Indiana State University Newsroom

Analyst tells ISU audience subprime crisis far from over

March 20, 2008

Saying there has been “precious little discussion” of the reasons behind the subprime mortgage crisis, a former investment banker who is now a research analyst blames federal policies and a change in accounting practices.

Speaking at Indiana State University’s College of Business Wednesday (March 19), Christopher Whalen said the crisis has resulted in the liquidation of $3 trillion in assets and suggested ongoing interest rate cuts by the Federal Reserve will not solve the problem.

Noting that housing is a lagging economic indicator, Whalen, co-founder and senior vice president of Institutional Risk Analytics, said “the bottom in the U.S. housing market probably lies in 2009. No amount of Fed interest rate ease can change the fact that reviving the housing market means affordability must be restored to home valuations; that is, prices must fall substantially in many markets.”

The bottom in the market likely will not be reached until mid 2009, Whalen suggested, predicting additional consolidation this year and next in the mortgage banking industry and the liquidation of hedge funds.

The collapse in the subprime market is attributable to many factors, Whalen said, but he cited three issues that he believes are at the root of the problem:

• Public policy that has endorsed “creative financing” to increase home ownership in the U.S. • Encouragement by the Securities and Exchange Commission and federal bank regulators of over-the-counter derivatives and securities by all types of financial institutions • And the related embrace by the SEC and Financial Accounting Standards Board of “fair value accounting” instead of “historical cost.”

During an interview prior to his formal presentation to faculty, students and businesspersons, Whalen said “Wall Street has become more of a casino than ever before.”

The casino mentality came about, he said, as private mortgage banks struggled to compete for investors’ dollars against government-sponsored entities (GSEs) Fannie Mae - the Federal National Mortgage Association (FNM), which has its roots in the Great Depression - and Freddie Mac - the Federal Home Loan Mortgage Corp.(FRE), created in 1970 to expand the secondary market for mortgages.

Bear Stearns & Co., Countrywide Mortgage, and other firms that have failed were “nibbling around the peripheries on the scraps,” Whalen said. “The behavior we have seen is private banks trying to compete with government-sponsored entities, which is difficult to do. My fear is that in the future we’re going to have a cartel of big banks and a lot of little banks that can’t break into the cartel and that’s not good for our society.”

Whalen suggested solutions to the problem that he acknowledged may be unpopular with politicians. He proposes doing away with Fannie Mae and Freddie Mac; repeal of fair value accounting standards; standardized terms and structures of private label securitizations; registration with the SEC of all securitizations to be sold to banks, pension funds and mutual funds; and public disclosure of secondary market prices

“Wall Street now has a rare opportunity to recast the current market structure, strike a blow for national interest and make money at the same time. The false promise of private ‘credit enhancement’ has distorted investor behavior, but balance is returning,” he said.

“When - not if - the wave of defaults and foreclosures in conforming paper hits the GSEs, Congress and the new president will confront a huge public sector bailout. But rather than watching Washington further nationalize the housing finance market, the true underlying cause of the subprime crisis, both sides of the Street should organize and be prepared to bid against Fannie and Freddie. If investors could stop worrying about what the Fed is going to do or whining for a bailout from Congress, we might actually solve this problem and them some.”

Whalen’s presentation was sponsored by Networks Financial Institute at Indiana State University. Founded in 2003 with a grant from Lilly Endowment, the goal of Networks is to serve as a catalyst for change in the financial services industry. Whalen serves as a research fellow for Networks.

Photo: Christopher Whalen, co-founder and senior vice president of Institutional Risk Analytics, spoke at Indiana State University's College of Business about the subprime crisis. ISU/Kara Berchem

Contact: John A. Tatom, director of research, Networks Financial Institute, 317-536-0281, ext. 712, or

Writer: Dave Taylor, media relations director, Indiana State University, 812-237-3743 or

Story Highlights

Former investment banker Christopher Whalen, who is now a research analyst, blames the subprime crisis on federal policies and a change in accounting practices and suggests ongoing interest rate cuts by the Federal Reserve will not solve the problem. Whalen spoke at the ISU College of Business, sponsored by Networks Financial Institute.

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