Corruption

The American media is full of depicting foreigners overseas as being corrupt.

However, a casual study of American newspapers published throughout
the United States shows a daily reporting of corruption on the part of
politicians, public office holders, and businessmen.

Teapot Dome, the Savings and Loan Bank Scandal, Enron, Sub-prime
Mortgage Loans, etc., etc.

The October 31, 2007 New York Times quotes Arthur Levitt, Jr., former
chairman of the Securities and Exchange Commission, “that New York State’s
pension woes were just the latest in a series of scandals at public funds all
over the country, including those in the cities of Chicago, San Diego,
Philadelphia and the states of Illinois, Ohio and California”.

Another obvious arrangement for corruption is that certified public
accounting firms are hired on an “at will” basis by corporate board’s of
directors. The Enron and Arthur Anderson, and Price Waterhouse scandals
show the dependency of supposedly independent auditors have on the firms
that hire them.

It has been said that “Money is the mother’s milk of politics”.

And Mark Twain said “This is the best Congress that money can buy”.

Paul Krugman, in his column “A Catastrophe Foretold” published Oct. 27,
2007 in the New York Times, relates some of this corruption.

“Increased subprime lending has been associated with higher levels of
delinquency, foreclosure and, in some cases, abusive lending practices.” So
declared Edward M. Gramlich, a federal Reserve official.

These days a lot of people are saying things like that about subprime loans
– mortgages issued to buyers who don’t meet the normal financial criteria for
a home loan. But here’s the thing: Mr. Gramlich said those words in May 2004.

And it wasn’t his first warning. In his last book, Mr. Gramlich, who recently
died of cancer, revealed that he tried to get Alan Greenspan to increase
oversight of subprime lending as early as 2000, but got nowhere.

So why was nothing done to avert the subprime fiasco?

Before I try to answer that question, there are a few things you should
know.

First, the situation for both borrowers and investors looks increasingly
dire.

A new report from Congress’s Joint Economic Committee predicts that
there will be two million foreclosures on subprime mortgages by the end of
next year. That’s two million American families facing humiliation and financial
pain of losing their homes.

At the same time, investors who bought assets backed by subprime loans
are continuing to suffer severe losses. Everything suggests that there will be
many more stories like that of Merrill Lynch, which has just announced an
$8.4 billion write-down because of bad loans — $3 billion more than it had
announced just a few weeks earlier.

Second, much if not most of the subprime lending that is now going so
catastrophically bad took place after it was clear to many of us that there was
a serious housing bubble, and after people like Mr. Gremlich had issued
public warnings about the subprime situation. As late as 2003, subprime loans
accounted for only 8.5 percent of the value of mortgages issued in this
country. In 2005 and 2006, the peak years of the housing bubble, subprime
was 20 percent of the total – and the delinquency rates on recent subprime
loans are much higher than those on older loans.

So, once again, why was nothing done to head off this disaster? The
answer is ideology.

In a paper presented just before his death, Mr. Gramlich wrote that “the
subprime market was the Wild West. Over half the mortgage loans were made
by independent lenders without any federal supervision.” What he didn’t
mention was that this was the way the laissezfaire ideologues ruling
Washington – a group that very much included Mr. Greenspan – wanted it.
They were and are men who believe that government is always the problem,
never the solution, that regulation is always a bad thing.

Unfortunately, assertions that unregulated financial markets would take
care of themselves have proved as wrong as claims that deregulation would
reduce electricity prices.

As Barney Frank, the chairman of the House Financial Services Committee,
put it in a recent op-ed article in The Boston Globe, the surge of subprime
lending was a sort of “natural experiment” testing the theories of those who
favor radical deregulation of financial markets. And the lessons, as Mr. Frank
said, are clear: “To the extent that the system did not work, it is because of
prudential regulation and oversight. Where it was absent, the result was
tragedy.”

In fact, both borrowers and investors got scammed.

I’ve written before about the way investors in securities backed by
subprime loans were assured that they were buying AAA assets, only to
suddenly find that what they really owned were junk bonds. This shock has
produced a crisis of confidence in financial markets, which poses a serious
threat to the economy.

But the greater tragedy is the on facing borrowers who were offered what
they were told were good deals, only to find themselves in a debt trap.

In his final paper, Mr. Gramlich stressed the extent to which unregulated
lending is prone to the “abusive lending practices” he mentioned in his 2004
warning. The fact is that many borrowers are ill-equipped to make judgments
about “exotic” loans, like subprime loans that offer a low initial “teaser” rate
that suddenly jumps after two years, and that include prepayment penalties
preventing the borrowers from undoing their mistakes.

Yet such loans were primarily offered to those least able to evaluate them.
“Why are the most risky loan products sold to the least sophisticated
borrowers?” Mr. Gramlich asked. “The question answers itself – the least
sophisticated borrowers are probably duped into taking these products.” And
“the predictable result was carnage.”

Mr. Frank is now trying to push through legislation that extends moderate
regulation to the subprime market. Despite the scale of the disaster, he’s
facing an uphill fight: money still talks in Washington, and the mortgage
industry is a huge source of campaign finance. But maybe the subprime
catastrophe will be enough to remind us why financial regulation was
introduced in the first place.

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