Tuesday, October 23, 2007

Dangerous Barney

Led by House Financial Services Committee Chairman Barney Frank, House Democrats are proposing a broad array of regulatory remedies that are meant to control and punish the mortgage industry as well as provide relief to those consumers caught up in the current subprime mortgage problems. MANY of the measures have constructive intent and are worthy of debate and consideration. ONE is not constructive. That aspect of the proposals, a Barney favorite, is to impose legal liability on investment banking firms that securitize mortgages and to allow homeowners who are NOW in a fix to sue the investment banking firms that securitized their loans.

This is simply a neanderthal's approach to the financial system and shameless politics to boot.

The trial bar lobbies constantly for the opportunity to sue any "deep pockets" for anything. They are huge supporters of the Democratic party. While some of their leading practitioners are now facing jail time for fraud, there's not a peep from the Carl Levin's of the world who reveled in the corporate shenanigans of a few years ago. They still accept the money even from the firms of those indicted. The trial bar's biggest target now is the investment banks who securitize loans. Go Barney, unfortunately not a huggable purple dinosaur, well at least not purple.

No need to bore anyone with a primer on securitization here but here's a couple sentence description. Securization allows for mortgages, student loans, credit card debt, manufactured housing loans etc. to be packaged and sold to experienced investors who can take certain yields, maturities, and risk levels in their portfolios. Securitization provides liquidity that the banking system alone cannot possibly provide.

Regulating mortgage brokers, mortgage banks, and setting standards for origination integrity is all fine depending on how it's done, but opening up securitizations to the trial bar would be a disaster for the financial markets and an incredible windfall for that part(not all) of the trial bar that is without a shred of ethical contraint and support the Democrats who will deliver this bounty under the guise of protecting the little guy. When and if the class actions get tried by "juries of peers" in some litigation friendly southern or midwestern state, the goal of the trial bar, if the past is any guide, is primarily to win, demonstrate their power, and get their massive fees. Maybe they should call it trickle down justice for the people that this is advertised as protecting or reimbursing.

Legislation that encourages the trial bar in this way will also have a serious impact on the availibility of consumer credit, mainly to those consumers without top tier credit records that the House Barney's claim to be saving. Liquidity will be cut back, global investors will pull away, and credit costs for those without stellar credit will rise to a level that allows banks to hold it on their balance sheet, put appropriate capital against it, and have an ROE that allows their shareholders to get an honest return.

Those Democrats and a few Republicans that choose to promote this legislation understand this. From this perspective, their view of the risk/reward trade-off is perverse.

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