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Orangutans Hate Changes in Their Cages
By Stephen Pizzo (about the author) Page 2 of 2 page(s)
Change No.2: Bonding home loans
The Economist had a good piece this week on the Danes way of funding, originating and securing home loans. And it completely does away with the kind of “mortgage securitization” that has now spread so much misery and damage across the US and world economy.
Under the Danish model when a bank makes a home loan it must create and sell a bond of the same face value, same duration and same terms. That bond, secured by the property, is sold and the money provided to fund the purchase of the home.
Now, why is this different and why is this better than Wall Street securitization? The Economist explains:
“The Danish system has two characteristics that change it almost completely. The first is that the issuers of mortgage bonds remain responsible for making payments on them. This avoids a flaw that was so painfully exposed in America’s mortgage market: lax lending is encouraged when the link is broken between those who sell mortgages and those who bear the risk of default.
As with the change the conditions that govern corporate audits, switching to home loan bonds would change the incentives. Moral hazards abound under both schemes right now, which is why we are in them mess we're in. Whenever the care and feeding of other people's money is involved one has to make damn sure that those caring for that money do not have any incentive to cut corners, fudge inconvenient facts and then sell steaming turds to investors lulled into complacency by the stamp of approval of some compromised accounting firm.
The second feature of the Danish system is that mortgage-holders can also buy the bonds in the market and use them to redeem their mortgages. This is useful if a rise in interest rates (or a fall in house prices) causes mortgage-backed bonds to trade at a discount. Redeeming their bonds allows homeowners to reduce the amount they owe. In America, for instance, mortgage-backed securities have fallen far below their fundamental value in thinly traded markets, partly because the people who would benefit most from buying them have no mechanism to do so.
“Everybody can buy that bond at a discount except that one guy who is most involved with the loan, the homeowner,” says Alan Boyce, a mortgage expert who has worked with George Soros, an investor and philanthropist, on promoting the Danish model in emerging markets. In Denmark, by contrast, a fall in the value of mortgage bonds usually encourages homeowners to snap them up to redeem their own mortgages, as is happening now.” (Full article here)
There. Now was that so hard?
We've just begun repairing the damage done by the current rules governing how firms are audited, how mortgages are funded, made and sold on Wall Street. Those repairs are being made, as they were in past disasters like this, which the application of hundreds of billions of taxpayer dollars, being handed out to banks and other financial institutions that failed following and/or manipulating current rules. More often than not the rules they have played under are rules these industries themselves lobbied for, paid for, and got. Now we're paying for them. And we'll pay and pay and pay for them again, unless those rules are changed.
I understand the odds of getting anything like these two proposals passed range from slim to none. I recall a meeting I had with Senate Banking staffers back in 1991. At the time Congress was debating whether or not to repeal the Glass-Steagal Act, passed in the wake of the Great Depression barring federally insured banks from co-mingling their operations with Wall Street investment banks. The staffers listened to my arguments then one of the senior staffers spoke up.
“Listen Steve, banking industry is contributing mightily to get this legislation through. Now, just who do you suggest would contribute to defeat it.”
She wasn't trying to shake me down. She was simply schooling me on the facts of life that govern most of what happens in that town.
But really now, would it be too much to ask the politicians in charge of the leading capitalist nation on earth, to implement laws that walk that walk. Key to achieving that is first creating rules that allow the marketplace to really operate as Adam Smith envisioned – with incentives... but the right kind of incentives.
And the only way to do that is to make damn sure that risk... risk ... risk... is always, always, always, part and parcel of every business transaction on both sides of that transaction. And to insure that that risk is always, always always, aimed straight between the eyes of the party(s) responsible for every single decision that involves the care and feeding of other people's money ... particularly taxpayer money.
But I understand, it won't be easy to change the way business is done in America. As the old Simon & Garfunkel lyrics go:Orangutans are skeptical
Of changes in their cages,
And the zookeeper is very fond of rum.
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