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Is Washington becoming a subprime cheerleader?

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Washington may be at risk of becoming the new subprime promoter. The White House wants banks to provide riskier taxpayer-backed mortgages, according to the Washington Post. Meanwhile, the Federal Reserve's ultra-low interest rate policies have helped to boost the number of borrowers with poor credit getting auto loans. It's no 2007, but it smacks of policy makers ignoring potential bubbles to boost growth. That's a losing proposition.

The Great Recession showed how a bubble's costs can outweigh its initial benefits. Total residential investment increased U.S. economic growth by about $190-billion (U.S.) from 2002 through 2005, according to the Bureau of Economic Analysis. The cost of the correction that resulted was far greater. GDP fell by $450-billion from 2008 to 2009.

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Yet potential bubbles may be inflating again. Last year, investors snapped up $18-billion of bonds backed by subprime auto loans, according to Asset-Backed Alert. That's a 120-per-cent jump on 2010 and the most since 2006. Granted, the U.S. auto market is recovering and filling years of pent-up demand. But the subprime sector has grown three times as fast as its prime-loans cousin.

Investors desperate for yield thanks to low interest rates may be comforted by the relatively low number of subprime auto loan delinquencies during the financial crisis. But they're hardly getting paid for the risk any more. A top-rated one-year securitization sold by General Motors' subprime finance arm on Wednesday yields just 0.53 per cent, compared with 0.14 per cent for a 12-month Treasury bill.

The market's too small to cause a widespread crisis. But problems could cause loan defaults, investor losses and a shuttered subprime market. The localized pain could outweigh the shorter-term benefits of more lending and car sales.

Meanwhile President Barack Obama's administration wants to expand federal home loan guarantees to cover borrowers with weak credit. The Justice Department may also assure banks that they won't face prosecution if problems arise from these loans. Washington pushed Fannie Mae and Freddie Mac down a similar path a decade ago. That's hardly an encouraging precedent.

There are plenty of differences between now and the myriad circumstances that caused the Great Recession. But the last thing the nation needs to infer from more recent actions by policy makers and Wall Street is that they're convinced that this time, it's different.

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