are victims of everything from conscious fraud to bad luck. It’s important to peer through the anecdotal haze and determine what groups are truly in jeopardy of failing, and how harmful that might be — to them and to the economy/ ecosystem as a whole.
5. Should our help apply prospectively, retrospectively, or both?
Right now the subprime story is being driven retrospectively: Borrower B fears losing the first-time home she bought. She needs help.
Meanwhile, the prospective stories are all speculative. Will house prices drop? Will mortgage credit shrink? Will the subprime story slow the economy? Will there be a further financial shakeout?
Which way is the problem going?
It’s absolutely critical, in evaluating proposed interventions, that we distinguish those that help the currently unfortunate from those that head off future trouble, either at the borrower or marketplace levels.
6. Will the market ‘take care of things by itself’?
“Do you think it’ll stop raining, Mr. Twain?”
“It always has.”
Capital moves like lightning. Markets move fast. Property doesn’t move at all. In between are borrowers — who move and react in weeks and months and years — and companies, who move and react in similar intervals.
Government’s biggest problem is ‘chasing the puck,’ solving yesterday’s crisis and inadvertently amplifying tomorrow’s. When it comes to readjustments about capital-markets players (such as the New Century falling dominos), some very smart, very highly paid people are already obsessing 24/7 about how to fix their particular problem.
Are you prepared to recapitalize your portfolio now?
Before we send in the financial commandos, we should make sure their arrival will be timely.
7. Does this shakeout indicate a fundamental systemic weakness, and if so how can it be addressed?
Does the subprime story reveal that something is defective in our system? As I’ve written before, catastrophe normally precedes reform.
“Our market system is entirely on track.”
It takes a collapse to open government’s eyes to its enormous systemic risks. So Black Monday led to the Securities Exchange Commission, the S&L debacle led to FIRREA, and Fannie Mae’s multi-billion-dollar oops will probably lead to stronger oversight.
Even if we find there is a problem, is it revelatory of a larger issue? The larger issues are the ones we want to fix.
Plumb knocked me off my horse, it did
Some systemic weaknesses we’ve seen suggested already are:
1. Should consumers have more disclosure? Many borrowers claim, very plausibly, that they were duped or at the very least under-informed.
2. Should we curtail low-payment introductory loans? Many borrowers are hitting trouble when they encounter the step-up in payments.
3. In a world of automated underwriting and self-certification, how do we control originators? There’s a very substantial agency risk in these “liars’ loans,” as they have been dubbed.
8. Who (if anybody) should be punished? How, and by whom?
Where there are victims, are there victimizers? We want to believe that — it satisfies our deep psychological need for meaning in the universe — but it is not always so.
And if there are those who deserve punishment, will the market do that by itself?
9. What’s the minimum effective intervention we want?
I phrase the question this way not out of a political or libertarian slant but rather because experience shows that government programs are prone to outlasting their time.
If we do less, we can always do more. In government and policymaking, the reverse is seldom true.
Similarly, if we can create a self-adjusting or self-obsolescing system, we can act more quickly. (An insurance premium against a risk, for instance, becomes uneconomic when the market’s risk tolerance rises.) Can we create self-correcting systems?
10. Must we act quickly, or can we act in sequence?
A headline is immediate. A pledge is quickly made. A program is long-arriving, from statute through regulations to administrative guidance and decisions. Some actions must be done right away if they are done at all.
Well, get on with it, Mac!
Relief must needs be immediate. Systemic overhaul benefits from measuring twice, cutting once.
Lest your plans turn into a pumpkin
