The Ongoing Battle Against Error and Hypocrisy

By James Kwak

With the financial reform bill out of the Senate Banking Committee last week (another good thing that happened while I was away) and fresh off of victory in the health care war, the Obama administration is upping the rhetorical pressure to pass financial reform. This was most obvious in Deputy Treasury Secretary Neal Wolin’s speech at the U.S. Chamber of Commerce last week, in which he called out his hosts with fighting words: “the Chamber of Commerce – funded, no doubt, with a good deal of your money – has launched a lavish, aggressive and misleading campaign to defeat the proposed independent agency.”

Elizabeth Warren, who has never minced words when it comes to enemies of consumer protection, steps up today with an even more withering attack on the flip-flopping of the American Bankers Association, which was for the separation of consumer protection from prudential regulation before it was against it. As Warren says:

“ABA lobbyists now aggressively insist that separating consumer protection and safety and soundness functions would unravel bank stability. Yet just a few years ago, they heatedly argued the opposite—that the functions should be distinct.

“In 2006, the ABA claimed to act on principle as it railed against an interagency guidance designed to exercise some modest control over subprime mortgages.  It criticized the proposal for ‘combin[ing] safety and soundness guidance with consumer protection guidance, creating confusion that is best addressed by separating them.'”

Huh? To understand the ABA’s position in 2006,  you need to realize that it was arguing against a proposal by the major regulatory agencies to make consumer suitability (the appropriateness of a mortgage product for a consumer) an element of safety and soundness regulation. And so the ABA argued that consumer issues and safety-and-soundness were two separate things. But this is what it really cared about (from the 2006 ABA comment, page 9):

“In discussing underwriting, the Agencies should be focusing on risk levels of default and loss and creditworthiness of borrowers rather than ‘appropriateness.’ We are concerned that the Agencies are creating a new ‘appropriateness’ or ‘suitability’ standard that we are very reluctant to see applied in lending, if ‘suitability’  is to mean something other than creditworthiness.”

In other words, the ABA’s bottom line is that it does not want regulators worrying about consumers at all, and it will use whatever argument happens to be handy at the moment. In 2006, it was for separating prudential regulation from consumer protection. Now that the threat is an independent consumer protection agency, it is for unifying consumer protection with prudential regulation (because that would preserve the existing set of regulatory agencies, none of which is primarily responsible for consumer protection).

The ABA’s current argument is that if you split consumer protection from prudential regulation, the consumer protecters will write rules that will make it hard for banks to make money, thereby weakening the banks. While this argument seems to make sense, it has two independently fatal flaws. First, the implication is that if banks can’t survive without screwing their customers, then they should be allowed to screw their customers. Second, it flies in the face of the lessons of the past few years, when, as Warren says, “it was the lack of meaningful, independent consumer protection that helped bring down the entire banking system and cause the current crisis”; the banks nearly failed (would have failed without government support) because their customers couldn’t pay off their toxic mortgages.*

Of course, the ABA is a lobbying organization, and some (like a majority of the Supreme Court in Citizens United) might say that this is how politics is supposed to work: corporations that have certain interests should be able to give money to lobbying organizations that will do whatever it takes to advance those interests, and being constrained by things like logical consistency or even a sense of shame would be a dereliction of duty for those organizations. So maybe the ABA is just doing its job. But that doesn’t mean that the members of the United States Senate have to fall for it.

(By the way, did you know that Elizabeth Warren also wrote, “If you want to understand how Wall Street captured Washington and how it tenaciously hangs on to that power, read 13 Bankers“?)

* Yes, I know this is a bit complicated, because many of the toxic mortgages were originated by nonbank mortgage lenders, who then sold the mortgages to banks, who packaged them into mortgage-backed securities and CDOs and held onto some of the tranches of those CDOs, which were what blew up the banks (in part — Lehman also added a healthy dose of explosive commercial real estate). But the banks were largely responsible for the originations in the first place, both because they provided the demand for the toxic mortgages and because in many cases they provided the funding for the nonbank mortgage lenders.

Update: Shahien Nasiripour has more.

23 thoughts on “The Ongoing Battle Against Error and Hypocrisy

  1. —————-
    “as Warren says, “it was the lack of meaningful, independent consumer protection that helped bring down the entire banking system and cause the current crisis”; the banks nearly failed (would have failed without government support) because their customers couldn’t pay off their toxic mortgages”

    I don’t really buy this line of argument.

    Consumer protection is important in its own right, but it certainly doesn’t guarantee against financial crisis.

    Anytime you have agents bidding up asset prices with borrowed money, you will always reach a point where ex post income generated by those assets falls short of ex ante expectations of that income, resulting in an inability to service the debt, resulting in fire sales, resulting in plunging asset prices, resulting in economic depression. Whether the buyers of those assets are “consumers”, “individual investors”, or “firms” is irrelevant.

  2. I have to say I largely agree with the ABA’s 2006 position. Banks should be more focused on the creditworthiness of individual borrowers than on whether or not the products they offer pass some sort of an appropriateness test determined by government officials. The financial crisis was caused in large part by the abject failure of banks and non-bank mortgage originators to accurately gauge their customers’ creditworthiness. Determining whether that failure was the result of stupidity, greed, or malice is IMHO rather less important than creating policies that force banks to engage in realistic assessments of their customers’ creditworthiness. The question then is: does the CFPA further that goal?

    Ever since the CFPA proposal has been stripped of the ability to mandate financial institutions offer plain vanilla mortgages and other financial services I’ve been skeptical of whether or not the CFPA reform will be useful in preventing further crisis. I just don’t know if the regulators staffing any future CFPA will be able to create guidelines that ensure financial products are truly safe. Unfortunately, the track record of past regulators does not inspire much confidence.

  3. On a related note, Paul Krugman has been talking about “idiot proofing,” financial reform proposals recently:

    Rather than allowing regulators much discretion Professor Krugman favors a rules based approach. Probably most on this website (including me) would agree with this approach. So I guess the way I see it is that mandating banks offer plain vanilla products is a rules based approach. Now that that’s gone I just don’t know if I can trust future CFPA regulators to pick and choose financial products that are truly safe. One size does not fit all and there is the ever-present threat of capture.

  4. Half of Commercial Mortgages to Be Underwater: Warren

    Monday, 29 Mar 2010 |

    “By the end of 2010, about half of all commercial real estate mortgages will be underwater, said Elizabeth Warren, chairperson of the TARP Congressional Oversight Panel, in a wide-ranging interview on Monday.

    “They are [mostly] concentrated in the mid-sized banks,” Warren told CNBC. “We now have 2,988 banks—mostly midsized, that have these dangerous concentrations in commercial real estate lending.”

    As a result, the economy will face another “very serious problem” that will have to be resolved over the next three years, she said, adding that things are unlikely to return to normalcy in 2010. (See the video – for the full interview.)”

  5. “But the banks were largely responsible for the originations in the first place, both because they provided the demand for the toxic mortgages…”

    Uh, besides the super-senior (etc) tranches banks retained, they weren’t the ultimate demand (nor the ultimate funding).

  6. Irish banks may require up to €32 billion to cover losses

    March 30, 2010, 19:23- Irish Times – excerpt

    “Irish banks require an estimated €22 billion to cover losses from soured property loans and this total may rise by a further €10 billion depending on the extent of impaired loans at Anglo Irish Bank, the Dáil was told today.

    The true scale of the “black hole” left in the sector by toxic property debt was laid bare today as Nama confirmed the initial tranche of bad loans would be acquired at a discount of 47 per cent, substantially more than the Government’s initial estimate of 30 per cent.” (1.00 EUR = 1.34131 USD)

  7. I think the focus should be on “Too Big to Fail” and breaking up the mega-banks. “Too Big to Fail” is the root of the problem. If banks believe they can count on the government to not only bail them out but in fact essentially reward them through the bailouts for making bad loans, which is what has happened, they will make more bad loans. This is both common sense and Economics 101. If someone pays you to screw up, you should screw up.

    The banks have demonstrated over the last 10-15 years that they can subvert federal governmental regulatory agencies. The Federal Reserve, the US Treasury, the SEC, and many other agencies already had the power to reign in and prevent most of the present fiasco. Creating yet another federal agency will not resolve this situation.

    Finally, all of this focuses attention on obscure financial issues that the general public, businesses, and other interest groups don’t understand. That is much of the purpose of the derivative securities and other complicated financial structures. They are very complex and obfuscate a simple financial scam, pretty much a Ponzi scheme.

    Rather than get tied up in the Gordian Knot of complex financial instruments and regulations, opponents of these disastrous policies must make a simple case, pointing out clearly the enormous cost to most people in the US and the world. The message has to be something simple and clear along the lines of the federal government is subsidizing gross incompetence and the waste of trillions of dollars on bad “investments”.

    It needs to be made clear that trillions of dollars spent on housing in the 00’s and goofy telecom and Internet schemes in the 90’s represents trillions of dollars not spent on critical human needs such as energy production, more efficient energy systems, transportation, and so forth. We see the consequences of this in rising energy prices and a declining standard of living.

    Opponents of these policies must aggressively debunk the use of “growth”, “investment”, “innovation”, and “research and development” justifications for these disastrous policies which demonstrably involve a massive diversion of resources to frivolous uses.

    The problem needs to be phrased in terms of people’s pocketbooks, their take home pay, their savings and retirement funds, and the profits of the many small and medium sized businesses suffering from these policies.



  8. If the informative commentaries and Mr Kwak’s main link are even partially true, – then what can explain the markets current “ebulliance” or “irrational exhuberance” and the startling uptick in the market? Perpetuation of the same cataclysmic systemic fraudulence, by the same fraudulent actors, being cloaked by the same fraudulent regulators would be one possible explanation.

    The math is hopelessly awry. There’s much more missing, than is understood. Are we not in the midst of yet another speculative bubble rooted in, and based on systemic fraud and the intentional lack of transparancy? The only people benefiting from the markets wild increase are the same predatorclass den of vipers and thieves who conjured, cloaked, and profited wantonly the most devastating financial crisis since the Great Depression. Few working Americans see, or recognize any benefit from the markets ebullience. If fact most American’s are peering into the abyss of financial hardship unseen since the 1930’s, a realworld loss of income, gainful employment opportunities, and a marked lowering of standards of living.

    Thefew have pillaged far toomuch, from way toomany. There must be a reckoning and a balancing, – and accountability for grotesque failure, and blatant criminality by the predatorclass titans in our financial sector.

  9. just received my copy of 13 Bankers. am very excited to read it. nice cover!

    Simon and James, please keep up the good work and i hope the profits from the book allow you to sing your message even louder and clearer. we need more patriots like you.

  10. This comment seems to run counter to what William Black has been saying about the FBI’s analysis of the ongoing mortgage fraud abuses in the housing market. See here for example:

    Professor Black’s contention is that bank officials at the highest level deliberately pushed for underwriting standards to be lowered so more and larger credit default obligation (CDO) products could be created and sold. As evidence he points out that nearly all of the underlying mortgages in many of the CDO products marketed by banks like Goldman Sachs were fraudulent. Just coincidence? I haven’t looked at the FBI data myself so I’d be interested in hearing other points of view. Maybe banks weren’t the ultimate source of demand or funding for “toxic mortgages,” but what about for the CDO’s we now know were backed by fraudulent mortgages? Any insight beyond your blanket assertion here would be appreciated.

  11. Says YOU. The banks’ greed in creating garbage filled CDOs created the bad mortgages, not the other way around. And if you think the CRA created the housing problem in Cleveland OH, that scheduled brain surgery you have isn’t gonna do it. You’re gonna need a transplant.

  12. ABA and FRB sitting in a tree, K-I-S-S-I-N-G. First comes love, then comes marriage, then Bernanke’s pushing the baby carriage.

  13. John wrote:

    “The problem needs to be phrased in terms of people’s pocketbooks”

    Well put, but there are repercussion in becoming a whistleblower.

  14. Housing Prices May Be Heading for a Double Dip

    30 Mar 2010 | 4:41 PM ET | Excerpt

    “Anyone thinking housing prices have reached a bottom had better do some recalculating. Despite Tuesday’s Case Schiller report showing smaller declines in January, housing prices may already be in another free fall.”

  15. March 30, 2010 03:44 PM – Huff TV

    “When the discussion touched on Sen. Chris Dodd’s (D-Conn.) latest financial reform bill, one MSNBC anchor jokingly asked, “We’re going to have reform, right? And it’s all going to be OK? There will not be another meltdown right?

    “No, unfortunately,” Johnson said. “I wish that were true.”

    The next crisis will come sooner rather than later, Johnson said, unless the nation’s largest banks are broken up and some sort of Glass-Steagall-type approach…”

  16. All this emphasis on creating a consumer protection agency is ridiculous. Such an agency will not protect against future bubbles. Instead, we’ll just get a bunch of bureaucrats spinning their wheels on whether credit card interest rates should be capped at 19% or 18%. Imagine Maxine Waters multiplied by 1,000.

    To the extent members of the public were victimized in the housing bubble, it was mostly a result of the liquidity made possible through unregulated mortgage securitizations. All that liquidity needed to be marketed, so that led to excessively risky loans being created and marketed through mortgage brokers (outside of the banking system) to members of the public who couldn’t read the fine print. Fixing these problems doesn’t require a new agency that will only grow over time and become yet another waste of taxpayer dollars. We really need to think twice before creating a new government agency, because once you do, you’ll be living with it forever.

  17. Prudential regulation to ensure “safety and soundness” is, by its nature, inconsistent with consumer protection. A regulator cannot serve two masters, paricularly when it is co-opted by the one with all the money. Congress knows this, it too is controlled by the institutions with all the money.

    But the debate over the consumer protection function — which has never existed and, if it did exist, is unlikely to have prevented the last debacle — is hardly the most important shortcoming of the financial regulation proposals now on the table. Take consumer protection out of the bill and require an up or down vote. But let’s focus on a new version of Glass-Steagall or some other form of restructuring that prevents TBTF and puts finance in its proper place. Speaking as a former consumer protector (in the ’60s and ’70s), there are more important things in these bills on which to focus.

  18. I just finished reading “The Big Short” (thankfully, because 13 Bankers just arrived), and I became convinced that if the CFPA had existed at the beginning of the subprime worst spree (say circa the time that Gramm Leach was passed) perhaps the bubble never would have happened because the lending activities supporting all of the absurd bonds, CDS’s, CDO’s, etc., would not have been fueled by the absurd generation of absurd securitizations. It certainly would have made the bubble far more difficult to create. And, by the way, if anyone ever offers you a loan on what appears to be favorable terms without even income verificationm, don’t even listen let alone sign — it will be as much of a joke at the no cash down loan given a strawberry picker in California to buy a $750,000 home. And, by the way, all of the CEO’s of the TBTF’s should be in prison, if for no other reason than stealing from the American people under false pretenses (but there are real, legitimate cases to be made, like violation of fiduciary duty.

    But, back to your point. The ABA is a crock. Just look at who pays their dues — trust me its not the tax payers, its the tax avoiders who cheated the taxpayers.

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