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Borrowing Short and Lending Long Poses Problem.(Mortgage Scene)
Byline: Paul Muolo
What's more dangerous: originating a 30-year fixed-rate mortgage using short-term deposits and then holding that note in portfolio - or gathering subprime loans through a loan broker who's using a wholesaler that intends to securitize through a Wall Street firm that eventually will create a CDO and then hedge that investment using credit default swaps?
Three years ago the answer to that question would have been simple. Even folks without a Wharton MBA know that "borrowing short and lending long" is a recipe for disaster. But for 150 years savings and loans (a k a building and loans or thrifts) did just that: they borrowed short and lent long. And it worked until inflation reared its ugly head during the Carter administration and money market deposit accounts sucked savings accounts out of thrifts, which by law, were only allowed to offer 5.5% on their deposits.
Up until federal deregulation, circa 1982, federally charted S&Ls were not allowed to originate and hold ARMs, which would've given them some degree of protection against interest rate moves. But then again, having your liabilities capped at 5.5% can be problematic when all your depositors are fleeing for 12% MMDAs at Wall Street firms and banks.
Of course, the spike in MMDA yields eventually came down, as did inflation. And thrifts were de-regulated on the state level and then both state and federal thrifts were later re-regulated back into being mostly home mortgage lenders and investors. By this time the deposit-gathering playing field had been leveled along with the FRMs vs. ARMs conundrum. Also, securitization of conventional loans made assets quite liquid.
It can be argued that the post-FIRREA (Financial Institutions Reform Recovery and Enforcement Act) model worked the best. S&Ls could securitize their loans, sell them to the GSEs, or hold ARMs in portfolio. To remain profitable they would need to hedge their interest rate exposure.
Yes, borrowing short and lending long can only, eventually, lead to trouble. But let's, for argument's sake, say that a thrift or bank did just that over the past 10 years. A thrift could fund mortgage production using low-cost checking and ...
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