20 Jun Why Should There Be Greater Regulation of Subprime Lenders? Part 1: Can You Say Enron?
The late Ronald Reagan was the poster child for deregulation, but while his dream about a less intrusive federal government was noble, it assumes that people in power can suppress their natural propensity for greed. If you have never seen the documentary, Enron: The Smartest Guys in the Room, it is a case study in the necessity of governmental oversight. In the years leading up to its demise, Enron was “legally” allowed to report projected future profits as present income using an approved accounting scheme known as “Mark to Market.” In one example of its many accounting abuses, it reported a $51 million dollar profit one year for a venture with Blockbuster Video that never made a dime.
Eventually, the lies caught up to Enron’s management, and the company collapsed overnight. The scandal was so widespread, the collapse engulfed Arthur Andersen, the second largest accounting firm in the United States. In 2002 the firm voluntarily surrendered its licenses to practice as Certified Public Accountants in the U.S. pending the result of prosecution by the Department of Justice over the firm’s handling of the auditing of Enron. The conclusion one draws from the Enron debacle is, without oversight, millions of people can lose greatly with few being held accountable for unreasonable (even illegal) levels of greed.
As a result of the Enron scandal, the United States Congress passed the Sarbanes-Oxley Act of 2002, which established new or enhanced standards for all U.S. public company boards, management, and public accounting firms. The purpose of the Act was to reestablish the public’s confidence in the publicly traded corporations, which it largely accomplished.
Unless you are a former Enron employee or shareholder, the Enron story is quickly becoming a distant event in America’s collective memory, but the lessons learned should quickly be applied to subprime lenders. For an excellent explanation of a subprime loan, see Andy Miofsky’s recent BLN Article. In essence, a subprime lender offers higher risk loans to people with poor credit. While the idea of subprime lending is great, banks have been using unreasonable levels of greed to propel the market, and the lives of many individuals, into oblivion.
How big is the subprime lending mess? In 2005 and 2006, the percentage of sub-prime home loans doubled from previous levels of 10% of the home loan market. The ripple effect has crippled the housing market and left investors and consumers holding the bag. Home foreclosures are at an all-time high, and according to a recently published report by the National Association of Home Builders, the housing market is at its lowest point in sixteen years. The group’s chief economist, David Seiders, expects the slump to continue through year’s end.
The housing market isn’t the only economic sector feeling the sting. Wall Street is also suffering the impact of a mortgage industry run amok. In recent reports, two of the world’s largest investment banks, Goldman Sachs and Bear Stearns, reported losses due to holdings of sub-prime loans repackaged as securities.
So, what exactly are the sub-prime lenders doing wrong? Read Part 2.
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