By Sebastian Mallaby
Monday, March 19, 2007
The Great Mortgage Meltdown of 2007 recalls the beginning of the dot-com implosion in 2000. Once again, paper wealth is going up in smoke; once again, Wall Street banks that created the dud securities turn out to have been imperfect guides as to their value. But the current financial meltdown also differs importantly from the tech bust.
The danger is that Congress will see only part of this distinction.
The Internet bubble was a textbook popular delusion. Its guiding spirit was the "day trader," the amateur investor who chased up the price of thinly traded stocks without asking dull questions about profits. When the party blew up, you could put it down to inexperience. The day traders had forgotten the lesson of the 1987 crash. They had never learned the lesson of the 1968 crash. Pros would have done better.
Unfortunately for this comforting theory, you don't hear much about day traders' role in the current mortgage meltdown. The collapsing value of riskier mortgage securities cannot be tracked on most retail brokerage Web sites, and when I called up Fidelity and asked for a piece of this rarefied action, I got a surprised "huh?" from the salesman. Mortgage securities have been sold overwhelmingly to institutional investors -- the professionals who understand risk and have the smarts to value it.
Or at least they do in theory. In practice, the professionals often bought paper backed by mortgages that were almost bound to blow up -- "liar loans," in which home buyers provided no documentation of their supposed income; "exploding ARMs," in which rock-bottom teaser interest rates leaped higher after two years or so. How could sophisticated Wall Streeters lend money on terms that invited default? The answer is that the pros were conned: Investment banks bamboozled ratings agencies into assigning misleadingly high credit scores to some mortgage-backed bonds, and money managers were too desperate for a speedy buck to kick the tires on the Ferrari.
Just as the financial actors in this drama contrast with the day traders of the tech bust, so, too, its real-world victims could hardly be more different. In the wake of the dot-com bomb, it was mainly bright young adventurers who were thrown out of work -- and most of them found new jobs a half-dozen lattes later. The mood of the era was summed up by an advertisement in a sports club window: "Hey, dot-comers, look good when you lose your shirt," it teased, as though the giant tech pop were a dating opportunity.
There's no fodder for advertising laughs in the mortgage debacle. Many of the liar loans and exploding ARMs were extended to low-income families, who now can't meet their payments and face the prospect of eviction. According to the Center for Responsible Lending, one in 10 recent home buyers who are black will lose their properties, 2 1/2 times the likely rate for whites.
If even sophisticated financiers make unrepayable loans, and if the victims of this craziness are families who are too weak to take a blow, perhaps the sophisticates should be reined in by regulation?
That seems to be the thinking of Chris Dodd (D-Conn.), chairman of the Senate banking committee and, perhaps not irrelevantly, a presidential aspirant. But before Congress charges down this path, it should consider a final contrast between the tech bubble and the mortgage shambles.
Silicon Valley stocks hailed from the economy's unregulated fringe. But mortgage finance is intensively scrutinized by multiple regulators, and two vast government-chartered lenders, Fannie Mae and Freddie Mac, tower over the market. This government involvement failed to prevent the mess, and it's not clear that more regulation would work better.
It may be tempting, for example, to turn to Fannie and Freddie to help stabilize the mortgage market in its time of need. But these institutions are a potential source of instability themselves; they have used their government link to grow so big that a collapse would cause chaos. The policy debate needs to stay focused on cutting Fannie and Freddie down to size, not on giving them a white-knight role in the mortgage debacle.
New regulation may well hold out less hope than new financial products. Thanks to an infant market in tradable credit insurance, credit-rating agencies, the main culprits in the mortgage mess, are becoming less important. The new "credit default swaps" provide an alternative way of gauging the likelihood that a bond issuer will go bust. They reflect the collective wisdom of investors who put money on the line rather than the unilateral judgment of one agency.
If this market in credit-default swaps had been as vibrant when the mortgage bubble started as it has become, some of the mess might have been avoided. But the swaps market does not vote, so expect a regulatory push from Washington.