Fundamental reform arrives, step by careful step
“When you’ve got them by the wallets, their hearts and minds will follow.”
– Not said by Nixon presidential aide Chuck Colson
Even as the American housing financial ecosystem continues to distribute the strain of rolling losses, the ecosystem also continues to adapt rapidly. Ever since the St. Patrick’s Day coup, where the Federal Reserve and Treasury injected capital into banks in unprecedented ways, the financial institutions have been able to bank on value – but the price of taking the Danegeld will be never getting rid of the Dane of ongoing regulatory supervision.
So much has already been made clear, as illustrated by this recent story in The New York Times:
Ben S. Bernanke is reflected in the teleprompter glass during his speech in
WASHINGTON — With no end in sight to the turbulence in the housing and financial markets, the chairman of the Federal Reserve said on Tuesday morning [July 8, 2008 — Ed.] that it would issue new lending rules next week to restrict exotic mortgages and high-cost loans for people with weak credit.
We’re moving these into position to prevent financial crackups
The chairman, Ben S. Bernanke, also said that the Fed was considering extending its program of low-cost overnight loans to the nation’s largest investment banks into next year.
‘Considering’, in this case, means ‘you bet your sweet bippy we will.’
Shall we ’sock it to the markets’?
The lending program, which is supposed to be temporary, began in March in response to liquidity problems on Wall Street during the near-collapse of Bear Stearns, which was sold to JPMorgan Chase to avert going into bankruptcy.
Why, New York Times, are you sniffing permanence in the loan program?
Not going to get rid of the foam any time soon
The lending program was originally set to last at least six months, through mid-September. It was established at the same time that officials were engineering the rescue of Bear-Stearns after Fed officials concluded that credit markets had all but frozen, raising fears of widespread defaults on Wall Street.
Under federal law, the program can continue only if the Fed continues to determine there are “unusual and exigent circumstances” in the markets.
Not a difficult finding to make.
At a forum in
Catastrophe is a precondition of fundamental reform, in part because fractures widen under stress.
He said they included poorly underwritten mortgages, regulatory gaps, tight credit and insufficiently capitalized financial institutions.
That would certainly seem to cover the full range, wouldn’t it?
Mr. Bernanke repeated his support for overhauling the oversight of Fannie Mae and Freddie Mac, the two mortgage financing giants, which suffered significant stock declines on Monday [July 7 – Ed.].
Strengthening and improvement of GSE (Government Sponsored Enterprises) regulation has been on Congress’s shopping list for nearly three years, and really ought to have been enacted long ago. Indeed, until very recently it appeared that the GSEs would escape scot-free, but the collapse of Bear, followed by the pummeling Fannie and Freddie’s stock prices have taken in recent weeks, moved it back onto the front burner.
Turning up the heat on the regulatory-reform stove
He and other senior government officials have expressed hope that the two companies can play a central role in helping to prop up the markets by providing billions of dollars of investments in mortgages.
Why are you worried about house prices?
‘Prop up’ is a tiresome journalistic cliche, connoting overloading or overweighting. A better metaphor would be to prevent capital gridlock, and keeping liquidity moving through the financial system:
“If these firms are strong, well-regulated, well-capitalized and focused on their mission, they will be better able to serve their function of increasing access to mortgage credit, without posing undue risks to the financial system or the taxpayer,” he said.
The decision to consider extending the Fed’s Wall Street credit program, which provides overnight loans to the 20 largest investment banks who serve as “primary dealers” and trade Treasury securities directly with the Fed, suggested that the Fed is coming to believe that the crisis that has been plaguing financial markets may spill into next year.
The program allows the government to hold as collateral a wide variety of investments, including hard-to-sell securities backed by mortgages.
The Federal Reserve is acting simultaneously in several parts of the mortgage and debt credit value chain. Providing short-term loans to large investment banks adds liquidity into the secondary market. For the primary market, the Fed wants to improve consumer disclosure, and reduce ‘agency risk’ by forcing loan originators to take a professional look at whether their applicants can in fact repay the loan.
The Federal Reserve is expected to announce new mortgage lending rules at a meeting on Monday. It is not known whether the Fed will significantly change the proposal it made last December, which provoked more than 5,000 letters, including heavy criticism from the mortgage industry and other parts of the housing industry.
A flood of letters is no proof that a reform is bad, just that it threatens the profitability of an incumbent industry. Any trade association worth its salt can send out the blast email and generate a flood of letters.
Fair drowned the post office, it did
Industry lobbyists maintained that at a time of tight credit, tougher rules could make many mortgages more expensive by creating more paperwork and potentially exposing lenders to more lawsuits.
Undoubtedly, new rules create new administrative requirements, and new duties create new litigation exposure.
Three of the industry’s most influential trade groups — the American Bankers Association, the Mortgage Bankers Association and the Independent Community Bankers of America — separately filed letters criticizing the proposals.
As I wrote in Narrowly right, but broadly wrong: Part 1, narrowly right, that doesn’t make them unwise policy:
The tactical trap of narrowly right. That is the trap of defending the narrowly right but broadly wrong. Even as the industry fought off ill-thought legislation, I suspect it was deaf to the underlying public-policy concern – namely, that brokers will bamboozle clients into taking out financially voracious loans – and indifferent to the lawmakers’ desire to develop something better.
From where we look at it, there’s no problem at all
In the days when I was in a science fiction writers’ workshop, one of our principles was, If you see a flaw, you are duty-bound to offer an improvement. A similar philosophy should apply to public policy. If the legislators’ attempts to solve the problem are ham-handed and unwise, those who are expert have a moral duty, if no other, to help them create better laws. If you don’t embrace the legitimacy of the policy concern, you have no right to complain when they enact something that’s inadvertently damaging to you.
The best program participants should lead the drive to reform, both in self-defense and in self-interest. Self-defense comes from not evolving yourself into being a bad actor:
I have evolved far beyond bad acting … into no acting at all
The strategic trap of narrowly right. Beyond the tactical reason – enlightened self-protection – the strategic trap is simpler. Lenders are experts in finance, customers are amateurs. That information asymmetry should impose on lenders the financial equivalent of the physician’s ‘duty of care’ – an obligation to give the customer enough information so that the customer can make an informed decision.
I’m not advocating that the lender has to stand in for the customer (as is contemplated by the impossible-to-meet “proof of tangible net benefit” standard). Rather, the lender – the expert – should be obligated under what I think of as the good-friend test. “If someone came to me for this product and I were her very good friend, what would I tell her or ask her before I acceded to her request?”
Even a bear of very little brain knows to question a refinancing before signing up
The good-friend test doesn’t prevent the professional from doing business, and it doesn’t impose the professional’s judgment over the customer’s. It simply requires the professional to exercise a little bit of professional caution, to temper the customer’s enthusiasm, so the customer has a chance to temper herself.
With reform comes a larger market –
The [mortgage lenders] also complained that the restrictions were too broad and would restrain lenders from issuing otherwise creditworthy loans.
– and the best participants increase their market share.
The expanding universe is expanding my consciousness
In the long run, such a rule also benefits the profession of expertise, because it encourages customers to trust professionals. If they know that the professional has a duty to explain, even if in tedious detail, customers are more likely to confide. So while the rule is against the industry’s short-term interests, it serves their long-term interests.
“Personally, I think and have long felt the Fed should have done more early on,” Mr. Andrews says. “But I don’t think anybody realized the level of problems that were going to come out in the last year or two. If you had said to me the industry was going to melt down, I would have said you were absolutely insane.”
Wouldn’t it be nice, Mr. Andrews, if all your clients’ customers had had better disclosure before they took out the loans? Wouldn’t that make their legal position, and their moral/ political position, much more comfortable if they had demonstrated solicitous concern before swapping money and signing papers?
Only one thing matters – get them to sign on the line which is dotted
As I posted in Microfinance born in the USA? Part 2, evolution, we saw this dynamic play out this eighty years ago with the emergence of the household-finance lending business:
When the industry is infected, what heals it? The biological metaphor holds true – the organism has to manufacture its own antibodies:
Turning out new defenses to calumny
Leadership arises when a market participant turns on its fellow travelers who are free-riding on its successes and tarnishing its (and the industry’s) good name. […] You can never win against government by static trench defense, you have to give the elected officials something better. You have to do their work for them.
In doing work for elected officials, you actually have to put yourself in their shoes. Figure out where the consumer is vulnerable, and protect consumers from exploitation.
On the other hand, consumer groups complained that the proposed rules would not be strong enough. They maintained that any efforts to further weaken the proposal would render it all but useless.
More hyperbole: ‘all but useless’ is a tired phrase trotted out to mean ‘less than I think I can get.’
It’s too hard to think of a new phrase
As envisioned when the proposal was issued, the Fed sought to broadly apply special consumer protection to a far broader class of borrowers than it had previously.
The trend of regulation is ever outward. That’s particularly necessary here, where there are so many variations of financial products, obtainable through myriads of different types of outlet.
Under its existing rules, based on the Home Ownership Equity Protection Act of 1994, the Fed’s extra protections had originally applied to less than 1 percent of all mortgages — those with interest rates at least eight percentage points above the prevailing rates on Treasury securities.
Interest rates 800 basis points over the safe rate are, in the
The proposed new rules, by contrast, invoked broader legal authority to apply to any mortgage with an interest rate three percentage points or more above Treasury rates.
T + 300 will pick up a lot more mortgages. It’s still well above the typical home loan, which these days is probably about T +150.
Fed officials said that would cover all subprime loans, which accounted for about 25 percent of all mortgages last year, as well as many exotic mortgages — known in the industry as “Alt-A” loans — made to people with relatively good credit scores.
Looking at the household-finance industry, I extracted a six-step program to legitimize and grow an industry that had expanded too fast, got into trouble, and besmirched its brand. These points, particularly, the last four, look like good advice for today’s investment banking industry:
We’re throwing you out
Whether the Fed’s proposed limits are the last step in increased regulation, or if they are followed by more (as they surely will be), there can be no doubt they are useful steps – and once implemented, they will almost certainly be permanent.
I’m not moving any time soon
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