Barney Frank declares war on… securities?

It was probably inevitable, but that doesn’t make it any less depressing. Barney Frank has now come out and said that investors in mortgage-backed bonds should be liable for the underlying loans.

“More money was being lent than should have been lent,” Frank said in an interview from Washington. Frank, who last month predicted that the House would approve such a bill this year, said growth in the market for mortgage bonds “provided liquidity without responsibility.”…

Lenders this decade have increasingly relied on mortgage-backed securities to fund new loans rather than tap capital from federally insured bank deposits. Frank called the process flawed, saying that as a subprime financing mechanism, banks’ exposure to the risk of default is excessively diluted.

By dispersing risk, the bonds fueled reckless and unscrupulous lending and compromised underwriting standards, he said. “There should be a decrease” in the money available for subprime mortgages, he said.

Um, Earth to Barney? There already has been a whopping great decrease in the money available for subprime mortgages. Apparently subprime MBSs are now trading at 550 basis points over Libor, up from 150bp over in early February. What you want to happen? Has already happened – without any legislation at all!

Barney seems incapable of understanding that sometimes markets can self-correct without any help at all from Washington. Underwriting standards have tightened up. The most egregrious lenders with the worst track records have gone out of business. The mortgage market is now pretty much where it ought to be, having overshot in the direction of too much liquidity about a year or so ago. We’ve made our mistakes, we’ve paid for them, and the worry now is not that there’s going to be too much liquidity but rather that there’s going to be too little.

Frank’s not going into much detail about what his proposed legislation is going to look like. But anything which penalizes bondholders is a really bad idea. The existence of the MBS market has made the US mortgage market much more efficient than any other mortgage market in the world. That’s a good thing. Let’s not break it.

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