The Promise of Subprime. Where is Michael Milken When You Need Him?
The implosion in the subprime mortagge market is a tragedy. It’s terrible for those people that bought a piece of the American Dream with an opaque, complex, risk-laden, poorly understood mortgage products.
But it’s also a tragedy because of a lost opportunity. The subprime mortgage market held out the genuine priomise that the potent combination of financial engineering and the capital markets could lead to greater wealth for deprived, hard-pressed communities. It’s a case Michael Milken, the financial innovator behind the junk bond market, has been making for years. The evolution of the subprime market to Wall Street says Milken was on to something.
In his book “Who’s Afraid of Adam Smith?” Peter Dougherty drew a bright line between Wall Street and Diamond Street. Wall Street is Manhattan’s money bizarre on steriods. Diamond Street is a downtrodden neighborhood in North Philadelphia. Doughterty, a long-time economics editor, muses in his book about how Adam Smith would confront the dismaying contrast between the two places.
The tale of these two streets, one racing with fortune and possibilities, the other rife with desperation, would set Adam Smith’s mind astir. In his characteristically philosophical way, he would worry first about Diamond Street. He would think about how to make every North Philadelphian a merchant, for in doing so he would provide the key not only to greater wealth for the unlucky and deprived, but also the basis for community–for enriched social capital and for greater democratic engagement. The key he would identify would be that of new ownership–of homes, of jobs and businesses, of financial assets…. Smith, in his economist’s intellectual style, would set himself to figuring out how to harness the financial horsepower of Wall Street in the interest of Diamond. The disparity that seperates these streets, as if on two different plants, has challenged some clever economists to think, in Smithian style, of using the prosperity of Wall Street to power the returns of Diamond Street by turning the undeveloped assets of Diamond into potential profit for Wall.
The growth of the subprime market proves that the fundamental insight is right: The financial might of Wall Street can be harnessed to build assets for the poor. The problem with the subprime mortgage market is that no paid enough attention to the actual contracts being peddled, many of them fraudulent at worst and misleading at best. The neglect is coming home to roost.
I hope that the promise of subprime financial engineering isn’t lost during the current backlash against subprime lenders. Where is Milken’s successor? To be sure, Milken ended up spending some time for securities law violations. But the junk bond market he helped create has thrived in his absence. Who will be the junk bond king of Diamond Street?
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