WASHINGTON (Reuters) – Little is being done in Congress orthe Bush administration to repair a collapse of trust inprivate securitized debt markets that is threatening sectorsbeyond its origin in the subprime mortgage crisis.
Student loans are being hit as are the auction-rate bondmarkets used widely by municipal governments to help financevital everyday projects such as roads, schools and parks.
Capital freezing up in these markets and possibly otherscould cause long-term damage to the financial system and theeconomy, some economists and lawmakers say.
While Congress and the White House focus on short-termsteps to shield Americans from rising foreclosures and crackdown on mortgage brokers, no major legislation is on offer todeal explicitly with the dysfunction spreading though thecapital markets.
"There’s been a lot of talk about it, but we don’t have alegislative package together at this point," Sen. Byron Dorgan,a North Dakota Democrat, said in an interview.
Committee Chairman Christopher Dodd, speaking on the Senatefloor last week, expressed concern about local governments’finances being hurt by auction-rate market failures.
Warning that some student loan programs were shutting downdue to lack of capital, the Connecticut Democrat pointed to "acrisis of confidence that has serious consequences."
Like many in Congress, however, Dodd said the firstpriority must be to stem the home foreclosure wave that hasalready engulfed tens of thousands of Americans and couldaffect millions more over the next two years.
As urgent as the foreclosure crisis is, some economists sayit is equally important for lawmakers to take a hard look athow to fix the broken secondary market for mortgages and otherdebt.
CREDIT MARKET SHUT DOWN
"People need access to mortgages to buy homes and ourcredit markets have shut down," said Lawrence Lindsey, a formersenior economic adviser to President George W. Bush.
Unless global investors’ trust in securitized debt can berestored and steady flows of investor capital replenished tofinance new mortgages and other loans, the mortgage industry’sfuture and home values are in long-term jeopardy, he said.
Lindsey, now head of a private economic advisory firm, tolda Senate Finance Committee hearing last week: "None of theplans now being suggested, either by the current president orby those (hoping) to be his successor have this as the focus… The real solution to the housing problem is to find a newand sustainable housing finance system."
The secondary debt market has exploded in size andcomplexity over the past decade, with Wall Street churning outan alphabet soup of new products such as asset-backedsecurities (ABS) and collateralized debt obligations (CDOs).
Profits derived from the basic process of securitization –transforming ordinary debt into finely tuned investmentvehicles — was highly profitable until the past year or two.Now the same banks that assured Washington for years thateverything was under control are losing billions of dollars.
"Some of this is of their own doing," Dorgan said. "Thosemarkets created such sophisticated instruments and securitizedthings that many people don’t even understand them."
Many of the institutional investors who bought securitizeddebt did not understand them, as is now clear. They trusted thejudgment of others, such as credit rating agencies and bondinsurers. But much of that trust was misplaced and now demandfor many securitized debt instruments is soft, said Lindsey.
SEAL OF APPROVAL
In the vacuum left behind by diminished faith in creditraters’ opinions, Lindsey suggested forming a "Federal Board ofCertification" to give a seal of approval to privatesecuritized debt, offering investors the same confidence theystill have in much of the government-chartered debt marketsdominated by Fannie Mae and Freddie Mac.
The board would be formed from a variety of federalregulators with banking oversight, including the FederalReserve and the Treasury Department, Lindsey suggested.
"This does not involve a federal guarantee … All thecertification board would do is assure investors," he said. "Ican think of no single action by the government that could domore to restore confidence in the mortgage lending process."
Lindsey’s concern about restoring credibility along thesecuritization chain of loan originators, securitizers andinvestors is shared by Dodd and Democratic Rep. Barney Frank.
Frank, chairman of the House Financial Services Committee,has pushed a bill through the House to give home loan borrowersmore rights to sue securitizing institutions, an idea known asassignee liability.
Late last year, Dodd tentatively proposed a similar andtougher Senate measure. But the Senate has been slower to act,while Wall Street and mortgage bankers have been lobbying toblock any form of widened assignee liability.
In an interview, Michigan Democratic Sen. Debbie Stabenowcalled Lindsey’s testimony "interesting."
Like Dodd, she stressed addressing the foreclosures issuefirst. "We’ll start there. But I think it’s now spreading outinto all kinds of other areas — student loans, small businessloans," said Stabenow, a finance committee member.
"There’s a lot of discussion going on as to what extent weshould get involved. But I hear across the board … that theissue is lack of stability and lack of trust in the markets asa whole. We’re trying to figure out what’s appropriate."
(Reporting by Kevin Drawbaugh)
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