International Herald Tribune Editorial - Housing and hedge funds
Copyright by The International Herald Tribune
Published: June 28, 2007
It should not be permitted for lenders, banks and hedge funds to risk everyone's economic well-being in their attempts to enrich the few.
The United States needs vastly better regulation than it now has. It must embrace global coordination of hedge fund regulation, just as banking regulation is increasingly global. Mortgage lenders must be restricted to recommending loans that are reasonably within the borrowers' ability to repay over time. Hedge funds should be regulated if they accept pension money, because doing so exposes ordinary people to outsized investment risks. Regulation should also cover hedge funds with large sums of borrowed money.
In this context, there may be a silver lining in the recent hedge fund debacle at Bear Stearns. Until now, the deepest pain of the housing slump has been felt by hard-pressed borrowers, generally low-income homeowners stuck with unsuitable and even predatory subprime loans - adjustable-rate mortgages made to people with weak credit.
As monthly payments have increased, the loans have become unaffordable, while falling housing prices and tougher credit terms have made them harder to refinance. Defaults and foreclosures have multiplied, but Congress has provided scant relief.
Now the pain is being felt by Wall Street. The two big Bear Stearns hedge funds that neared collapse last week were full of tricky investments tied to subprime mortgages.
To try to ensure that hundreds of billions of dollars worth of similar investments don't also plummet, endangering the financial system, Congress may finally have to do more to help lower-end borrowers. That, in turn, would prop up the investments based on their mortgages.
We're all for helping distressed borrowers. And we accept government's role, if necessary, to avert a financial collapse. But in the end, intervention on behalf of Wall Street would be an outrage, because Wall Street - abetted by lax federal regulation - is largely to blame for this fiasco. Wall Street firms encouraged the issuance of risky loans to troubled borrowers and then reaped a windfall by packaging them as investments for hedge fund clients.
Yet, the possibility of economywide problems from further Bear Stearns-like debacles is real. The Bear Stearns funds, like many others, borrowed big to invest in subprime loans. Investing with borrowed money juices returns in hot markets and magnifies losses in down markets, making losers out of lenders as well as equity investors.
One of the Bear Stearns funds borrowed some $6 billion, from Merrill Lynch, Goldman Sachs, Bank of America and other powerhouses. For the other fund, Bear Stearns reportedly put up $3.2 billion to help liquidate holdings. That's 32 cents on the dollar for assets once valued at $10 billion.
In the past two years, Wall Street firms have issued investments similar to the Bear Stearns holdings, worth about $500 billion on paper. If those were to tank, the damage could be felt broadly.
In the coming year, interest rates on some $850 billion in mortgages are scheduled for their first increase. Over half of that is in subprime loans. That is the dangerous financial world we live in. It needs strong regulations.