Fed­eral reg­u­la­tors come un­der fire for hous­ing cri­sis

The Washington Times Weekly - - National - By Pa­trice Hill

Sheila Bair logged onto her email ac­count re­cently and got a popup ad of­fer­ing a $175,000 home loan with monthly pay­ments of only $400.

“I thought, ‘Oh no, it’s com­ing back al­ready,’ ” said Mrs. Bair, the Fed­eral De­posit In­sur­ance Corp. chair­man who had spot­ted prob­lems with abu­sive and risky mort­gages long be­fore the mort­gage cri­sis broke out last year.

The pop-up on the screen took her back sev­eral years to the time she first saw trou­ble brew­ing. The ads had been the warn­ing flags: pop-ups, spam e-mails and junkmail fliers of­fer­ing loans at ex­traor­di­nar­ily easy terms and low rates with­out ex­plain­ing that the pay­ments would even­tu­ally shoot up to un­af­ford­able lev­els — a prac­tice that will be banned in the fu­ture.

To­day, fed­eral reg­u­la­tors are on the fir­ing line try­ing to ex­plain why they were seem­ingly asleep at the switch and failed to crack down on the abu­sive loans that led to the worst hous­ing bust and fi­nan­cial col­lapse in mod­ern times.

If reg­u­la­tors failed to act quickly or ag­gres­sively enough, they can share the blame with most of their in­ter­roga­tors in Congress. Elected of­fi­cials did lit­tle to de­ter risky lend­ing and in­stead mostly sat on the side­lines cheer­ing on the hous­ing boom be­tween 2000 and 2006, and the easy mort­gage fi­nanc­ing that made it pos­si­ble.

Three years ago, those early signs prompted a fruit­less ef­fort by the FDIC, Fed­eral Re­serve and other reg­u­la­tors to is­sue guid­ance warn­ing banks against the risky lend­ing prac­tices that were pro­lif­er­at­ing, in­clud­ing of­fer­ing loans with teaser rates as low as 1 per­cent whose monthly pay­ments could more than dou­ble in size once the loans ad­justed to mar­ket in­ter­est rates.

While that light-handed reg­u­la­tory guid­ance may have been heeded by a few banks it had no ef­fect on the le­gions of mort­gage bro­kers op­er­at­ing out­side the bank­ing sys­tem. They took their march­ing or­ders from Wall Street in­vestors ready to throw bil­lions of dol­lars into the lu­cra­tive mort­gage se­cu­ri­ties de­rived from pools of subprime and ex­otic loans.

Bro­kers joked that any­one who could fog a mir­ror could get a loan, bor­row­ers ex­ag­ger­ated their in­comes with im­punity, and the race to the bot­tom in lend­ing stan­dards went largely unchecked un­til the mar­ket for such loans col­lapsed in the mid­dle of last year. The cri­sis brought on by spi­ral­ing de­faults on subprime loans quickly spread to nearly ev­ery cor­ner of the credit mar­ket.

It seemed like a win-win sit­u­a­tion when the boom was rag­ing. Many first-time buy­ers at­tained the Amer­i­can dream of home­own­er­ship while the 70 per­cent of Amer­i­cans who al­ready owned homes boasted about their house­hold wealth soar­ing along with house prices.

Fed­eral and state tax cof­fers were filled with rev­enue gen­er­ated by boom­ing home sales and prices, and po­lit­i­cal lead­ers reaped mil­lions of dol­lars in cam­paign con­tri­bu­tions from the highly prof­itable real es­tate and mort­gage busi­nesses and Wall Street firms, all of which ben­e­fited from keep­ing the party go­ing.

“Ev­ery­body was happy,” said Mrs. Bair. No one in Wash­ing­ton wanted to break up the fi­nanc­ing orgy and end the hous­ing bo­nanza. “So long as prices were go­ing up, not many peo­ple were com­plain­ing. [. . . ] Con­sumers were get­ting th­ese mort­gages, but they could re­fi­nance out of them” when the pay­ments shot up, as long as the mar­ket for house prices and sales kept ris­ing.

Mrs. Bair in 2001 and 2002 as a top Trea­sury of­fi­cial worked with con­sumer groups and other reg­u­la­tors to try to es­tab­lish vol­un­tary “best prac­tices” aimed at marginal­iz­ing preda­tory lenders, but the ef­fort went nowhere, as did leg­isla­tive ef­forts on Capi­tol Hill spear­headed by lead­ers of the House Fi­nan­cial Ser­vices Com­mit­tee — Reps. Bar­ney Frank, Mas­sachusetts Demo­crat, and Spencer Bachus, Alabama Repub­li­can.

“Back then, we mainly looked at it as a con­sumer is­sue. I don’t think any­body thought it had eco­nomic im­pli­ca­tions,” she said. Few peo­ple at the time had “a full ap­pre­ci­a­tion of the costs of th­ese mort­gages, or if the mar­ket stopped go­ing up [bor­row­ers] would lose their abil­ity to pay.”

The re­sult to­day of the lax over­sight by Congress and the ad­min­is­tra­tion is record fore­clo­sures and a ma­jor credit cri­sis that likely has thrown the econ­omy into re­ces­sion. Many an­a­lysts com­pare it to the sav­ings and loan cri­sis two decades ago, when lax fed­eral poli­cies al­lowed a pro­lif­er­a­tion of fraud and abuse in bank lend­ing that ended in a big real es­tate bust and re­ces­sion.

“The smart peo­ple re­ally screwed this one up,” said Mr. Frank, now chair­man of the House com­mit­tee. He has spent much of the last year threat­en­ing to im­pose a heavy-handed leg­isla­tive ham­mer on the fi­nan­cial in­dus­try if vol­un­tary and reg­u­la­tory ef­forts by the ad­min­is­tra­tion fail to make head­way re­solv­ing the cri­sis and clean­ing up lend­ing stan­dards.

Mr. Frank and many fi­nan­cial an­a­lysts say Alan Greenspan, the for­mer Fed­eral Re­serve chair­man, made a “grave mis­take” by re­fus­ing to im­pose tougher stan­dards on the in­dus­try. The Fed is the only reg­u­la­tor with the broad author­ity to curb lend­ing abuses both by banks and the army of mort­gage bro­kers op­er­at­ing out­side the bank­ing sys­tem.

Many economists also blame the ex­traor­di­nar­ily low in­ter­est rates Mr. Greenspan en­gi­neered in 2003 for get­ting the hous­ing bub­ble go­ing and en­abling lenders to of­fer un­be­liev­ably low teaser rates that even­tu­ally ad­justed to higher rates that bor­row­ers couldn’t af­ford.

Mr. Greenspan’s suc­ces­sor, Ben S. Ber­nanke, who Mr. Frank ap­prov­ingly called the “unGreenspan,” un­der prod­ding from the House and Se­nate bank­ing com­mit­tees used the Fed’s pow­ers in De­cem­ber to pro­pose a na­tion­wide ban on the most abu­sive prac­tices.

Those in­cluded re­quir­ing no in­come doc­u­men­ta­tion from bor­row­ers with poor credit, ad­ver­tis­ing loans with low teaser rates with­out in­form­ing bor­row­ers about fu­ture pay­ment in­creases, and co­erc­ing ap­prais­ers to rat­ify in­flated house prices. The rules are ex­pected to be fi­nal­ized soon.

Mr. Greenspan de­clined to an­swer ques­tions for this ar­ti­cle. An ar­dent ad­vo­cate of free mar­kets and dereg­u­la­tion, Mr. Greenspan gen­er­ally dis­liked gov­ern­ment in­ter­ven­tion in fi­nan­cial mar­kets and once boasted that Pres­i­dent Rea­gan signed off on ev­ery pro­posal to dereg­u­late mar­kets that he pre­sented him as chair­man of the White House Coun­cil of Eco­nomic Ad­vis­ers be­fore he joined the Fed.

Mr. Greenspan also fre­quently dis­cour­aged Congress from reg­u­lat­ing the huge and com­plex mar­ket of credit de­riv­a­tives — es­ti­mated at $62 tril­lion — which be­came a key source of fi­nan­cial in­sta­bil­ity in March, threat­en­ing the bank­ruptcy of Wall Street ti­tan Bear Stearns and forc­ing the Fed to in­ter­vene with a bailout.

But even the free-mar­ket en­thu­si­asts at the Bush White House, who also sat on the side- lines while the lend­ing de­ba­cle de­vel­oped, say they have learned a les­son about al­low­ing easy­money loans to pro­lif­er­ate.

Keith Hen­nessey, chair­man of the White House Na­tional Eco­nomic Coun­cil, said if the ad­min­is­tra­tion could do any­thing dif­fer­ently to have pre­vented to­day’s hous­ing cri­sis, it would have en­cour­aged the Fed to crack down on lend­ing abuses much ear­lier.

“If you had a magic wand, would you have liked to put those reg­u­la­tions in place a few years ago? Sure,” he said. “But it’s not the gov­ern­ment’s job to nec­es­sar­ily step in and in­ter­fere in private mar­ket ac­tions. Our job is to see if the mar­ket is cre­at­ing dis­tor­tions” and make cor­rec­tions through reg­u­la­tion only if nec­es­sary, he said.

“We had a dry for­est out there,” cre­ated by years of lax lend­ing stan­dards, that led to to­day’s hous­ing morass, tes­ti­fied Trea­sury Sec­re­tary Henry M. Paul­son Jr.

One fac­tor that ap­peared to pre­vent the Fed and the ad­min­is­tra­tion from mov­ing ear­lier against abuses was their pre­oc­cu­pa­tion early in the decade with try­ing to re­duce the dom­i­nant role played by Fan­nie Mae and Fred­die Mac in the mar­ket for mort­gage se­cu­ri­ties.

Ar­gu­ing that the gov­ern­ment en­ter­prises had grown too large, com­peted un­nec­es­sar­ily with private se­cu­ri­ties firms and Wall Street bro­kers, and posed a po­ten­tial risk to tax­pay­ers should they ever fail, the ad­min­is­tra­tion and

reg­u­la­tors ac­tively pushed for in­creased pri­va­ti­za­tion of the mort­gage se­cu­ri­ties mar­ket.

Their ef­forts to di­min­ish the role of Fan­nie and Fred­die were largely suc­cess­ful. Re­spond­ing to pres­sure from the ad­min­is­tra­tion and Congress and pub­lic pres­sure cre­ated by ac­count­ing scan­dals in 2004, the agen­cies mas­sively with­drew from the mar­ket.

Mort­gage-backed se­cu­ri­ties is­sued by the agen­cies peaked at $1.9 tril­lion in 2003 but plum­meted to un­der $1 tril­lion in 2004 and stayed there un­til last year af­ter the subprime mort­gage cri­sis broke out, when is­suance crept back up over $1 tril­lion, ac­cord­ing to Inside Mort­gage Fi­nance.

As the gi­gan­tic hous­ing agen­cies’ pres­ence in the mar­kets shrank, private se­cu­ri­ti­za­tions of un­con­ven­tional, subprime and ex­otic mort­gages took off. The amount of such “private-la­bel” mort­gage se­cu­ri­ties soared from $136 bil­lion in 2000 to $864 bil­lion in 2004 and peaked at $1.2 tril­lion in 2005 be­fore plum­met­ing last year to $707 bil­lion with the col­lapse of the subprime mar­ket.

The ad­min­is­tra­tion’s and Fed’s ob­ses­sion with curb­ing the em­pire of Fan­nie and Fred­die likely ac­cel­er­ated the cri­sis, an­a­lysts say, as the mort­gage agen­cies had been in ef­fect the main “reg­u­la­tors” in the mar­ket through­out the hous­ing boom, im­pos­ing min­i­mum lend­ing stan­dards on in­de­pen­dent mort­gage bro­kers seek­ing to sell them loans.

Fan­nie’s and Fred­die’s seem­ingly old-fash­ioned in­sis­tence on mak­ing loans to peo­ple with good credit, doc­u­mented in­come and a stake in their prop­erty caused them to lose mar­ket share to private is­suers who aban­doned tra­di­tional stan­dards.

Fan­nie and Fred­die made lim­ited for­ays into the non­tra­di­tional loan mar­ket, but their higher stan­dards en­abled them to sur­vive the mort­gage mar­ket rout last sum­mer that wiped out the subprime in­dus­try and many firms spe­cial­iz­ing in ex­otic and jumbo loans. Since that time, the agen­cies have played a larger role than ever, pro­vid­ing three-quar­ters of the fund­ing for new mort­gages to­day.

The lais­sez-faire poli­cies that led Mr. Greenspan and the ad­min­is­tra­tion to en­cour­age pri­va­ti­za­tion of the mort­gage mar­ket and hold off reg­u­lat­ing lenders re­flected both their deep-held con­vic­tions as well as Repub­li­can or­tho­doxy about how to best man­age the econ­omy.

But they also catered to the in­ter­ests of the ad­min­is­tra­tion’s fi­nanciers. Dur­ing the crit­i­cal 2004 po­lit­i­cal cam­paign when subprime and ex­otic lend­ing was tak­ing off and Mr. Bush was in a close con­test for re-elec­tion, he was the top re­cip­i­ent by far of fund­ing from all the af­fected in­dus­tries — in­clud­ing Wall Street in­vest­ment firms, com­mer­cial banks, sav­ings and loans, credit com­pa­nies, and mort­gage and real es­tate bro­kers.

The $23.8 mil­lion Mr. Bush raked in from fi­nan­cial and real es­tate busi­nesses that year was more than two times the $10.6 mil­lion re­ceived by Sen. John Kerry of Mas­sachusetts, the Demo­cratic pres­i­den­tial can­di­date and the sec­ond top ben­e­fi­ciary of fi­nan­cial con­tri­bu­tions, ac­cord­ing to OpenSe­crets.org.

Some key law­mak­ers also were among the top re­cip­i­ents of fi­nance com­pany cash. Sen. Charles E. Schumer, New York Demo­crat who be­came in­flu­en­tial Joint Eco­nomic Com­mit­tee chair­man when Democrats gained con­trol of Congress in 2007, pulled in $2.65 mil­lion from fi­nan­cial firms. Sen. Christo­pher J. Dodd, Con­necti­cut Demo­crat who be­came the Se­nate bank­ing chair­man, at­tracted $2 mil­lion.

Both of those Democrats, even while out of power in 2004, re­ceived more con­tri­bu­tions from the fi­nan­cial sec­tor than Sen. Richard C. Shelby, Alabama Repub­li­can, who was then chair­man of the Se­nate Com­mit­tee on Bank­ing, Hous­ing and Ur­ban Af­fairs.

Other Democrats who en­joyed the largesse of fi­nan­cial firms were Sen. Barack Obama, fresh­man Illi­nois Demo­crat, with $1.8 mil­lion in con­tri­bu­tions; and Sen. Hil­lary Rod­ham Clin­ton, fresh­man New York Demo­crat, with $1 mil­lion.

The cam­paign con­tri­bu­tions shed light on why Congress was slug­gish in re­spond­ing to the de­vel­op­ing cri­sis. Mr. Dodd, while be­rat­ing the Fed for not crack­ing down on abu­sive lend­ing, spent much of last year cam­paign­ing for the Demo­cratic pres­i­den­tial nom­i­na­tion and failed to push leg­is­la­tion through his com­mit­tee ad­dress­ing the hous­ing cri­sis even as Mr. Frank shep­herded a com­pre­hen­sive bill through the House.

Mrs. Clin­ton has pushed for vig­or­ous ac­tion to ad­dress the mort­gage cri­sis, call­ing for a na­tion­wide mora­to­rium on fore­clo­sures last fall, while Mr. Obama crafted his re­sponse to the hous­ing cri­sis only this spring and took a less heavy-handed approach to­ward the in­dus­try.

While the tor­rent of con­tri­bu­tions made it easy for politi­cians to ig­nore the risks cre­ated by the un­bri­dled hous­ing and lend­ing bub­bles, they were able to cloak their ties to the fi­nance in­dus­try by stress­ing the pub­lic ben­e­fits of the hous­ing boom and the easy money loans that fed it for home­own­ers and com­mu­ni­ties.

Mr. Bush touted the “own­er­ship” so­ci­ety as one with less crime and so­cial ills and more jobs and op­por­tu­ni­ties, while Demo­cratic law­mak­ers trum­peted that loans with low ini­tial pay­ments and easy terms en­abled many dis­ad­van­taged Amer­i­cans to stretch their in­comes and be­come home­own­ers for the first time. Subprime loans, in par­tic­u­lar, went dis­pro­por­tion­ately to black and His­panic bor­row­ers.

A com­mu­nity rein­vest­ment law passed by Congress in the 1990s re­quired banks to go to great lengths, in any case, to make loans avail­able to mi­nori­ties. Many mort­gage bro­kers who made loans to peo­ple who couldn’t af­ford them ra­tio­nal­ized that was what Congress and the fed­eral au­thor­i­ties wanted.

“The po­lit­i­cal pres­sure to cre­ate a hous­ing ‘happy meal’ was enor­mous,” said Ge­orge Cor­meny, a for­mer loan of­fi­cer and vice pres­i­dent at All­first Bank who also worked as a leg­isla­tive aide. The cir­cu­lar rea­son­ing ra­tion­al­iz­ing the subprime lend­ing boom be­came “un­real” to any long­time ob­server in the lend­ing world, he said.

“A fi­nan­cial in­sti­tu­tion would be re­warded with a good score and heaps of praise for mak­ing in­creas­ing quan­ti­ties of poor qual­ity hous­ing credit avail­able to marginally credit wor­thy bor­row­ers,” he said. “The reg­u­la­tors had al­most com­plete dis­re­gard for the con­se­quences. [. . . ] The costs of this so­cial ex­per­i­ment will be large and linger for a long time.”

Bloomberg News

Point­ing fin­gers: Many fi­nan­cial an­a­lysts say Alan Greenspan, the for­mer Fed­eral Re­serve chair­man, made a “grave mis­take” by re­fus­ing to im­pose tougher stan­dards on the mort­gage in­dus­try.

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