Kass: Four to Blame for the Subprime Mess

Over time, home prices, especially on the coasts, were elevated to levels that stretched affordability well beyond the means of most buyers. Ultimately, despite relatively strong employment and low interest rates, the residential housing market crashed hard.

Second, Greenpsan suggested -- at just the wrong time and at the very bottom of the interest rate cycle -- that homeowners retreat from traditional, fixed rate mortgages and turn to more creative and floating rate mortgages -- interest only, adjustable option ARMs, negative amortization, etc.

He said this in February 2004 at a Credit Union National Association 2004 Governmental Affairs Conference:

"American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest-rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home."

One year later Greenspan continued the same mantra and cited the social benefits of the financial industry's innovation as reflected in the proliferation of the subprime mortage market.

A brief look back at the evolution of the consumer finance market reveals that the financial services industry has long been competitive, innovative, and resilient. Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. Such developments are representative of the market responses that have driven the financial services industry throughout the history of our country. With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. The widespread adoption of these models has reduced the costs of evaluating the creditworthiness of borrowers, and in competitive markets cost reductions tend to be passed through to borrowers. Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10% of the number of all mortgages outstanding, up from just 1% or 2% in the early 1990s...We must conclude that innovation and structural change in the financial services industry has been critical in providing expanded access to credit for the vast majority of consumers, including those of limited means. Without these forces, it would have been impossible for lower-income consumers to have the degree of access to credit markets that they now have. This fact underscores the importance of our roles as policymakers, researchers, bankers, and consumer advocates in fostering constructive innovation that is both responsive to market demand and beneficial to consumers.

But even as Greenspan was taking interest rates to levels that encouraged the egregious use of mortgage debt and exhorting the opportunities in creative and variable mortgage financing, there were some smart cookies out there who recognized the risks; here are quotes from two of the smartest who warned of the danger in the mortgage market.

When I took economics in World War II, and we were studying the Great Depression, one of the reasons given were all the interest-only loans that came due. They were an indication of an economy getting into unsound lending. Ever since then it's been a rule that when you go into interest-only loans, you're very substantially increasing the risk of default.

-- L. William Seidman. Former Chairman of the Federel Deposit Insurance Corporation and Chairman of the Resolution Trust Corporation

Our own Robert Marcin put it even more precisely (and vividly) in his prescient warning back in mid-2005.

If Greenspan had a clue (remember, he didn't have one in the tech bubble, or maybe he did), he would jawbone the banking industry to tighten or even strangle lending standards for residential real estate. He should not kill the entire economy to slow the real estate markets. Now that bag people can buy condos in Phoenix with no down payments, maybe the Fed should get involved. You can't expect mortgage bankers to do anything; they get paid to lend money. But like Greenspan's unwillingness to raise margin rates in 1999, I expect him to do nothing until the market declines. Then, the taxpayers will be on the hook for the stupidities of the real estate speculators. Remember, I expect a sequel to the RTC in the future.

-- Robert Marcin, Making Money Before Housing Crumbles.

Greenspan will go untouched and will continue to give speeches at $200,000 a pop.

Culprit #2: Irrational lenders like Novastar, New Century, Fremont General, Option One, Accredited Home, OwnIt Mortgage Solutions and others were no smarter than a sixth grader.