- Giving the Fed systemic risk regulation authority The Fed has, unsurprisingly, been talking up this idea for quite some time. No one was really in charge of regulating the bank holding companies, and more importantly, no one had the legal or political tools to deal with such a vast failure. This seems like a good idea. The biggest worry is that this will seriously challenge the independence of the Federal Reserve. Congressmen really like to fiddle with their friendly neighborhood banking regulations.
- Eliminating the Office of Thrift Supervision There's been a lot of talk about regulatory arbitrage as a source of the instability that brought the system down, and President Obama name-checked this idea in his speech. I think this is overblown; the actual examples of regulatory forum-shopping, rather than a theoretical belief in same, are pretty thin. On the other hand, I'm hard pressed to come up with a good argument as to why the Office of Thrift Supervision should exist.
- Creating a new consumer protection agency. I can only presume that the hand of Elizabeth Warren is in here somewhere, as this is one of her pet ideas. As it stands, it's at worst harmless, and at best mildly helpful; Obama's speech put the focus on transparency. On the other hand, I'm hard-pressed to see that it will make much of a difference. The problems that are now bringing consumers low are not the things hidden in the fine print. They're the things that were right out there on the front page: their interest rate. The size of their loan relative to their income. The fact that the interest rates on adjustable rate loans can adjust upward. The people who took out Option ARMs or borrowed $40,000 in credit card debt on a $45,000 income were not unaware of these things. They ignored them. It's not a terrible idea, but I'm skeptical that it will have any effect.
- Making originators retain a percentage of the loans they originate. Again, not a bad idea. But I'm skeptical that this will change much. The biggest problem with firms like Lehman is that they held onto too much of the toxic waste they were churning out. Nor has a similar regulation saved Spain from an enormous housing bubble, and a correspondingly enormous messy pop.
« Paul Krugman's Prophetic Prescience | Main | The Cost of Taxation » A New Era for Financial Regulation17 Jun 2009 01:20 pm
Obama has announced a sizeable overhaul of the structure of financial regulation in this country. Here's a look at the provisions, and some thoughts about their costs and benefits.
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Is Lehman considered a loan originator? I thought the loan originators were the folks like BofA that actually sold you the mortgage, not the packagers like Lehman who purchased the mortgages from the originators and then securitized them.
Is Lehman considered a loan originator?
Aug. 22 (Bloomberg) -- Lehman Brothers Holdings Inc., the biggest underwriter of U.S. bonds backed by mortgages, became the first firm on Wall Street to close its subprime-lending unit and said 1,200 employees will lose their jobs.
Shuttering BNC Mortgage LLC will cut third-quarter earnings by $52 million, Lehman said in a statement today. Lehman, led by Chief Executive Officer Richard Fuld, bought Irvine, California- based BNC in 2004 and used it to expand in lending to homeowners with poor credit or heavy debt loads. The job cuts are equivalent to about 4.2 percent of Lehman's workforce of more than 28,000.
Peter,
So, to answer your question. Yes, both Bear and Lehman had large, direct to consumer, subprime lending divisions.
I stand corrected.
I have to give credit where it's due. There is some good stuff in this proposal. One personal favorite - forcing states to allow de novo branching by nationally chartered banks. This would effectively allow national banks chartered by the new National Bank Supervisor to open branches in any state without having to first acquire a locally (i.e. state) chartered bank. Thrifts can already do this, but many states still do not allow de novo branching by nationally chartered banks, thus permitting much protectionist interference by state bank regulators in favor of local banks. If enacted this would remove one of the few remaining obstacles to a truly national market for retail branch bank services. Pleasant surprise to see at least some sensible deregulation in this omnibus proposal.
The Fed as systemic risk regulator. This is itself troubling. The Fed is supposed to regulate monetary policy. Not that they do a great job at that, but they don't need more distractions.
Also, I just *love* the notion that national banks can obviate state regulations. I'm not so sure this is a good thing. While state regulations can be anti-competitive, there are also important constitutional reasons not to make all banks national banks.
My thoughts, too. And I'd really like to see a study done of which banks -- national or regional -- gave out the most stupid loans. Was it small banks or big that dug us our hole? Which banks needed TARP funds?
Current state laws prohibiting de novo branch banking have nothing whatsoever to do with the banking crisis. Yes, national banks dug the deepest holes in terms of risky products, but making it easier for them open up branches in multiple states will not in any way make it more likely that they will repeat their mistakes. In fact, it should only give national banks greater access to retail deposits, adding stability to their funding sources.
Note also that some state banks were also pretty awful at risk management. The FDIC has been quite busy with state banks recently.
Not all deregulation is bad.
On the negative side of the leger, the proposal is chock full of efforts to ban mandatory arbitration clauses in financial contracts (e.g. mortgages and broker customer account agreements). This is a sop to the trial lawyers' lobby pure and simple. There is no evidence whatsoever that clogging the courts with every minor dispute over the terms of a brokerage account agreement will do anything whatsoever other than give trial lawyers another line of business for extorting settlements from deep pocketed defendants. Costs will inevitably go up.
This is certainly something trial lawyers would fight for, but it's not just a sop to trial lawyers. The main benefit of mandatory arbitration agreements in these situations is taking class actions out of the picture. Class actions tend to be abused and often frivelous, but they also provide a real remedy to people who have been wronged but don't have the resources (or potential damages to be represented under a contingency fee arrangement) to hold anybody accountable. Lots of people are screwed out of 10K to 15K by insurance companies, banks, or other institutions and have no avenue for relief if class actions aren't a possibility.
Because our legal system is screwed up in many ways and because of the costs ridiculous lawsuits and damages awards impose on society as a whole, I tend to favor measures that cap awards and limit the ability to certify classes, but these are still blunt tools that sacrifice the rights of a individuals that have truly suffered harm in order to prevent a screwed up legal system from imposing greater costs on society (even though the costs would be spread out). Mandatory arbitration agreements in consumer contracts are the same thing, a blunt tool that has a lot of costs to go along with the benefits. Not to say I would never support them, but the costs shouldn't be ignored.
Actually, there's a case to be made that consumers would benefit from a reduction in arbitration, too. At least, it gives corporations an awful lot of power (finance-related stuff comes after the really horrible, horrible opening story).
There is nothing here.
The Fed has always had authority to regulate banks to eliminate systemic risk. The Fed itself is a systemic risk. That's what's so comically tragic about this weak regulatory scheme proposal.
The reality is that banks cannot be allowed to sell securities and insurance. That is a systemic risk that has gone unchecked by the Obama Administration. They can't see that because they aren't the smart guys in the room.
When banks bet their capital on securities; when banks sell credit default swaps that are nothing more than thinly disguised, but wholly unregulated insurance products ... that's a systemic risk.
When the government requires banks to deploy their capital lending to everyone equally .... that's a systemic risk because everyone isn't equal. Some people are deadbeats who need to have a red line drawn around them.
What Obama isn't doing is regulating. What he's doing is surrendering.
To Megan's points
1)Giving the Fed systemic risk regulation - Good, that is what central banks are for - they should regulate any party that can gum up the payments system or securities clearing and settlement system. This includes derivatives counterparties
2) Eliminating the Office of Thrift Supervision - an OLD idea that has finally come. Good. no surprise there
3) Creating a new consumer protection agency - TERRIBLE idea. Staffed by dozens of Elizabeth Warren types. Harvard Law hucksters and amateurs who don't understand that things like prepayment penalties in ARM loans are good ideas from a bank safety and soundness point. Prediction:There will only be fewer products available at higher cost. Oh yes, and socially directed lending
4) Making originators retain a percentage of the loans they originate -
depends on who an originator is. Small mortgage brokers and mortgage bankers - the ones with greatest incentive to lie (beside predatory consumers' lying) but have no skin in the game. Fannie n' Freddie used to buy loans where they had recourse to the mortgage banker that sold the loans, but those days are long past. Those days should return (as long as Fan&Fred are still the only game in town). As for capital markets companies, they should have to hold some first loss piece of structured finance deals they market, though of course this will drive up the cost of capital. The bankers can always short the exposure they have to the portion of risk they retain, but that would at least force them to find someone willing to take that risk (be on the other side of the short). Am curious to see how the Obamacons enforce this
In response to jmo3, no, Lehman and Bear never "had large, direct to consumer, subprime lending divisions." I've done lots of business with both those companies. Like Fan&Fred, they buy (bought) closed loans, usually from mortgage bankers. A PRIMER on how mortgage banker worked until about 10 months ago:
A retail lender deals directly with the consumer and closes the loan "in their own name" as it is called. That is, when the consumer (borrower) signs the loan doc, the retail lender is the party on the loan docs. The loan might have come to the retail lender from a mortgage broker, but the retail lender funds the loan in their own name. If the retail lender is a bank, thrift or credit union they may keep the loan or more likely sell it to Fan&Fred or a wholesaler.
A wholesaler buys loans from retailers - that is, buys closed loans. They may have even lend the retailer the money to fund loans, but they usually buy loans that are 3 -90 days old.
A mortgage securities originator can be Fan or Fred or can be the bankers who take either wholesale or retail originated loans and puts them into mortgage securities.
BTW - Bear and Lehman had mortgage banking companies that bought loans, generally Alt-A loans. Those companies were wholesalers.
Sorry dude - but they did both.
BNC Mortgage, Inc. Company Profile
BNC Mortgage originates subprime residential mortgages for customers who don't meet standard lending criteria. The company then sells virtually all of its loans, including servicing rights, into the secondary market for cash. Its client base includes first-time borrowers or borrowers with hard-to-document income or spotty credit histories. BNC Mortgage has about 50 offices throughout the US; it also originates mortgages through more than 36,000 independent loan brokers
Jozef,
Also, the "36,000 independent loan brokers" incentives to lie would be just as large as the commissioned salespeople who worked directly for BNC/Lehman.
er, jmo3
both companies acquired loans wholesale, sorry
and if you think they had anything 36,000 people working directly for their lending business (not their securities businesses) then it is small wonder you are so confused
This MARKETING HYPE (not sure where you copied and pasted from) about using 36,000 brokers is funny. They would need more than 50 offices just to handle the brokers, since - if you anything about the mortgage business you'd know that - brokers don't actually close loans, so reunderwriting, perparing loan docs, funding, would take an army. If you care to, why don't you edify us all by telling use where Bear Stearns 50 regional subprime loan offices were?
Also, Spanish banks are in fact holding 10s of billions of bad mortgage debt (USD equivalent)
both companies acquired loans wholesale, sorry
I'm confused. Are you say that BNC had no employees making loans directly to consumers? I'm pretty sure they did. Did they also process the loans for the 36,000 mortgage brokers - oh, most certainly.
You claimed that BNC never originated any loans directly from homeowners and I'm certain they did. It might have only been 20% of their business - but they certainly had a retail business.
jmo3s post of June
Also, the "36,000 independent loan brokers" incentives to lie would be just as large as the commissioned salespeople who worked directly for BNC/Lehman.
... suggests they had 36,000 commisioned sales people, a preposterous number (particularly since they DID NOT do direct retail lending)
I doubt whether they (Lehman or Bear) even directly faced 36,000 brokers, since they usually bought closed loans from mortgage bankers. Their wholesale channels may have been fed by 36,000 mortgage brokers, but I verymuch doubt they dealt with Bear and Lehman's mortgage companies. ALSO Nowhere did I suggest they did not process loans they got from 3rd parties, they simply were not the client-facing party.
Also, jmo3 insists (to "Diversity")that Spain and Spanish banks are not saddled with 10s of billions of bad mortgage debt. In fact they are, a point he did not bother to respond to.
Megan
" Making an originator hold part of a loan" did not stop Spain having a housing bubble which popped spectacularly; but it did stop us having anything like the US or UK overhangs of toxic debt. It really is a key to stopping that.
Diversity,
How do you figure? Spanish banks, insurance companies and pension funds aren't holding 10's of billions in bad mortgage debt?
I don't understand...
We will continue to have financial crises as long as finance is dominated by institutions Too Big To Fail. As has been said many times, Too Big To Fail is just another way of saying Too Big. The top management of AIG, Bear, Citi, Merril, Lehman, etc., didn't - and couldn't possibly - understand what was going on within their companies because of the excessive size, diversification, and complexity of their business. Their clients and counterparties were even more in the dark. See the essay at www.american.com (Jan 29, 2009, Our Epistemological Depression, JZ Muller). Sorry I'm not computer-literate enough to supply the link; perhaps a fellow Megan reader could help.
Part of any new federal regulations should be designed to return to the model that prevailed, not all that long ago, when Merril was a brokerage, AIG was only an insurance company, and Citbank was not Citigroup but just a commercial bank. If these institutions were smaller, less complex, and less diversified, the rest of us would be much more protected from the consequences of their failure.
Removing the consumer protection responsibilities from the banking regualtors strikes me as a terrible idea. One of the problems causing the crisis seemed to be that there were too many regualtors who weren't communicating with each other. Creating another one to do a PORTION of what's required to effectively supervise a bank, doesn't make any sense. To top it off, the vast majority of consumer compliance issues didn't happen within the nationally (OCC/OTS) chartered banks. Further, I've never bought into the argument that Safety and Soundness (now to be under the auspices of the National Bank Supervisor) were that distinct from compliance issues. For a bank to operate in a safe and sound manner, surely it must have a decent compliance program in place. Multiple regulators was part of the problem, and now it looks like the administration believes it is somehow part of the solution?
Re: making sure loan originators keep more money on hand.
I worked at Countrywide breifly (in training) after the housing bubble burst. One problem encountered was that Countrywide purchased mortgages made by local banks and a lot of those loan originators tanked and went out of business. Now, normally Countrywide could force these originators to buy back their deficient loans (loans which weren't made correctly) via threat of not doing business with them again till they did. But you can't get blood from a turnip. Ammendments to the CRA during the time of the Clinton administration lowered the amount of money that banks had to keep on hand from a loan. Raising it back up is a responsible move.
Also, it helps ward off a domino effect of failing banks that the Fed has to take care of. The American style FDIC may create a sort of moral hazard. The Brits only insure 95% of a citizen's total bank deposits over a certain amount, so there's less incentive for savvy investors to put their money in unstable banks while still incenting people to put their money in A bank.
This doesn't solve the biggest problems, but it seems helpful.
Unfortunately, there is nothing in the proposed regulations to eliminate, or even reduce the severity of, the Community Reinvestment Act, which effectively coerces banks to make bad loans. In fact, the new Consumer Finance Protection Agency is tasked with ensuring the rigorous application of the CRA. I see nothing in the proposal that will actually help financial stability and security, only measures to increase the power of government agencies, which is not the same thing.
Jozef,
Also, jmo3 insists (to "Diversity")that Spain and Spanish banks are not saddled with 10s of billions of bad mortgage debt. In fact they are, a point he did not bother to respond to.
I said: "How do you figure? Spanish banks, insurance companies and pension funds aren't holding 10's of billions in bad mortgage debt?"
See that question mark at the end of the second sentance? I wanted him to confirm that they aren't as I am almost certain that they are carrying billions in bad mortgage debt.
I guess this thread is pretty much over....but i read part of the draft that was release..the part that is pretty specific. Money Market Funds.
Two things stuck me 1. MMF will no long be able to say that their NAV is a buck per share. and 2. THat they must have an agreement with someone who will provide "emergency liqidity" to them in a crunch, so that they don't break the buck.
Well, that seems a costly idea. MMFs have a rather small cushsion (say 60 bp) which can be eaten up rather quickly. Thus making for smll differences between MMF and bank.
So, yes, i think fewer securitization, few MMF and less credit card, less of those awful. PayDay loans.....less leverage will come out of this (but maintain a focus on minority housing)