In two recent posts, Derek discussed the impending (if not already occurring) subprime mortgage lending crisis. Two editorials today – one in USA Today and one in the New York Times – do the same and make a strong case for federal intervention.

Large players in the subprime market are teetering on the brink of bankruptcy. On one view, that is merely a market corrective for the lenders’ risky behavior and does not warrant government action. On another view, however, the problem both reflects the widespread use of predatory lending tactics to lure unsophisticated borrowers into predictably risky loans and prefigures the financial catastrophe that could result on both sides of the market when those borrowers can’t make their payments.

It is too late in this lending cycle to address the former problem. In December 2005, the Federal Reserve Board, the Treasury Department, and several other federal agencies issued non-binding guidelines to reduce unreasonably risky loans; the current situation demonstrates that lenders largely ignored them. In a highly liquid, hyper-competitive market, non-binding guidelines will not suffice to alter lenders’ behavior. Moving forward, Congress and state legislatures should enact common sense regulations with teeth to eliminate the most extreme loans – essentially, the ones lenders know from the start borrowers will not be able to repay. Will a small number of families lose access to credit and not become home owners as quickly? Undoubtedly. But under the status quo they assume high-risk mortgages they cannot repay when interest rates kick in or rise and, in too many cases, end up losing their homes and filing for bankruptcy.

That segues to the borrowers’ side of the market. It is not too late for Congress to help dampen the financial calamity. Senator Chris Dodd and the Senate Banking Committee are considering doing so. Even those who oppose government intervention as inherently inefficient should recognize in this case that giving people a little extra time to restructure or escape a high-risk mortgage could help stave off a domino-like wave of foreclosures. The potential risk of not doing so ranges from widespread hardship among middle class families (roughly $164 in aggregate lost wealth) to a full-blown, nationwide recession.

I would greatly prefer that the mortgage market regulate itself. It is abundantly clear, however, that is has not. It is precisely because we recognize the potential upside of widespread access to credit that we must demand prudence from (and, if necessary, impose it on) lenders. One has to wonder whether Democrats, who are not opposed on principle to common sense, cost-effective regulation of risky industries, could have eliminated some of the risk that today threatens the mortgage market and the American economy at large.