Housing ; Housing - Prices ; Banks and banking, Central

Otmar Issing

English

Research Papers in Economics

85
Mr. Issing: I think the authors have demonstrated that we can un-
derstand the present system and its problems only by looking into 
the past and into the evolution of the system as we have it today. 
Because of time constraints, I would like to draw your attention to 
probably two questions. First, we have seen that markets have be-
come more efficient. But, as Bill White has indicated at the end of 
his contribution, the question is, Did this come at a price, and what 
was the price?  
Second, indeed we have seen convergence of systems across the 
world. The authors have even referred to countries like Bangladesh, 
but we still have differences. At the same time, countries that have 
different systems at home are connected by investors’ decisions glob-
ally. So, you might have a country like Germany, which has a rela-
tively conservative mortgage system, but, at the same time, German 
banks and institutions have bought collateralized debt obligations 
that come from other markets. 
You have this combination of, on the one hand, globalization of 
investors’ decision and, on the other hand, institutional differences. 
Perhaps these are two issues to draw your attention to. 
General Discussion:   
The Housing Finance Revolution
Chair: Otmar Issing86  Chair: Otmar Issing
Mr. Meltzer: I thought Bill White brought up what is a really cru-
cial point that isn’t much discussed—that is, there is a sharp policy 
implication, it seems to me, in all of these papers. It has to do with 
the fact, as he said, that the risk has been taken out of the banking 
system, which is in many ways a good thing, but it has been placed 
who knows where. You find out only when there are failures and de-
faults, for the most part. 
So, with this change, there is a change in responsibility if we rely 
on failures to discipline the lenders and the financers because central 
banks don’t know where the risks are and are not in a good position 
to overcome them. We can’t expect either central banks or regulation 
to do some of the things they did wisely or foolishly in the past. 
What is needed now is for the central banks to announce that is 
their policy—that is, to tell people that if you are going to take these 
risks and you want help, you had better be holding collateral that we 
find acceptable. Otherwise, you are at risk of default. 
In the 90-year history, the Fed has never announced a strategy, and 
it has never followed a consistent path. Sometimes it does bailouts. 
Sometimes it doesn’t. That creates, and I think it is quite obvious at 
the moment, unnecessary uncertainty while the market waits to see 
which way the Fed will jump and whether they and Congress and oth-
ers can force them to make that jump. It is commendable that so far 
they haven’t done that, but they would be better off and policy would 
be better off if we knew that was strategy and only people who hold 
collateral can expect to be saved. That is a task which I think central 
banks have been reluctant, certainly here, to undertake, but at the pres-
ent way in which risks are divided, it becomes extremely important. 
It becomes extremely important in the European Central Bank 
(ECB) also because, in the ECB, there really isn’t an effective lender of 
last resort in the same sense that can create liquidity or is responsible 
for creating liquidity in the various countries to even out the risks.
So, that is a challenge to the central bankers. It seems to me that Bill 
White’s comment really gets to the policy implication of recent action. General Discussion  87
Mr. Visco: I would like to consider some effects of securitization 
on housing market loans. We have been presented with the effects on 
lenders, the incentives to them to originate loans with little attention 
to their quality, an aspect that has been most emphasized by Susan 
Wachter, Richard Green, and Bill. The reason is they could be easily 
sold to investors. 
Now, what about the borrowers?  In the past, as it is still the case 
in many countries, there were personal relations between lenders and 
borrowers that allowed the borrowers who were temporarily in difficult 
financial conditions to get some flexibility, some margins, and some-
how come with payments with some lags and solve their situation. 
Now, what we have is that, if these loans are actually in the hands 
of foreign banks or international hedge funds, it might be almost au-
tomatic to have foreclosures generated by attempts to contain losses 
once the falls in housing prices start being observed. This could lead 
to a vicious circle, with further falls in prices and defaults. 
The question is, In a securitized world, which has many advantages 
as we know, would it be possible to write contracts in a way that 
would restore some flexibility, some margins to the borrowers?  
Ms. Wachter: It is a difficult question. 
Mr. Green: One thing that is encouraging is Fannie Mae and Fred-
die Mac have developed automated servicing models, where they 
look at borrowers who are 30 days delinquent and try to figure out 
what kind of borrower they are. Is the 30-day likely to turn into a 60-
day?  And then they try to react accordingly. So, there is an attempt 
to use automation in order to figure out the cost-minimizing way to 
cure the problem, but that is within a fairly narrow part of the overall 
securitization market. That is the good news story.
The bad news story is these securities get sliced up into tranches. 
Very often it is the case that, within different tranches, investors have 
different incentives with respect to how delinquent loans are treated. 
Some may want to renegotiate and others might not. So, you have an 
apparent conflict within the securities themselves about how to deal 
with the borrowers. That can make the flexibility difficult.88  Chair: Otmar Issing
Mr. White: Just to respond to Allan Meltzer’s comment. A phrase 
one hears increasingly in central banking circles these days is “con-
structive clarity,” as opposed to constructive ambiguity. So, there is a 
tendency for people to react to these kinds of concerns. 
The second point I would make refers to Ignazio Visco’s comment 
about workouts. It does seem to me that in the kind of world that we 
have, which is effectively much more dependent on market securiti-
zation and in a global context, it makes workouts of all sorts much 
more difficult. The days when you could get Bill McDonough or Bill 
Rhodes and 10 people around a table and sort it out, those days are 
basically gone. 
One of the worrisome aspects of this is that it does mean—because 
of the difficulties of doing traditional workouts—that there is more 
of a reliance to go back to monetary policy as really the only tool that 
remains to help sort out difficulties. If one could find institutional 
ways of ensuring an easier workout process, whether in the housing 
area or elsewhere, it would be extremely helpful.

The housing finance revolution: general discussion

http://www.kansascityfed.org/Publicat/Sympos/2007/PDF/GeneralDiscussion1_0415.pdf

The housing finance revolution: general discussion

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