Zandi’s Financial Shock a Good Primer

Financial Shock: A 360 Degree Look at the Subprime Mortgage Implosion and How to Avoid the Next Financial Crisis

Mark Zandi, the chief economist for Moody’s economy.com, provides a good simple book on the subprime debt crisis. It is an excellent primer for anyone interested in how we got into this mess. Zandi explains the crisis in historical context and through the different perspectives of the multiple players responsible for the implosion. Most telling is that there is no single villain in this crisis. There is enough greed to go around for everyone. There is enough shifting of responsibility and incompetence to suggest that just turning this over to regulation may not be the solution.

Zandi provides a good set of prescriptions for solving the mess. Potential solutions now have to be the focus of all involved because like a doctor we do not want to create more harm. The list of changes includes:

1. Adopt a mortgage writedown plan. This should have been the objective of TARP but was missed in the Fall.

2. Establish mortgage lending rules. We have yet to see an overhaul here.

3. License mortgage brokers. Again a significant need for the industry to provide some trust that the system will work.

4. Expand data collection on mortgages. This is always the last thing that money is spent on, yet this provides the basis for any discussion. If we do not have data on the problem, we cannot form solutions.

5. Reform foreclosure process. There is no national method for handling foreclosure so there is the potential for a patchwork of solutions on a state by state basis. This is a major problem for investors in MBS.

6. Invest in financial literacy. It is necessary for consumers to know what they are signing and for contracts to be made in plain English. The buyers should know what he is signing through good clear examples. Financial literacy should become part of school programs.

7. Modify mark to market accounting. What is the value of the mortgages held on the books of banks? We do not know yet we have imposed the idea that we can determine fair value. There has to be a new set of rules so that firms will not be driven into insolvency based on short-term liquidity crises.

8. Overhaul financial regulation. This will be coming, but there is no clear idea what will be best for the market. It is not clear that a single super agency will solve the problems.

9. Pay attention to asset bubbles. The Fed under Greenspan believed that the central bank should not be involved with identifying or stopping financial bubbles until after the fact. This now seems like short-sighted approach. The Fed had a number of tools that could have been used to slow the mortgages crisis and none of them were employed.

We look forward to Zandi using his clear language to help the regulatory debate.