Regulators Repeat Exactly What They Did During the Last Housing Boom

By James Kwak

The Dodd-Frank Act was supposed to require securitizers to retain 5 percent of the credit risk of the mortgage-backed securities that they issued, in order to reduce the risk of a repeat of the last housing bubble. Today, the federal financial regulators said, “Whatever,” and ignored that requirement. In particular, they created an exemption that would have covered at least 98 percent of all mortgages issued last year.

Why? Because

“adding additional layers of regulation would have contracted credit for first time home buyers and borrowers without large down payments, and prevented private capital from entering the market.”

That’s according to the head of the Mortgage Bankers Association.

This is the exact same argument that was made in favor of deregulation during the two decades prior to the last financial crisis, without the slightest hint of irony. It’s further proof that everyone has either forgotten that the financial crisis happened or is pretending that it didn’t happen because, well, maybe it won’t happen again?

Even leaving aside the specific merits of this decision, the worrying thing is that the intellectual, regulatory, and political climate seems to be basically the same as it was in 2004: no one wants to to anything that might be construed as hurting the economy, and no one wants to offend the housing industry.

44 responses to “Regulators Repeat Exactly What They Did During the Last Housing Boom

  1. Moses Herzog

    Of course, regular readers and fans of Mr. Kwak’s and Professor Johnson’s blog knew clear back in 2009 that when Barack Obama lacked the testicles to use his bully pulpit, be a leader and build public support for the mortgage cramdowns, that we were going to head for another crisis. http://www.senate.gov/legislative/LIS/roll_call_lists/roll_call_vote_cfm.cfm?congress=111&session=1&vote=00174

    This was the moment when naive people (Mike Konczal??, Rachel Maddow??) should have clued in that this President is not “for the little guy”!!! They should have known in the weeks building up to April 30, 2009, that this President is mostly concerned with people who stroke him (See Timothy Geithner, See Larry Summers, See Jamie Dimon) rather than those who were thrown out of their jobs (through no fault of their own) and couldn’t make some of their mortgage payments. Where was Barack Obama on April 30, 2009??? Falling in love with himself in the mirror?? Telling Larry Summers how observant Larry was for noticing the streamline contour of his ears??? Because President Obama was NOT on a whistlestop tour in the vein of Harry Truman for American homeowners.

    Bottom line, while guys like Chris Christie and Marco Rubio are going to try to convince us Mexicans who pick their Wal-Mart tomatoes are the enemy, the members of these two following organizations (which are really UNIONS FOR FATCATS not “associations”) are the ones that should worry people.

    http://en.wikipedia.org/wiki/National_Association_of_Realtors

    http://en.wikipedia.org/wiki/American_Bankers_Association

  2. Per Kurowski

    The encore is not restricted to the US. The production of Basel III is in the same hands of the producers of the Basel II flop, using the same script. Neither Hollywood nor Bollywood would do a dumb thing like that.

    http://subprimeregulations.blogspot.com/2013/08/members-of-basel-committee-for-banking.html

  3. When ‘everyone’ is referred to as not caring or wanting definite preventive change, I have a real problem. Its not the anyone (s) within the everyone (s) that had or have access and lobbies to water existing regulations to the point of melting, but the very banking everyone (s) who most benefited by their own schemes. I am so fed up with the efforts to diminish responsibility by spreading the blame to those with the least power. Lots of people rob banks but we don’t write how the rest of society collectively had some kind of hand in it.

  4. Bruce E. Woych

    “adding additional layers of regulation would have contracted credit for first time home buyers and borrowers without large down payments, and prevented private capital from entering the market.”
    ===================================================

    http://michael-hudson.com/2013/07/the-bubble-economy-as-a-2-part-play-for-privatisation/

    “This financial engineering is not your typical bubble. The key to the post-2000 bubble was real estate. It is true that the past year and a half has seen some recovery in property prices for residential and commercial property. But something remarkable has occurred. This new debt-strapped low-interest environment has seen Hedge funds and buyout funds doing something that has not been seen in nearly a century: They are buying up property with cash, starting with the inventory of foreclosed properties that banks are selling off at distress prices.”
    The Bubble Economy as a 2 part play for Privatisation
    July 4, 2013
    By Michael Hudson
    ——————————————
    …so who will benefit from less regulation (?) as a new pumped up bubble is plotted and planned? The turnover from cheap distressed (real-estate) assets will be guaranteed by easy flipped loans and the competition for housing will permit prices to be set by bubble finance sectors that have bought with the exclusive liquidity provided by (quantitative-eay-money) against competitive austerity and the context of legitimating “recovery’ mandates that favor class preservation and sustain the too big to share economy.

  5. Bruce E. Woych

    That should be: “quantitative-easy-money’ against ‘NON-competitive austerity sectors…’
    or in other terms: the great looting & gaming of the system has reached asset grabbing stages where turning over properties will depend upon new levels of loans to be available…and if that means looking the other way by regulators…well the business of Government is Big Business; and regulators must fall into the rank and file of sustained denial.

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  7. winstongator

    But we need private capital in the market! If it takes lowering standards and eliminating safeguards, so be it.

    I thought gov’t capital was what got thrown around willy-nilly and private funds were well looked after. So private capital can’t withstand some limited restriction? Doesn’t sound so robust to me.

    I would imagine that those same people worrying about contracting credit are the same people pushing for Fannie & Freddie to be wound down. They are the real source of mortgage credit today and winding them down will definitively contract credit. One cannot play the ‘contracting credit’ card and hold both arguments: loosen restrictions on private banks and wind down the GSEs.

  8. @Margsview – “….Lots of people rob banks but we don’t write how the rest of society collectively had some kind of hand in it….”

    Millions of FIAT $$ thrown at PR campaigns to come up with that abusive psychobabble….so much for the SANE approach to food clothing shelter medicine – which, btw, is where all the puerile philosophies of Ayn Rand fall apart

    there’s a SCIENTIFIC man to land ratio and it is not trash 99% of the planet to lift 480 people into the stratosphere of TRILLIONS in personal FIAT $$ wealth…

    So now BOTH religion and economics HATE bringing REAL, not virtual, EQUATIONS into “politics”….

    Sounds like the best time to UNIONIZE ethical scientists.

    Yea, the rabid raccoon pervs ruling the world for the “caretaker” who HATES humanity, especially women, were kinda hoping that the word “science” can be pushed off the internets by repeating the same 50 political words that mean NOTHING real anymore – white noise for an IQ above 10, a dog whistle to start snarling and biting for the hired ORK hooligans.

    BILLIONS spent to spy on us and IGNORE us at the same time? Ripping food out of people’s mouths by using the life’s savings that were STOLEN from them if you ask me…yup, not much “regulation” going on….

  9. ReturnFreeRisk

    This is not a surprise to me. I have been saying for the past couple of years that regulators will never be effective because of political and other reasons (regulatory capture by banks). So a regulatory response to bubbles is a pipe dream.

  10. Here’s the quote that should have been excerpted from the WSJ article;

    ‘The new proposal marked a win for a coalition of mortgage lenders, real-estate agents, home builders, civil rights groups and consumer advocates. They formed a group, called the Coalition for Sensible Housing Policy, that lobbied heavily against the tighter rules proposed earlier.’

    Pure Public Choice Economics. Entirely predictable.

    Instead of putting your faith in regulators, how about another approach (from Bulow and Klemperer);

    http://www.voxeu.org/article/market-based-bank-capital-regulation

    —————-quote————–
    Many proposals add ever-more elaborate regulations to an already baroque regulatory system – one that is already unmanageable. We propose instead to make things much simpler.

    ERNs [Equity Recourse Notes] are a counterweight against pro-cyclicality. They make capital raising – and therefore lending – easier rather than harder in recessions. Counter-cyclicality also increases the credibility of the plan, because there will be no incentive to scrap it in bad times. Jettisoning complex capital rules, and simply transferring tail risk back where it belongs (with private investors) takes taxpayers off the hook and ensures that banks with profitable opportunities can use them.

    In short, our system eliminates distortionary incentives for regulatory arbitrage and forbearance, facilitates counter-cyclical raising of unsecured capital, and clearly and credibly assigns losses to private investors where they belong.

    While we rely on markets to determine banks’ risk capital requirements, our system is robust to the market being wrong, or less accurate on average than regulators’ or banks’ internal models. By contrast, current regulatory models will often lose money, and perhaps cause a crisis, if markets are right.
    ——————–endquote——————–

    Something like the above might actually work.

  11. Per Kurowski

    Patrick. What if all banks had held the ERN during the current crisis? Would that have made the consequences of the losses sustained in AAA rated securities and loans to Greece which resulted from regulatory distortions, any easier on the real economy? Not much!

    How the costs of misallocations are distributed might indeed have a lot to do with justice, but, in terms of the overall real economy, a loss from a misallocation is a loss, no matter what pocket it hits.

  12. Bruce E. Woych

    http://newyorksstateofmind.wordpress.com/2013/07/25/giving-investment-banks-another-pass/

    “…virtually every major component of Dodd-Frank meant to curtail the excesses of the big banks has either been gutted or delayed by the regulators. If you believe in moral hazard, the idea that if you don’t hold people accountable for their misconduct you are effectively telling them that they’ve done nothing wrong, then this is yet another troubling example of the power that finance has come to hold over the American economy.”

  13. Well Per, the first thing to consider is that the ERNs would have completely changed the incentives facing the banks; i.e. changed the loans they wanted to make. Especially attractive to you, I would think, is that it would no longer be the regulators rating different investments that would be determinative. It would be the market.

  14. 20 Year ago, NAFTA started rippling though the US. Loss of manufacturing jobs, and the piece parts that go with it reduced pay. Replacement jobs at Burger King and Wall Mart cannot support diversity of home ownership.

    So were back to the Ponzi Scheme of the CRA and its progeny.

    Having 20% manufacturing, R&D, Innovaiton is a must for a country of > 300 M. If just 5% of the $85B were spent on innovation, and restoring Manufacturing, the US might have jobs and ROI. Detroit provided an example of this.

    When Bernie Maddoff friends and mimics are running the country – do we think there might be a different outcome?

  15. @Woych, “….If you believe in moral hazard, the idea that if you don’t hold people accountable for their misconduct you are effectively telling them that they’ve done nothing wrong, then this is yet another troubling example of the power that finance has come to hold over the American economy…..”.

    I believe that this is the very argument being made to go blow up stuff in Syria. Perpetual war funded with Ponzi Fiat $$$$ – AKA as home ownership, Jobs, and bankrupted cities that BUILT the MIC…

    BANKRUPTED CITIES LIKE DETROIT…

    Doesn’t Detroit look like Syria….?

    There is MUCH more “evidence” to prove that 911 was an inside job – biggest FINANCIAL crime the world has ever know thanks to the internet – than there is to prove Assad, personally, cracked open rusted containers of industrial ammonia….wait, no one tested the blood of the corpses to KNOW what it was, did they? And at this point, who would BELIEVE the results of a lab test anyway – pffffftttt – what’s the cost of a fraudulent lab test to the hedge hogs at 740….?

    HAPPY LABOR DAY!

  16. Well I guess that being half way between the silver and gold aint all that bad a place to inhabit. So here’s another, tip of the hat to Bruce, and his natural way of aspiring to last few hours we have to enjoy this way of life. And no, my name is not, Manule Labor!

  17. Per Kurowski

    @Patrick ref: ENR’s “it would no longer be the regulators rating different investments that would be determinative.

    That could be if risk-weighting is eliminated… but that is not an integral part of the ENR proposal.

  18. Actuall Pat, once someone throws the book at you, it’s not. So your is, is in the present tense, and Per’s is, is in the future tense, and “we”, are stuck in the middle having to listen to, and watch, the never ending hidden public pain of arrogance and hypocrisy. As the clock, which never seemed so alive, ticks away.

  19. Per Kurowski

    @Patrick “Per actually it is”

    Patrick, the proposal has good points and could be used, as a complement, but it is not referring to how much capital (equity) the banks need to hold. And while that figure is the result of risk-weighting, we will not get rid of the distortions to the allocation of credit to the real economy.

    Again what if all banks had held the ERN during the current crisis? Would that have made the consequences of the losses sustained in AAA rated securities, or loans to Greece, which resulted from regulatory distortions, any easier on the real economy? Not much!

    Do not forget that while how the costs of misallocations are distributed might indeed have a lot to do with justice, in terms of the overall real economy, a loss from a misallocation is a loss, no matter what pocket it hits.

  20. Per, you might want to go to Klemperer’s site and read the entire paper;

    http://www.paulklemperer.org/

    But even in the excerpts at Vox, they call for, ‘Jettisoning complex capital rules….’ Which would be replaced by market forces determining the banks capital structures.

    Consider;

    ‘Our plan would also require a subtle but crucial transformation of secured (i.e., collateralized) borrowing by banks undergo. Currently a secured creditor has a claim against the posted assets plus an unsecured claim against the bank for any shortfall, if things go wrong. If there is a good chance that the government will bail out a failing bank, the terms of the loan will be based partially on the government’s credit rather than on the quality of the bank’s. The solution is to limit the recourse that a creditor would have, beyond the posted collateral, to either shares of stock or ERNs.’

    This is NOT a complement to the current situation. It’s replacement of it.

  21. Per Kurowski

    @Patrick: “Per, you might want to go to Klemperer’s site and read the entire paper… This is NOT a complement to the current situation. It’s replacement of it.”

    Of course I read the document before opining. I commented on it a couple of days ago in response to what Tim Harford wrote about it in FT.

    IT IS a complement, and the document specifically proposes to “Replace all unsecured debt with ERNs”, and NOT to replace capital (equity) with ERNs.

    In that respect the ERN is a market driven way for interpreting the risk that remains after risk-weighing, although indeed it could perform that function better than CoCos.

    And so the fact is that even with ERN, regulators will establish some basic levels of capital requirements… and, if these keep on discriminating based on perceived risk, the misallocation of bank credit in the real economy will go on… and in the big scheme of things the health of banks is less relevant than how the real economy is moving on.

  22. Per, even if regulators like Baselians continued to set risk weighting standards (instead of being ‘jettisoned’ as Bulow and Klemperer want) they would become irrelevant. If bond holders knew that their only recourse was to the equity inherent in the ERNs, then they wouldn’t care about the regulators ideas.

    And, of course, there is much more to the scheme than just the ERNs.

  23. Funny how 911 happened just when a lot of bonds needed to pony up….

    What wild times – Putin seems to be the only one on the current stage who has consistently not focused on ripping off USA Middle Class through perpetual war in the Middle East (and all the attending home grown skin-‘em-alive with taxes to pay for meta-data spying *churches* and their shamans of censorship, psychobabble and torture).

    Go figure.

    Centuries of globalization and not a single genius mathematician did a risk assessment to the *global* economy based on the very real threats to LIFE-MAINTENANCE commerce such as invasive species and plagues (bees, trees, people, etc.).

    It’s not a game.

  24. Patrick. “they would become irrelevant. If bond holders knew that their only recourse was to the equity inherent in the ERNs, then they wouldn’t care about the regulators ideas.

    How you can figure out how the one who sets the capital requirements can become irrelevant is beyond my comprehension. Of course the day everything breaks down, that happens, but by then it is too late for everyone. Just like the Fed can become irrelevant.

    And, don´t get me wrong, I am not talking about the banks as much as about the real economy,

    You tell me, how is the ERNs to help the efficient allocation of bank credit to the real economy, in the midst of the confusion created by the risk-weights.

  25. Pat,…you are going to get Trumped here, in a big way, don’t kid yourself, time is not on your side. Trust me,

  26. ‘… in the midst of the confusion created by the risk-weights.’

    As I said, the risk-weights will be irrelevant to bond buyers. They’ll be focusing on the stock price of the bank. The canary in the coal mine.

    And, that’s only if the regulators get to maintain their ability to rate risks, which Bulow and Klemperer want to get rid of.

  27. ‘Trust me,’

    Ha, ha, ha, ha, ha…

  28. Per Kurowski

    Patrick.
    So you hold that ERN’s would clear the distortions produced by facts such as, for instance in Europe, banks being required to hold 8 percent in capital when lending to a small business but zero when lending to the government? Well good luck!

  29. Bruce E. Woych

    SEC to Close Revolving Door Loophole

    In a major victory for revolving door reform, the Securities and Exchange Commission (SEC) will close a loophole that allowed many regulators to lobby the agency on behalf of Wall Street immediately after leaving, blurring the line between regulators and the regulated. POGO highlighted this loophole in a report published this February and recommended longer “cooling-off” periods for regulators who go to work for Wall Street. Read more on POGO’s blog.

    http://www.pogo.org/blog/2013/08/sec-to-close-revolving-door-loophole.html

    “As POGO described in its report, Dangerous Liaisons: Revolving Door at SEC Creates Risk of Regulatory Capture, the revolving door may cause staffers throughout the agency to identify too closely with the industry they oversee, effectively blurring the line between regulator and regulated. This can make it easier for private interests to sway SEC policy and may “help to explain why the agency does not take a tougher stand against the businesses it oversees,” POGO wrote.

    Now, as a result of the new rule change, SEC alumni who made more than $155,440.50 a year will have to wait at least one year before they can represent clients before the agency, according to reports citing the ethics memo.”

  30. You don’t need luck, Per. You need lenders to buy your bonds.

  31. Per Kurowski

    Oh Patrick. Be my guest. Just ask your pension fund to buy those bonds.

  32. However as pointed out in a US News report, the 43% total of total debt payment, including taxes and insurance on the property still stands, as well as the increased documentation requirements. So no janitors getting 1,000,000 mortgages based on no docs. The article cried crocodile tears over the poor small business type with a varying income, not being able to buy a home, and the general requirement remaining of documentation. This at least until modified kills off the alt-A and no doc mortgage. It also means that folks with big student loans will be unable to buy much in the market, as even with the income based repayment, that limit becomes 33% for all debts &taxes other than student loans. Of course that does mean we might see folks fleeing the coasts for the center of the country.

  33. Game, set, match. It was fun playin wit you Pat. My condolences for your loss, you took it like the pro you were too, just as I expected.

  34. Per, the point is that they won’t buy those bonds if the share price of the bank’s stock is headed toward the trigger price.

  35. Of course Patrick. We are not talking about the bonds that will not be purchased but of those which have already been purchased.

  36. We haven’t been talking about bonds floating around now. We’ve been talking about the new ERNs.

    But, I imagine that financial markets will take note of what’s going on, and that ‘your grandfather’s bonds’ won’t escape downgrading.

  37. Patrick, you know very well I was referring to the case of ERN’s already purchased in the future… so lets leave at this.

  38. Bruce E. Woych

    @failedevolution: very interesting posting and a good read.

    Apparently this blog would not let me place the link to the article, and in the process…wiped out a detailed reply. I am assuming that we have not entered the stage where “we” get censored but the BS (mine is bigger than yours talk) that has been trolling comments here has dominated the discussion with worthless equivocations. Your entry was a welcomed intelligence against that chitter-chatter of hot-shot business acumen that goes nowhere and bores the life out of us as a practiced institutionalism of the bureaucratic norm.

  39. Bruce E. Woych, thank you very much for your kind words. I just try to inform about the situation in my country and share some thoughts of how I see things generally and globally. The point is to participate, every thought, every comment can boost a discussion. Thanks again.

  40. Bruce E. Woych

    29 June, 2013
    Europe, look what will happen to you!
    by system failure
    Excerpted from “failedevolution” link above.

    ” The truth is that, the neoliberal Thatcherian type agenda in its most cruel form, must prevail at all costs, and that’s why the public broadcaster should be targeted, one of the last symbols of cultural resistance against the transformation of everything in cost and profit, a kind of economic totalitarianism. People abroad understood that and reacted directly.

    The dictatorial behavior of the Greek government spread terror in Europe and European public broadcasters, as they saw that someday may have the same ending. The European Broadcasting Union (EBU) reacted directly, and hustled to support ERT, one of its founding members, by providing technical support, in order to make sure that ERT will continue broadcasting, while the president of EBU spoke about the worse type of censorship we ever saw, and asked Samaras, through a letter, to recall the decision immediately. The black background in the front pages of French newspapers “Liberation” and “Humanite” is also characteristic.

    Neoliberal dictatorship will try to erase the independent voice of public broadcasters in Europe – through the Greek experiment – and dictate a Too Big to Fail model for the largest private media, following the same pattern applied on the banking sector, in order to erase the independent information in maximum degree. The next big step will be to find a way to control the independent Internet information, in order to complete its domination.”

    [BRAVO!]
    accessed through the archive or from the article navigated from the link above:

    http://failedevolution.wordpress.com/2013/08/31/self-management-societies-vs-anarcho-capitalism-the-new-global-war-of-ideologies/

  41. I found this interesting, coming from the same link(s) as Bruce mentioned. I don’t know who could have “followed the money” like that, or how one can prevent such, acts of inflation, from occurring. Everyday products, especially food, have been rising dramatically recently with little or no notice from those whos job it was to contain this price inflation.

    http://www.dailymail.co.uk/news/article-2401410/When-Greece-banks-melted-EU-talked-threatened-cut-loose–10billion.html#comments

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