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The End Of Mortgage Backed Securities

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So you think some of the big banks might get hit by the subprime mortgage meltdown? That's so last week. The reaction to the subprime meltdown might be an even bigger threat. The Democrats are scheming to exploit the attention being paid to the problems of the subprime mortgage market in order to pass legislation that would impose "predatory lending" liability on everyone from the original lender to those who create mortgage backed investment products.

Representative Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee, said in an interview on Friday that he intended to move legislation in the coming weeks. He said the measure he was preparing would discourage abusive loans by imposing legal liability “up the chain.” It would give borrowers and others the ability to sue the Wall Street firms that package those mortgages and then sell them as mortgage-backed securities, as well as the purchasers of those securities in the secondary market.
“Anybody, including the original borrower, can make a claim, and the liability would go up the chain,” he said. “People say it may discourage certain kinds of lending. But that’s precisely what we want to do. We will pass a bill that won’t allow companies to loan people more money than they can pay back or loans for more than the value of the house.”

This would be a disaster for anyone in the mortgage backed securities industry, first shutting down the products people and eventually the trading desks. Ted Frank at Point of Law expresses exactly the right reaction:

This sort of deep-pocket/innocent-bystander legislation is dumbfounding. These mortgage-backed securities consist of hundreds or thousands of mortgages, and the banks receive only a transaction fee for their services. If the process of repackaging means that one is liable for alleged wrongdoing in each and every of the mortgages, it just means that repackaging won't happen any more as due diligence requirements and the risk of litigation for the entire value of the mortgage (plus punitive damages?) make transactions costs skyrocket, which means the mortgage market will become less liquid, which means a tremendous shock to the economy.
Most upsetting is to see that one of the senators behind this is Chuck Schumer. It seems to have taken him less than two months to pull back from his observation that the litigation risks Wall Street faces is unduly damaging the economy, and that what is really needed is to expose them to more parasitic wealth transfers.

Lawmakers Aim to Curb Loan Abuses
[New York Times[
More Democratic earmarks for trial lawyers [Point of Law]