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October 21, 2008

The Fix We're In: Tamara Draut on "the deregulatory impulse"

With the stock market nosediving, credit lines freezing, retirement savings disappearing overnight, and the state budget on the chopping block, we are facing an economic peril as great as any since the Great Depression. What are we to make of these frightening times? We asked some leading voices in the world of economics, political science, and public policy to help make sense of the tumult we find ourselves in. See all of them here. Below, Strapped author Tamara Draut:

If I had to choose one word to describe the financial situation confronting the United States, it’d likely be “outrageous.” It’s outrageous that we find ourselves forced to spend billions of dollars to clean up another speculative bubble created by Wall Street. It’s outrageous that our economy is close to a collapse that was entirely preventable if certain key regulators (Alan Greenspan chief among them) had heeded numerous calls for more oversight of the sub-prime mortgage lending and financial derivatives markets. And it’s outrageous that millions of families will lose their homes as a result of toxic products pushed by unregulated mortgage lenders and brokers, who had the full backing of capital from august financial institutions.

As our nation’s economic morass spreads throughout the globe, high-level multi-national summits are planned, and American banks are nationalized, it’s easy to forget that the crisis began with the pedaling of sub-prime mortgages. Fueled more by demand from Wall Street than by demand from homebuyers or homeowners, a vast army of unregulated mortgage brokers barreled through down-on-their-luck neighborhoods offering salvation via cash-out refinancing in the form of exploding adjustable rate mortgages.

Contrary to popular perception, the majority of these mortgages weren’t taken out by speculative investors, nor by middle-class families fulfilling their aspirations for ever-more home on an ever-shrinking income. In fact, in many cases, the mortgages were sold to existing homeowners, who were duped into trading their affordable fixed-rate mortgage for an ultimately unaffordable one. According to the Wall Street Journal, by the end of the refinancing boom, more than half of all sub-prime loans were going to people with credit scores that could have qualified them for traditional mortgages. 

These sub-prime mortgages were typically second mortgages -- cash-out refis by strapped homeowners dealing with job loss, medical expenses, or the simple reality that their basic costs were rising faster than their earnings. Unlike the market for prime mortgages, where buyers search out a lender or broker when they’re purchasing a home, sub-prime mortgages were aggressively marketed to current homeowners, particularly in predominantly African American and Latino neighborhoods. Many sub-prime borrowers were elderly homeowners, who hadn’t ever thought about refinancing, but were convinced of the idea when a broker knocked on their door. According to a report by the AARP, more than 60 percent of a sample of older borrowers reported that a broker or lend had initiated the contact, leading the AARP to conclude that these loans were “sold, not sought.”

The sub-prime mortgage frenzy that begat a financial meltdown of catastrophic proportions is yet again a terrible lesson of what happens when the deregulatory impulse goes too far (remember the S&L collapse and ENRON/WorldCom, etc). Wall Street devised arcane instruments that were supposed to ensure against risk in the form of mortgage-backed securities, credit default sweeps, and so on — but instead infected the entire financial bloodstream. Meanwhile, Congress and regulatory agencies loosened laws designed to protect consumers from shady lending practices and toxic financial products — making cash-strapped homeowners a convenient host.

The current meltdown is the logical conclusion of a radical conservative philosophy that captured mainstream institutions and the regulatory mechanisms supposedly charged with protecting the public interest. The dictum quite simply demanded that government get out of the way of financial innovation.

Over the last two decades, average Americans have lost ground as earnings have stagnated or declined, while the cost of everything from health care to college to food have risen faster than inflation. And government has stayed out of the way, disinvesting in our nation’s infrastructure and overall neglecting the public purpose. While re-regulation of the financial sector must be a first-order task, it is the long-term planning of our economy that has been sacrificed in the name of market fundamentalism and small government. Redirecting our nation’s energies and brightest minds — in both the private sector and the public sector — to creating a future characterized by innovation and broadly shared prosperity must be the larger, and more fundamental challenge. If there is any silver lining to this crisis, it may be that it has expanded the boundaries of what’s possible.

Tamara Draut is vice president of policy and programs at Demos, and the author of Strapped: Why America’s 20- and 30-Somethings Can’t Get Ahead.

See Tamara Draut's 2006 Conversation with CommonWealth magazine here.

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