Back in the day, mortgage lenders were very careful in making loans, since they bore the entire risk of default.
For decades, this principle was eviscerated, leading to the global financial and economic collapse in 2007 and 2008. The securitization process permitted lenders to sell risky loans to unsuspecting investors in the form of derivative securities, thereby preserving an immediate profit for themselves while transferring potential risk and losses to the investing public.
In many cases, government-sponsor enterprises, such as Fannie Mae and Freddie Mac, guaranteed these loans, and the losses were borne by the general taxpayers.
The Dodd-Frank Act of 2010 was intended to upend this practice. This did not happen. And it severely threatens the future of our financial system and economy.
Former Rep. Barney Frank, D-Mass., the co-author of this legislation and the former chairman of the House Financial Services Committee, rightfully believed lenders needed to have their own capital at risk to better guarantee the soundness of their loans.
Unfortunately, his legislation did not stipulate what the proper lending parameters would be. The bill relied on regulators to subsequently draw up prudent rules. Four years after this legislation was passed and signed into law, rules governing this practice were recently approved.
Intense lobbying by mortgage lenders, builders and low-income advocates convinced a large majority of congressional members to abandon risk retention and down payments on most residential mortgages.
Barney Frank has acknowledged the serious shortcoming of this measure. This moment might be the fulcrum that pivots history back on itself.
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