Thanks, but no thanks

By DAVID MOON, Moon Capital Management
March 25, 2007

I'm from the government and I'm here to help, update:

According to the Wall Street Journal, regulators are issuing more stringent standards regarding the issuance of 'subprime' mortgages''the mortgage industry's equivalent of payday loans. Both products provide services to less creditworthy clientele, and in return they charge higher interest rates''often disguised''to counter the higher default risk.

In case you've been too focused on Anna Nicole Smith or college basketball to notice, subprime mortgages have been a hot business topic the last several weeks. It seems default rates on all mortgages are increasing, but especially in the subprime market. New Century Financial, the second largest U.S. issuer of subprime mortgages, last month warned of increased losses; the stock has fallen 90 percent, from $30 to $3.

Now that some lenders are experiencing 15 to 20 percent default rates, the federal government has decided to offer some preventive medicine in the form of more stringent lending standards. In the immortal words of Jojo, 'It's just too little too late.' (If you don't know who Jojo is, ask someone between the ages of 12 and 20.) If the government was going to get involved it should have happened two years ago, not two weeks ago.

This is the same government that passed the Sarbanes-Oxley Act in 2002. The act was passed in large part as a reaction to the corporate scandals at Enron, Tyco, Arthur Andersen, and WorldCom. Whether Sarbanes-Oxley did more good than harm is a subject for debate, but what is certain is that it did no good for the investors in Enron, Arthur Andersen, or WorldCom.

Of course, the government's 'help' doesn't always amount to shutting the barn door after the cows escape; sometimes the harm precedes the foul. In a previous column I noted that in 2004 Alan Greenspan suggested that homeowners should exchange their fixed-rate mortgages for the adjustable type. Since that speech, the interest rate on one-year adjustable mortgages has risen by over sixty percent.

Thanks, Al.

The former Fed chief with cable news rock-star status didn't limit his prognostication to mortgage refinancings alone. At the Federal Reserve System's fourth annual community affairs research conference two years ago, Greenspan suggested the subprime lending market was reasonable, useful and safe: '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.'

Somehow I don't think the stockholders of New Century Finance would agree with Greenspan's assertion about efficiently judging the risk. If the company had been able to properly judge the risk, then it would not have made all those loans to people who don't pay them back. I also doubt the stockholders take much consolation from the increased scrutiny by the federal regulators.

Increased regulation by a government reacting to bad press headlines is the kind of help I can live without.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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