Sheila Talks Tough

Sheila Bair spoke at the Wharton School today. She laid it on the line regarding what she thinks should be done to reform the nation's mortgage market and the role that the government plays. Everyone should read this speech. Especially the current crop of “deciders” in Congress and the Administration. I agree with Ms. Bair on almost all of her points. Her speech confirms to me that she has a vision of what must be done. She is the only one in Washington who has the guts to spell it out for us. I have said in the past and will say again now that Sheila Bair should be our Treasury Secretary. We need leadership. We have none.

I am convinced that what Sheila describes will happen in one form or the other. It is not a question of “if” the government’s role in the mortgage market will change. It is a question of by how much and how fast it will change. We can do this over the next 10 years and suffer a lost decade or we can accelerate the process. Ms Bair is in the sooner versus later camp.

As you read through the speech (or the few snippets below) consider what she is saying in the broader context of the US housing market. It is clear to me that the changes to come will have a long-term deflationary impact on the housing market and the related industries. Should that be what’s in store, I am left wondering where the economic growth will come from.

A critical task lies before us: rebuilding U.S. mortgage finance on a sounder footing, not only to restore the confidence of homeowners, investors and lenders, but more fundamentally to restore balance to our broader economy.

If we are willing to take bold steps, and return to the fundamentals we can get back to a more rational world.

We must recognize that the financial crisis was triggered by a reckless departure from tried and true, common-sense loan underwriting practices.

Traditional mortgage lending worked so well in the past because lenders required sizeable down payments, solid borrower credit histories, proper income documentation, and sufficient income to make regular payments.

All told, over $2.1 trillion in private securities backed by risky subprime and Alt-A mortgages were issued between 2004 and 2006.

Market discipline was tossed to the wind. It explains why trillions of dollars in faulty mortgage paper was issued before the home price bubble finally collapsed.

We need to have some basic underwriting guidelines that apply to all mortgages. Basic limits on loan-to-value and debt-to-income ratios, and consistent documentation requirements should be set for any loans held by a depository institution or sold to a securitization trust.

In 2009, the FHA and the GSEs accounted for 95 percent of total U.S. mortgage originations.

Does it make sense for the federal government to subsidize homeownership in an amount three times greater than the subsidy to rental housing? In the end, these subsidies have helped to promote homeownership, but have failed to deliver long-term prosperity.

Homeownership was once regarded as a tool for building household wealth, in the crisis it has instead consumed the wealth of many households.

The financial crisis and the Great Recession it spawned threw 8 million people out of work, reduced our GDP by about 3 percent, caused a huge increase in federal debt, and virtually wiped out the entire net income of FDIC-insured institutions for at least a two-year period.

We need to get back to a world where our financial sector supports the functioning of our economy, and not the other way around.