Monday, January 28, 2008

Regulatory Neglect and the Subprime Mortgage Crisis

Until a recent Washington Post op-ed piece, I was unaware that the federal government, in particular the Treasury Department's Office of the Comptroller of the Currency, had put an end to state regulations that might have prevented many of the subprime mortgage abuses.

Bagley, Nicholas. 2008. "Crashing the Subprime Party: How the Feds Stopped the States From Averting the Lending Mess." Slate (24 January). [op ed from the Washington Post]

"To combat this surge in predatory lending, several state legislatures decided to stanch the flow of easy credit to subprime lenders. In 2002, Georgia became the first state to tell players in the secondary mortgage market that they might be on the hook if they purchased loans deemed "predatory" under state law. This worked a dramatic change. Before, downstream owners of mortgage-backed securities might see the value of their investments drop, but that was generally the worst that could happen. Under the Georgia Fair Lending Act, however, players in the secondary mortgage market could face serious liability if they so much as touched a predatory loan. The AARP, which drafted the model legislation that formed the basis for the Georgia law, explained that imposing liability on downstream owners would "reduce significantly the amount of credit that is available to lenders who are not willing to ensure that the loans they finance are made in accordance with the law"."

That's when the feds came in. Some of the biggest players in the secondary mortgage market are national banks, and the states' efforts to curb predatory lending clashed with the banks' fervent desire to keep the market in subprime loans rolling. And so the national banks turned to the Treasury Department's Office of the Comptroller of the Currency. The OCC is a somewhat conflicted agency: While its primary regulatory responsibility is ensuring the safety and soundness of the national bank system, almost its entire budget comes from fees it imposes on the banks—meaning that its funding depends on keeping them happy. It was unsurprising, then, that the OCC leapt to attention when the national banks asked it to pre-empt the Georgia-like subprime laws on the grounds that they conflicted with federal banking law.


Myrtle Blackwood said...

Speaking of 2002, here's a link to an article published by Mike Ruppert that year warning of a pending economic crisis. (It's clear to me that those in power were/are acting in the full knowledge of the widespread accounting fraud going on. They are fiddling to delay the time of reckoning).

2002 – July 7th. Mike Ruppert publishes his article on the pending global economic crisis entitled ‘The Gathering Storm’. He said, apart from other things, that The International Forecaster’ had predicted that “40% of Fannie and Freddie’s loans are going to come back and haunt them…This will be the biggest financial disaster in history..” · Global Financial and Economic Crash Imminent· Stock Market, Pension Funds, U.S. Dollar on Brink of Collapse and Implosion· Theft and Fraud Losses to U.S. Taxpayers Exceed $4.2 Trillion

“One economic analyst has suggested that a nuclear exchange between India and Pakistan might be the perfect cover for the biggest financial wipe out in human history. I think that an ill-conceived and risky invasion of Iraq might serve the same purpose. From consumer confidence, to corporate accounting, to the dollar, to gold, to foreign capital flight, to pension fund wipe outs, to the derivative bubble, to debt -- there is not a single economic indicator that is not flashing red.… the prices are over-inflated by as much as 50 percent or more; that price/earnings ratios, now averaging more than 30 to 1, should properly be corrected to about 15 to 1. That means the Dow should be at 5,000 or lower. We'll talk about how the meltdown is being temporarily prevented later. It is first necessary to examine the severity of the crisis.….The International Forecaster has predicted that "40 percent of Fannie and Freddie's loans are going to come back and haunt them. We envision an S&L type bailout of $2.4 trillion down the road. This will be the biggest financial disaster in history." The full faith and credit of the U.S. government lie behind these home loans. If the homeowners go broke in an economic crash, they default. If the U.S. government goes broke -- before or after that point -- it defaults, and the holders of U.S. debt ultimately have the right (especially under WTO and globalization) to foreclose on the collateral -- your home loans. In the worst case scenario most of the United States could legally be owned by all of the countries holding U.S. debt -- better described as T-Bills, U.S. gold, or U.S. stocks… It's not a question about stealing a little here and a little there. It's a question about open,

full-scale looting -- but only from the pockets of the American people who, in my opinion, will soon

have almost nothing left. Let's look at the hard numbers of what has been taken and from where.

These numbers are by no means exhaustive. It's just what we know about.

- Social Security in 2001 (USA Today/Washington Post)

$34 Billion
- Social Security in 2002 (est.) (House Budget Committee)
$160 Billion
- Federal Employees Retirement System (Wall Street Journal 6/13/02) (to Meet 2002 budget deficits)
$42 Billion
- Civil Service Retirement and Disability Fund (ibid)
$2 Billion
- Stolen from the Dept. of Defense -- 1999 (Cong. Record and Insight Magazine)
$1,100 Billion
- Stolen from the Dept. of Defense -- 2000 (CBS News)
$2.300 Billion
- Stolen from HUD -- 1999 (Cong. Record)
$59 Billion
- Shareholder Equity Lost to Financial Fraud -- 2002 (Fox)
$600 Billion

$4,297 Billion
Pending Thefts
Social Security (by 2010)
(Washington Post citing Cong. Budget Office figures)
$845 Billion” ..

The Gathering Storm
July 7th 2002 said...

The WaPo story on the OCC was indeed a revelation to me also. So, it wasn't all Greenspan's fault.

Anonymous said...

How is it that a government department that imposes fees on the banks is dependent on their being "happy" for their funding? The fees are an obligation, not a contribution. WTF???

Anonymous said...

Anon. -- Because banks have an exit option -- they can choose to charter with the federal gov't and be regulated by the OCC, or they can charter with state governments and be regulated by state level banking authorities. If many banks (especially large ones) choose the latter, the OCCs budget may be impacted significantly

Anonymous said...

The OCC, which regulates national banks (like Citigroup), and the OTS, which regulates federal savings banks (like Countrywide), as part of their formal policy are concerned mostly with risks that impact the "safety and soundness" of the financial institutions. I've worked with these and other federal agencies. They only consider violations of consumer protection laws in the context of how any resulting liabilities could impact bank solvency. And, there conclusion is that the fines and penalties associated with consumer protection laws are not a significant threat to bank failure. The OCC and OTS have been very aggressive not only in blocking state regulators from bringing enforcement actions, but also in preempting state attorneys' general. This is especially true in New York and Ohio. Not surprising, considering the OCC and OTS are funded by the fees they receive from the lenders. (The OCC is even scaling those fees back this year because they have too much money... why not use that money to enforce some laws?) Anyone interested in hard facts describing the federal regulators impotence when it comes to consumer protection should see the OIG's audit of the FDIC (who also regulates banks that insure deposits): The Inspector General found that the FDIC's consumer protection department ("DSC") identified and reported 9,534 significant compliance violations during 2005. Of the 1,945 financial institutions examined in 2005, 1,607 (83 percent) had been cited with compliance violations deemed significant by the FDIC. Also, 837 (43 percent) of the 1,945 financial institutions examined had repeat, significant violations, of which 708 (85 percent) institutions were rated as having "strong" or "general strong" consumer protection compliance controls. This is right at the start of the option arm boom. This is shameful. The bottomline is the federal agencies are saying "we don't care about consumer protection and we're going to preempt any state officials who do." Laws with out regulatory enforcement are useless. That is why all the pending legislation around mortgages will be of no help. The homeowners only hope is that the self-interested plaintiff's bar and court system will bring justice.

Myrtle Blackwood said...

I've read that the countries affected by the Asian crises of 1997 tried to build up their financial reserves as a back-up against future capital flight. This involved the increasing purchase of US Treasuries, creating a flood of funds available for investment but with nowhere to go..except in dodgy subprime loans and asset markets.

Is that why Greenspan refused to regulate?

..Edward M. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.
But when Mr. Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman. In 2001, a senior Treasury official, Sheila C. Bair, tried to persuade subprime lenders to adopt a code of “best practices” and to let outside monitors verify their compliance. None of the lenders would agree to the monitors, and many rejected the code itself. Even those who did adopt those practices, Ms. Bair recalled recently, soon let them slip. And leaders of a housing advocacy group in California, meeting with Mr. Greenspan in 2004, warned that deception was increasing and unscrupulous practices were spreading. John C. Gamboa and Robert L. Gnaizda of the Greenlining Institute implored Mr. Greenspan to use his bully pulpit and press for a voluntary code of conduct. “He never gave us a good reason, but he didn’t want to do it,” Mr. Gnaizda said last week. “He just wasn’t interested.” Today, as the mortgage crisis of 2007 worsens and threatens to tip the economy into a recession, many are asking: where was Washington?..

Fed Shrugged as Subprime Crisis Spread. By EDMUND L. ANDREWS
December 18, 2007