Housing Bubble Accomplices Preparing for Death By Caroline Baum http://www.bloomberg.com/apps/news?pid=20601039&sid=a79_cFhW1pEA&refer=home April 12 (Bloomberg) -- Each asset bubble has features and sponsors unique unto itself. Some folks went wild over tulip bulbs in 17th century Holland while others flipped over not-as- yet-constructed Florida condominiums almost four centuries later. Yet they both -- they all -- share one thing in common, and it has to do with human nature. Just as terminally ill patients go through five stages of dying as described by the late psychiatrist Elisabeth Kubler-Ross in her 1969 book, ``On Death and Dying,'' so, too, do bubble participants experience denial, anger, bargaining, depression and acceptance. I first used this analogy in 1999 in writing about the bubble in Internet and technology stocks. The paradigm seems equally applicable to today's burst housing bubble. First came denial: It isn't a bubble. Banks don't have any exposure to mortgages. Housing is a small sector of the economy. Subprime mortgages are a small segment of the home-loan market. Then came the Feb. 7 double time-bomb from HSBC Holdings Plc, Europe's biggest bank, and New Century Financial, the No. 2 subprime lender in the U.S., that they were setting aside more money as a cushion against rising loan delinquencies. New Century filed for Chapter 11 bankruptcy protection on April 2, one of more than 40 lenders that have ceased operations or sought buyers since the start of 2006, according to Bloomberg data. Accountability Soon the anger set in. Delinquency and foreclosure rates rose. Everyone was shocked, shocked to learn there was risk in risky loans. The press bombarded us daily with tales of shady lenders preying on victimized homeowners who would soon be out on the street for non-payment of mortgage interest. No one was more upset than our elected representatives. Congress wants blood. Whose is irrelevant. ``Members of Congress want someone to be accountable for sensible lending,'' says Andy Laperriere, a managing director at the ISI Group in Washington. Let the bargaining begin. With the homeownership rate at 68.9 percent in the fourth quarter, just shy of the all-time high, the potential audience for congressional hearings and potential market for invasive action is huge. Unfortunately, Congress comes up with some really loopy ideas. ``Ideas that seemed out of the mainstream today may become mainstream in the future,'' Laperriere says. Options Open On Tuesday, Bloomberg News reported that the top Democrat and Republican on the House Financial Services Committee, Barney Frank of Massachusetts and Spencer Bachus of Alabama, respectively, said that mortgage-bond investors should be liable for deceptive lending practices. Congressman Bachus issued a statement saying there has been no specific agreement or decision on provisions in any subprime lending reform legislation. Congressman Frank's office confirmed the no-agreement agreement on the phone. A hearing is scheduled for Tuesday, April 17. Let's hope the committee calls some mortgage-bond investors to testify. If they can be sued for someone else's actions, they aren't going to buy any mortgage bonds. Period. Higher yields may compensate an investor for increased risk, but they don't offer adequate protection against class- action lawsuits. Precedent Chairman Frank might want to call some folks from the state of Georgia, where the enactment of a Fair Lending Act in 2002 rocked the mortgage industry. The law assigned liability for predatory lending to everyone along the food chain, from lender to securitizer to investor. The reaction was predictable. Many lenders pulled out of the state, the rating agencies refused to evaluate the pools of home loans and the secondary market dried up. The law, which took effect in October 2002, was amended the following March ``to address a number of unintended consequences'' and to limit assignee liability. New Jersey's Home Ownership Security Act of 2002 had to be amended in 2004, too, because ``the market shut down,'' according to Robert Levy, executive director of the Mortgage Bankers Association of New Jersey. The amended law put limitations on assignee liability. Liability ``does apply to high-cost mortgage loans, which carry more than 4.5 percent in points and fees and an interest rate greater than 8 percentage points over the comparable maturity Treasury,'' he says. Aligned and Assigned There is no market for securitized high-cost loans, Levy says, and not many loans originated. Which is probably what Congress is getting at. The common theme to the hearings on subprime lending has been that Wall Street is ``eager to securitize, rate and buy as long as the originators feed the beast,'' Laperriere says. ``Many members of Congress want the major players in the secondary market -- holders of mortgage-backed bonds and the investment banks -- to have their interests more aligned with homeowners.'' It would seem a lot easier to fix the problem at the source, tightening regulations on the lenders themselves. But hey, we still have two final stages of dying before the bubble is fully exorcised: depression and acceptance. If Congress follows through on its legislative reforms of the subprime market, the housing recession may turn into a depression. If that happens, can the rest of us find acceptance?