Fix the system!
That’s the cry in a lot of quarters now that the Federal Reserve has become the savior of Wall Street, the buyer of last resort for tainted mortgage-backed securities. After all, if the government is going to risk tax dollars bailing out private firms why can’t the government also require more regulation to prevent excess risk in the future?
The truth is that “fixing” Wall Street means different things to different people. While some would like more regulation, the pattern in Washington during the past decade has been just the opposite:
- 1999 — The Glass-Steagall Act of 1933 was repealed during the Clinton Administration. This legislation had prohibited commercial banks — banks that hold federally-insured deposits and can borrow directly from the Federal Reserve — from engaging in unregulated investment banking.
- 2003 — Officials from five federal agencies stood in front of reporters to announce “a plan to identify and eliminate outdated, unnecessary or unduly burdensome regulations imposed on insured depository institutions.” In case there was any confusion regarding the real purpose of the plan, James Gilleran from the Office of Thrift Supervision brought a chainsaw to rip through mounds government paperwork.
- 2004 — The Office of the Comptroller of the Currency announced rules that would prohibit state officials from regulating home loans made by national banks and their mortgage subsidiaries. The regulation covered such issues as interest rates, disclosure, prepayment penalties, licensing, advertising and escrow accounts.
- 2007 — President Bush announced a new federal initiative to reduce foreclosures at the end of August. This was a voluntary program with no new or mandated obligations for lenders.
Regulatory pull-backs have effectively created a new financial system, a private/public partnership of sorts where profits have been privatized but taxpayers can be saddled with losses if something goes wrong.
Regulatory Reform, 2008
The latest try at regulatory reform, a 212-page proposal, has now been introduced by Treasury Secretary Henry Paulson. Despite lots of front-page media coverage, a combination of Democrats and Republicans assures that the full Paulson Plan has no chance of passing Congress.
“In the middle of perhaps the greatest financial upheaval since the Great Depression,” says Business Week, “Treasury Secretary Hank Paulson is proposing a change in financial regulations which basically amounts to a big wink to Wall Street. His plan will go nowhere, both for political and practical reasons. In fact, it does not even meet the minimum standard of improving transparency, which would reduce the possibility of a similar crisis in the future.”
One reason the Paulson plan is not politically viable is that it proposes less day-to-day regulation and oversight than we now have, hardly an acceptable idea given the hundreds of billions of dollars already loaned to commercial and investment banks in exchange for mortgage-backed securities of dubious value.
“In the Treasury Department’s plan,” says the Washington Post, “the Fed would lose the responsibility for day-to-day monitoring of banks’ financial stability. It would gain a more loosely defined ability to monitor and correct risks to the entire financial system, whether they come from banks, investment firms or hedge funds. “To many people with ties to the central bank, that is a lousy trade.”
The Mortgage Origination Commission
In terms of real estate, a key provision of the Paulson Plan is to establish a Mortgage Origination Commission (MOC). It’s purpose, says the Paulson Plan, is to “evaluate, rate, and report on the adequacy of each state’s system for licensing and regulation of participants in the mortgage origination process. These evaluations would grade the overall adequacy of a state system by descriptive categories indicative of a system’s strength or weakness. These evaluations could provide further information regarding whether mortgages originated in a state should be viewed cautiously before being securitized.”
Why is a MOC needed? As the Plan explains:
“The high levels of delinquencies, defaults, and foreclosures among subprime borrowers in 2007 and 2008 have highlighted gaps in the U.S. oversight system for mortgage origination. In recent years mortgage brokers and lenders with no federal supervision originated a substantial portion of all mortgages and over 50 percent of subprime mortgages in the United States. These mortgage originators are subject to uneven degrees of state level oversight (and in some cases limited or no oversight).”
The reasoning used to justify the MOC does not address several issues:
First, state mortgage regulators have been frozen out of the marketplace since the OCC’s 2004 decision. They now have no meaningful authority to regulate mortgages from national banks, savings & loan associations or credit unions and as a result there’s little to evaluate. No less important, in the 2007 Watters decision, the Supreme Court said that not only were national lenders off-limits to state regulators, their mortgage subsidiaries were off limits as well.
Second, the Federal Reserve already has the authority to regulate the mortgage system under the Home Owner and Equity Protection Act (HOEPA). However, the Federal Reserve has never used its powers to require the use of fully-documented loan applications; curtail the use of interest-only loans; ban option ARMs or demand a full appraisal with every loan — requirements which would have stopped the use of most toxic loans had they been implemented in 2002, 2003 or 2004.
Third, a national mortgage licensing system would potentially elate lenders if it meant getting rid of progressive state rules such as those in North Carolina and California. This could happen with a new federal regulatory program because when there is a conflict between federal and state rules, federal rules generally have precedence.
Fourth, no where does the Paulson Plan directly suggest an end to the toxic loans and minimal underwriting standards which are at the heart of today’s mortgage meltdown.
“A major concern regarding the Paulson Plan is that it would take months and years to implement even if it met with universal approval,” says James J. Saccacio, chief executive officer at RealtyTrac.com, the nation’s largest source of foreclosure information and property listings. “In the same way that the federal government was able to move within days to provide $30 billion in loan guarantees to help with the purchase of Bear Stearns, quick action is also needed to help the growing number of homeowners who face foreclosure each day.”
No Fiduciary Obligation
The word “fiduciary” does not appear in the Paulson Plan, meaning that the terms of trade between borrowers and lenders would remain unchanged. Under the current system, borrowers are “customers” who are sold loan products and not “clients” to whom the lender is obligated as an agent to get the best possible products, rates and terms. Since borrowers rely on lenders for rates, information and program options, the current system makes borrowers dependent on the very people who profit most by selling high-cost mortgage products.
Given all its faults, why was the Paulson Plan suddenly unveiled? One possible answer is that Paulson’s proposal largely dominated the news of the day — which means the sudden and simultaneous resignation of HUD Secretary Alphonso Jackson did not.
Jackson is facing an FBI investigation regarding alleged contracting issues in New Orleans. A federal lawsuit is alleging that he denied HUD funds to the Philadelphia Housing Authority because it would not turn over land to a developer friend. Lastly, several senators had already called for his resignation.
While the well-promoted Paulson Plan may not go anywhere, the Jackson resignation was largely buried by leading media outlets. That reality alone may explain the political value of the Paulson Plan — and why it suddenly became hot news at the very moment an important Cabinet official was leaving office.
Peter G. Miller is the author of the Common-Sense Mortgage and is syndicated in more than 100 newspapers.