Fixing the mortgage mess

So suddenly everybody is in line to fix the financial markets - most notably the Bush administration, which on Monday will formally announce what the NYT describes as "the broadest overhaul of Wall Street regulation since the Great Depression." Well maybe, but as the Times points out, the plan includes only modest regulation - much of it in the hands of the Federal Reserve, which last time I checked was the nation's central bank, not a regulatory body. The White House proposal - really hatched by Treasury Secretary Hank Paulson - would impose minimal checks on hedge funds and private equity funds, which up to know have had pretty much a free ride with zero disclosure requirements. The administration is desperately trying to do something to placate critics of Wall Street laissez-faire. It's just that Paulson and Bush aren't prepared to do something.

Mr. Paulson is clearly taking a stand against critics who support even stricter regulations, while rejecting any notion that the crisis in financial markets or the collapse of Bear Stearns can be laid at the administration’s doorstep. In a draft of a speech to be delivered Monday, he declares: “I do not believe it is fair or accurate to blame our regulatory structure for the current turmoil.” And while he argues that the current regulatory structure is outdated, Mr. Paulson’s vision for the future echoes the traditional Republican view that new rules and agencies are no substitute for market discipline.

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The proposals would, for the first time, create a set of federal regulators with authority over all players in the financial system, be they banks, insurance companies or other entities like hedge funds and private equity funds, which now operate virtually without regulation. But that authority would be limited. The Fed, which Mr. Paulson proposes to make the “market stability regulator,” would be given explicit authority to limit the risks financial institutions take regarding “certain asset classes” and to “address liquidity and funding issues.” Broadly speaking, those are the problems that have cost the nation’s largest banks and brokerage firms tens of billions of dollars. They took risks trading an alphabet soup of unregulated products cooked up by financial engineers, like C.D.O.’s (collateralized debt obligations) and C.D.S.’s (credit default swaps).

Alan Blinder, professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve, has another idea: Create a modern version of the Home Owners’ Loan Corporation, the Depression-era entity that bought up old mortgages and issued new ones. Alternatively, and this is being suggested by Rep. Barney Frank and Sen. Chris Dodd, the Federal Housing Administration would guarantee new mortgages instead of buying up old ones. That makes the federal government a big insurer instead of a big bank. Here's more from Blinder's NYT piece:

The Frank-Dodd plan for a Super F.H.A. is intended to make a bad situation better. But it must not be too generous in shielding people and businesses from the consequences of their own bad decisions — both for economic reasons (to minimize moral hazard) and for political reasons (to gain voter support). So, what to do? In the Frank-Dodd approach, existing mortgages would be bought below face value, forcing investors to, as they say in the trade, “take a haircut.” But homeowners who get nice, new mortgages to replace their nasty old ones should also be made to pay for the privilege. If not, the Super F.H.A. would be flooded with applicants. So the proposal would make homeowners relinquish part of any price appreciation on their houses for as long as their Super F.H.A. mortgages remain in effect. Good idea. But I’d go further, by also making beneficiaries of the plan forfeit the right to take out second mortgages or home equity loans.

Anyway, expect lots more ideas to pop up in the coming months. Washington is trying to play catch up after years of neglecting the financial system (the Wall Street boys had convinced everybody in power that they really didn't need to be regulated). My guess is that they'll do something about mortgage relief - the politics of all those foreclosures is just too hot to ignore - and defer on Wall Street regulation until next year.