Wednesday, March 31, 2010

FinReg for ARMs?

Just a quick muse that will probably only interest me.
In 1982 Ronald Reagan pushed for, and passed, the Garn-St. Germain Act. This effectively ended the era of fixed-rate mortgages and ushered in the era of Adjustable Rate Mortgages. This, in and of itself, wouldn't be such a bad thing. Plenty of homeowners have used ARMs successfully to buy a house.
However, Reagan's war on regulation also included (in the same act) the deregulation of Loan-to-Value restrictions, which meant mortgage lenders could loan borrowers more than the value of the house in an ARM loan. And so now the benefits to the average homebuyer of the Garn-St. Germain Act start getting murkier.
But the next step of Reagan's war (which came, again, within the same act) was granting mortgage originators the ability to 'distribute' or sell the mortgage after they'd originated it. And with that, it's really clear that Reagan's war on regulation didn't benefit the average homeowner nearly as much as the mortgage and banking industries.
None of this is news to most people, but the Garn-St. Germain Act got me to thinking about what the Obama Aministration is considering as far as Financial Regulation (FinReg) as we move forward. There have been a lot of ideas bandied about regarding the banking sector and how to pass effective legislation that regulates it... including limiting the size of the banks relative to our GDP as well as a Consumer Financial Protection Agency to regulate 'vanilla' products like credit cards and auto loans.
However, I don't recall seeing any proposal that really gets to the heart of the twin problems of boom-and-bust cycles (as illustrated best by Charles Kindleberger in Manias, Panics & Crashes). He pointed out that asset bubbles historically correlate with housing bubbles but that asset bubbles on their own, are rarely as damaging as housing bubbles. So why not target some of the causes of housing bubbles with FinReg rather than target the banks who create them?
Why not get rid of the "originate-to-distribute" allowance for ARMs? Or, if we can't move that far, how about severe restrictions on distribution of ARMs? For instance, the originator is required to hold the mortgage for the same length of time AFTER the reset date as before? Seems to me like a pretty good way to ensure the originators will start paying more attention to who they're lending to, right?
Of course, this isn't to say that I'm against restricting the absolute size of the bank itself, or that I'm against regulation of derivatives (naked CDS are basically ridiculous) but considering the investment banking industry as we know it (1980-2010) was largely created by their ability to securitize, sell and trade mortgages, why don't we target the major source of one of our problems first?

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