Subprime: not ready for prime time.

• Author: Orenstein, Edith
• Position: Washington insights

The collapse of the credit markets over the past year perhaps has no better symbol than Bear, Stearns & Co., "rescued" through a purchase by JPMorgan Chase at a fraction of its share price several months ago, with precedent-setting guarantees backed by the Federal Reserve.

And that's not all. Investors in mortgage-backed securities (MBS) and in anything remotely related to housing were victims of massive writedowns in MBS and historic drops in housing prices and sales, all linked to the subprime mortgage crisis. Defined in its most simple terms, the subprime crisis refers to the overselling of housing to people who could not afford the house and/or interest rate, achieved by means of initial teaser rates followed by significant rate rises after a brief "honeymoon" period, often perpetrated through "low-doc" or "no-doc" loans or through actual mortgage fraud.

The FBI, Justice Department, U.S. Securities and Exchange Commission (SEC), state attorneys general and federal and state banking authorities have been investigating the fraud angle. The U.S. Treasury Department has been encouraging mortgage originators, investors and servicers to work in concert to counsel and help homeowners at risk of foreclosure on subprime mortgages by renegotiating the terms of the loan.

Some proposals circulating in the halls of Congress call for lenders and investors to take a loss in writing down the value of loans and MBS when homeowners are "under water"--when the current market value of a home is less than the mortgage outstanding. In some proposals, the lender/investor/servicer would also share in any potential upside gain.

However, many have objected to these proposals, especially when viewed as a taxpayer-funded "bailout."

Enhanced regulation of government-sponsored mortgage entities Freddie Mac and Fannie Mae has been discussed, as has enhanced regulation of credit rating agencies and enhanced transparency of their ratings models, particularly for complex debt securities.

Then, there is a certain chorus in the U.S. and internationally, claiming that accounting--fair value or mark-to-market accounting, in particular--was one of the primary causes of the subprime meltdown, or at least was an accelerator.

Some say a perfect storm of sorts was created by the precipitous drop in prices exacerbated by illiquidity of formerly liquid markets, making some question if the "fair value" obtained under the Financial Accounting Standards Board (FASB)'s newly issued...