Subprime Performance

One of the most significant questions surrounding the whole subprime mortgage meltdown is why, exactly, the mortgage industry was allowed by state and federal regulators to dole out billions of dollars in loans to people who had no prayer of ever paying the money back.

The shortest, simplest answer, says Tom Callahan, of the Massachusetts Affordable Housing Alliance, is that regulation simply did not keep pace with changes in the lending industry through the 1990s and into the 2000s. Even a flurry of anti-predatory lending laws passed by states between 2002 and 2004, says Callahan, didn't go nearly far enough to interfere with the runaway and dangerous game mortgage lending had become.

For an idea of how quickly and significantly the landscape changed, consider the fact that in 1990, four-fifths of all mortgages in Massachusetts originated in the more or less carefully regulated banking and credit union industries, while only 20 percent started out in the more lightly regulated and much murkier world of mortgage brokers and bankers. By 2006, that 80/20 proportion of loan originations had flipped to 20/80.

The saddest aspect of the subprime (meaning, of course, "worse than prime," not "lower than prime") crash is that no state or federal regulators saw this coming -- or if they did, none pushed hard enough for government to do something sooner.

On that score, Steven Krysofiak, president of the California-based Mortgage Brokers Association for Responsible Lending, has a fairly cynical view. Basically, he says, everyone was having too good a time to interrupt the party, including borrowers, lenders, Realtors, builders, investors, politicians and even erstwhile regulators.

Whatever the reasons for the mess, it's hard to gauge the depth of damage it has done. A recent report by the U.S. Conference of Mayors includes brutal numbers on foreclosure rates, as well as the impact on the national economy and state and local tax revenues. Meanwhile, state officials in Florida have had to step in and prevent local governments from pulling out of the state investment pool, which local managers view as too vested in mortgage-backed securities.

If a touch too late, there now has been a flurry of action aimed at preventing this situation from getting any worse. In November, Massachusetts passed what it claims is the toughest law in the nation protecting borrowers and curbing the worst offenses of lenders. It includes licensing of all loan officers and mandatory counseling for first-time home buyers.

A handful of states besides Massachusetts have, likewise, acted quickly and forcefully, either through legislation or by administrative fiat, to begin reining in mortgage lenders. The Bush administration's plan to freeze rates on some mortgages, announced last month, didn't address regulatory failings. But a bill passed by the U.S. House of Representatives, HR 3915, does impose a host of new regulations on lenders, including one rather sensible standard: The loans they make have to be ones borrowers can pay back.

As with all bills regulating the financial world, there were the usual territorial tussles over HR 3915. At one point, language was floated that would have preempted all state authority to regulate mortgage lending. In the final bill, however, federal standards would serve as a baseline and states could pass tougher laws if they wish. It's a standard that one hopes will be maintained as the Senate writes its version.

Also promising is that HR 3915 enlists states as partners in creating a national licensing and registration system for mortgage originators. One reason for the lack of action leading up to the crisis was uncertainty over which level of government was supposed to be overseeing the industry.

The possibility of intergovernmental cooperation is encouraging. It's also long overdue. While the past 15 years or so have represented a great party for many of those concerned, it's time to sober up and for government regulators -- at all levels -- to get back on watch. And while they're working together, state and federal regulators should be thinking about how and when the next party is going to start -- if it isn't already in progress.