What needs to be done in the wake of what experts agree is the worst U.S. financial crisis in seven decades?
Regulate, says Alan Blinder, former vice chairman of the Federal Reserve.
"A warning to laissez-faire-minded readers: The following is mostly about the dreaded ‘R’ word — regulation,” writes Blinder, now a Princeton University economics professor, in a New York Times opinion piece.
"But I’m afraid that we need more of that, starting in the mortgage market.”
Story Continues Below
Blinder has six recommendations. First, he writes, create a federal mortgage regulator.
"An inordinate share of the dodgiest mortgages granted in recent years originated outside the banking system,” Blinder points out. "They were marketed aggressively, sometimes unscrupulously, by mortgage brokers who were effectively unregulated.”
We all know how that worked out. "The need for a federal mortgage regulator – including a suitability standard for mortgage brokers — is painfully obvious.”
In what might come as a surprise to Blinder’s critics, his second recommendation is to maintain the current system in which banks originate mortgages, pool them together and then package them into mortgage-backed securities that are sold to investors.
"This seemingly convoluted model has given the U.S. the world’s broadest, deepest, most liquid mortgage market,” Blinder notes.
"And that, in turn, has meant lower mortgage interest rates and more homeownership. These are gains worth preserving.”
But, he says, the system should be tweaked. "A far less radical, though still regulatory, approach would require both originating banks and securitizers to retain some fractional ownership of each mortgage pool,” Blinder writes.
"Keeping some ‘skin in the game’ should accomplish two things: make the banks and securitizers more attentive to the creditworthiness of the underlying mortgages, and reduce the tendency to play ‘hot potato’ with mortgage-backed securities.”
Third, Blinder wants banks to hold capital to cover their off-balance-sheet assets.
"We must end the regulatory fiction that off-balance-sheet entities like conduits and SIVs (structured investment vehicles) are unrelated to their parent banks,” Blinder argues.
"Since last summer, we have seen one financial giant after another brought to its knees by losses that originated off balance sheet.”
Fourth, reduce leverage. In its rescue of Bear Stearns, the Fed made clear that it’s creating a safety-net for major securities firms, just like the one for commercial banks.
"Because securities firms are now under the Fed’s protective umbrella, they must start operating as safely and soundly as banks. That means both closer supervision and less leverage,” Blinder posits.
"How much less? You may recall that Bear Stearns ended its life with leverage of around 33 to one. Leverage of 10 or 12 to one is more typical for a bank.”
Blinder acknowledges that reducing leverage to that level will fundamentally alter investment banks and reduce their potential profitability.
"That’s the price you pay for access to a publicly financed safety net,” he says.
Finally, Blinder says ratings agencies must be reformed to provide more accurate readings of risk. And he urges closer cooperation among financial regulators around the globe.
These changes won’t get rid of speculative bubbles, Blinder warns, as bubbles are an inherent feature of free financial markets.
"But with each bursting bubble, new flaws in the system are exposed,” he points out.
"Like a good roofer after a soaking rainstorm, we should patch the leaks we see now, knowing full well that more leaks will spring up in the future.”
© NewsMax 2008. All rights reserved.
Editor's note:
Turn the Recession into 25% Profits by New Year’s Eve
U.S. Recession Could Devastate Commodity Prices.
The Hidden Upside of the Recession
Prosper in Recession. Best Steps to Take Now
The Greatest Investor You’ve Never Heard Of
20 Financial Institutions Most at Risk From Mortgage Meltdown
A Can’t-Miss Real Estate Play With a 15% Dividend
Discover Two Emerging Energy Trusts Yielding 12%!
Max Shows You How to Profit From $100 Oil
