The Fed and the Mortgage 'Crisis'

[Bradley in DC]

http://online.wsj.com/article/SB1211...mEditorialPage

The Fed and the Mortgage 'Crisis'
By WILLIAM M. ISAAC
May 22, 2008

The meltdown in the subprime mortgage market has caused a great deal of turmoil in the financial markets and hardship for individual homeowners and financial institutions. It prompted the Federal Reserve to take unprecedented actions to support the markets, one of which raises very difficult public policy issues.

I will return to the Federal Reserve, but first I will make some general comments. I believe that too much is being made of the current problems in the financial and real estate markets. This is probably due to three things: 1) a 24/7 news cycle; 2) a hotly contested presidential election in which roughly half of the population wants us to feel angst; and 3) we are spoiled by 25 years of unprecedented prosperity.
[The Fed and the Mortgage 'Crisis']
Martin Kozlowski

We have been told in headlines that we are in the midst of the worst banking crisis since the Great Depression. If there is a banking crisis, I have seen no evidence of it.

I can count on my fingers and toes every sizable bank about which I have had any concern during the past year. In the early 1980s, when I was chairman of the Federal Deposit Insurance Corp., it was far easier to count the major banks that were not in trouble. Virtually every major bank in the country would have failed in 1984 had a couple of developing countries renounced their debts, which the FDIC considered a distinct possibility.

The U.S. suffered through more than 3,000 bank and thrift failures during the 1980s and early 1990s, and still had 1,430 banks on the problem list at year-end 1991. I'm sure the problem bank list will grow during the next year, but it totaled only 76 at last count. Banks continue to have incredible access to the capital markets, and over 99% of all banks are considered "well capitalized" by the regulators.

When the headlines are not focused on the "banking crisis," they are fixated on the dramatic decline in home prices – more than 20% from peak levels in some major markets. At the risk of being politically incorrect, I'm not sure why we are upset about a 20%-off sale in housing.

After years of double-digit increases, housing prices in the city in which I live, Sarasota, Fla., jumped an astonishing 35% in 2005 – an unsustainable rate of increase that was pushing housing prices beyond the reach of far too many people. We really needed our housing markets to cool down quite substantially.

Millions of people – particularly the young – will benefit from a significant reduction in housing prices. While those who purchased homes in the past couple of years are unhappy if their investment is under water, the housing markets will be back for those who are able to hang on – with help from their lenders where appropriate. Congress's $300 billion "rescue" plan notwithstanding, the good news is that we have a lot of housing stock at more affordable prices for our growing population.

I don't mean to minimize the economic devastation for individuals or firms caught up in declining asset values if they don't have the financial resources to weather the storm. The last time it happened in a major way was in 2000 when the Nasdaq average took a breathtaking plunge from 5,000 to just over 1,000. That had a terrible impact on a lot of people, but we made it through it as a nation with little disruption.

This brings me back to the Federal Reserve. We had a major crisis of confidence in the financial markets, due in significant part to a loss of faith in the rating agencies and others, especially with respect to mortgage-backed securities. No one knew how big the problems were or even where they resided, so the mortgage securitization markets closed down, and financial firms stopped lending to each other.

The problems were exacerbated greatly by "mark-to-market" accounting, which required financial firms to write down their assets to fire-sale prices in the absence of a functioning market. Bank balance sheets ballooned due to the inability to sell assets at the same time accounting rules drained capital. This required banks to slow lending when loans were most needed.

The Fed displayed ingenuity and persistence on a variety of fronts in its efforts to help end the crisis in confidence. While some argue it waited too long, the Fed cut rates aggressively. It also developed and refined a unique auction process to put tens of billions of dollars of cash into the hands of the banks.

A seminal moment for the Fed came on March 14 when it extended a $30 billion nonrecourse loan to JPMorgan Chase so that it could in turn lend the money to investment bank Bear Stearns, which was suffering a liquidity crisis. Two days later JPMorgan Chase purchased Bear Stearns with considerable financial assistance from the Fed.

The rescue of Bear Stearns was a strong statement by the government that it would do everything in its power to restore sanity to the markets. Having been at the helm of the FDIC when Continental Illinois was rescued in 1984 by a very unusual and high profile transaction, I can appreciate what the Fed did. As part of an interim rescue package, the FDIC made a $2 billion subordinated loan to Continental Illinois. The Fed and the largest banks in the country also agreed to provide close to $20 billion of liquidity to the bank to prevent it from failing.

Now we are left with the aftermath of the Bear Stearns rescue. The transaction marks a vast expansion of the federal safety net. The safety net (i.e., the Fed discount window and the FDIC fund) has been paid for exclusively by insured banks, which are highly regulated. Among the questions raised by the Bear Stearns rescue is whether investment banks will now be required to support the safety net and be regulated like banks. If so, will they be able to maintain their creativity and competitiveness?

Bear Stearns also marks the first time the Fed has taken meaningful financial risk in facilitating a takeover. This is by far the most troubling aspect of the Fed's rescue effort. If the Fed had simply provided liquidity to Bear Stearns through JPMorgan Chase, I suspect there would be fewer critics of the transaction.

Do we want the Fed underwriting takeovers of failing firms? Are we willing to allow that to happen without a competitive bidding process, which is routinely used when insured banks fail? Would we want the Fed to rescue an insurance company? How about an auto company? In short, what are the rules going forward?

I'm delighted the liquidity crisis has eased, and I believe the Fed had a big hand in that. But I'm deeply troubled by the precedent that has been set and the implications for our financial system.

It might be possible to stuff the genie back into the bottle by restricting the Fed's powers to engage in Bear Stearns-type transactions. Under current law, the FDIC cannot engage in an open-bank rescue package like the one that saved Continental Illinois without receiving a recommendation from the secretary of the Treasury (after consultation with the president), and without receiving approval from two-thirds of the FDIC's board and the board of governors of the Federal Reserve.

It's time for a good debate about the authority and role of our central bank, just as we had about the FDIC in the wake of the Continental Illinois rescue.

Mr. Isaac, chairman of the Federal Deposit Insurance Corp. from 1981-1985, is chairman of the Washington financial services consulting firm The Secura Group of LECG.

[benqmark]

Hello everyone, I am looking for the best one to get a home mortgage through. Would it be best to go through banks, credit unions or other lenders that mortgage brokers might suggest? What are compatible and reasonable mortgage rates? Is 6.25% legit for a first offer or should I definitely keeping looking? What is your opinion?

[Primbs]

Shop around, there are plenty of mortgage brokers who are desperate for work.