Why we should beware cheaper mortgages

By Felix Salmon
September 8, 2009
Dominic Lawson (I was named after his grandfather, Felix Salmon) has a column saying that cutting bankers' bonuses would do more harm than good. He might be right, but his argument is a little bit odd:

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My distant cousin Dominic Lawson (I was named after his grandfather, Felix Salmon) has a column saying that cutting bankers’ bonuses would do more harm than good. He might be right, but his argument is a little bit odd:

When people get a cheaper mortgage because some financial whiz-kid on the trading floor did some clever forward buying in the currency markets, they don’t feel any particular sense of gratitude to the bank. Even in the good times, politicians are not likely to be misjudging the public mood if they propose to do something a bit nasty to bankers…

If a Treasury minister tells a Today programme interviewer that “we are imposing greater capital requirements on super-senior tranches of securitised mortgage obligations”, it is unlikely to resonate with the bleary 7am listener wanting to hear the noise of a banker having his head rammed hard into a wall.

The problem here is that never in the history of finance has a bank reduced its mortgage rates because it made lots of money in the currency forwards market. Banks aren’t charitable institutions which cross-subsidize their consumer-facing products from profits elsewhere: to the contrary, they will constantly attempt to maximize their profits in every business.

On the other hand, it was commonplace for people to get cheaper mortgages because banks had stupidly low capital requirements on super-senior tranches of securitised mortgage obligations. Thanks to those stupidly low capital requirements, banks could sell off “all” the risk associated with the bonds they originated, and keep billions of dollars of leftovers for themselves, without having to hold much if any capital against them. Since banks love to think of themselves as being in the business of buying and selling risk assets, they were happy to originate low-interest mortgages just so long as they could flip them for an immediate profit.

In other words, it’s systemically-devastating things like badly-structured regulatory structures and capital requirements which are likely to bring down mortgage costs and otherwise directly benefit the public. Large bonuses for traders, by contrast, will not benefit the public at all — they just benefit the traders in question.

More generally, anything which contributes towards people getting a cheaper mortgage is equally likely to contribute towards a housing bubble. Sometimes it’s very hard to tell whether a certain financial product is good for consumers or not.

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