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Every small-town banker in 1950s America knew that if you loan money to people who demonstrably cannot pay it back, you need not be surprised when they don’t. So what went wrong with mortgage lending in this first decade of the twenty-first century? Some mortgage brokers have been dishonest, no doubt about that. Some homebuilders have gone into the mortgage business themselves, which could be considered a conflict of interest. Certainly there were those who, eager to collect the financing and get the dirt flying, probably were tempted to misrepresent their customer’s credit situation. The builders would be paid, whether the lenders were or not.

But what was going on with those lenders?  Were they not at least as savvy as small-town bankers of 1950s America? Surely they were, but they didn’t care either. There was nothing at stake for them, since their game was to sell the loans to other institutions where they were packaged like assorted chocolates for sale to investors as equity assets. It was called “securitizing debt.” But there was not much security there. Many debtors did default, as easily could have been predicted, and now the Federal Reserve has had to step in with a lower discount rate at which banks can borrow from the central bank. As the Financial Times reported, they even can use subprime loans as collateral.

Democrats in Congress have been riding to the rescue, calling for lifting the $417,000 cap on the loans Freddie Mac and Fannie Mae, mortgage firms that operate under the aegis of the government, can buy from lenders, who now– guess what?– are shrieking in pain. So they were not as immune to trouble as they thought they were. Indeed, suspicion is so high that banks are no longer willing to lend money to other banks.  Hence the entry into the fray of the Federal Reserve, the bank of last resort.

Some politicians are sounding pretty populist, and why not? Hasn’t the financial community asked for it, those clever lenders who paid no attention and hedge fund managers who scooped up the new securities (managing risk, don’t you know?) and paid even less heed to what they were doing? Indeed, some relied on computer models to make their investments for them, as if human judgment were to be abhorred. Now they’re whining, “The computer made me do it.”

Legislation would be tricky and should not be entered into without considerable thought. The Fed must act with care also, lest it take bankers off the hook who deserve to hang there for awhile. Otherwise they never will repent. And even when they do pay, mightily, as happened in the late 1980s, others come long and invent even more exotic, chaotic and toxic circumstances for themselves, having learned nothing from all too recent history. Oblivious to the obvious, they now have created bad trouble for a lot of people, many of them innocent, that is totally unnecessary, that had no reason to happen, if reason were not so drastically out of fashion.

The shady operators in this case can and should be put out of business. But they’re the bit players. What really needs overhauling is the financial community itself. This means an end to secrecy and a recognition that investors have a right to know what they’re investing in. As for derivatives and other zingy instruments, remember the lesson of Enron: If you don’t understand how some people are making their money, the problem may be them, not you.

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