Fans of Economic Recovery Need Not Worry About Banks Being Penalized for Law Breaking

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Monday, 10 December 2012 05:45

The NYT reported that a new round of lawsuits could potentially cost banks hundreds of billions in damages and penalties from fraudulently marketing bad mortgages. The piece warned readers:

"Depending on the final price tag, the costs could lower profits and slow the economic recovery by weakening the banks’ ability to lend just as the housing market is showing signs of life."

Actually it is quite unlikely that the outcome of these suits would have a noticeable effect on the housing market. These suits may affect the asset position of major banks however they will not affect the incentives to issue proper mortgages going forward.

At the moment, the spreads between the interest rate on mortgages and the interest rate paid on mortgage backed securities are near record highs, which means that banks have enormous incentive to issue mortgages. If some of the major banks suffer big losses as a result of these suits it will not reduce these incentives. Therefore banks will still be anxious to make mortgage loans. Furthermore, since mortgages involve relatively quick turnarounds between the issuance of a mortgage and selling it in the secondary market, even banks with impaired capital are likely to still find mortgage issuance to be a very profitable endeavor.