A LENDER PROBLEM, NOT A BORROWER PROBLEM (via Bruno Behrend):

Sheila Bair’s Bank Shot (JOE NOCERA, 7/09/11, NY Times Magazine)

Arriving at the F.D.I.C. that summer, Bair found an agency that was floundering. “There hadn’t been any bank failures in a long time,” she said. “We were in this so-called golden age of banking, regulation had fallen out of favor and the F.D.I.C., which had a reputation as a tough regulator, had fallen on hard times.” Its budget had been slashed, employees had been let go and morale was terrible. Except for a 10-second handshake, she never even spoke to Henry Paulson her first year or so in office.

Alone among the regulators, though, the F.D.I.C. began to home in on subprime lending. By 2006, the subprime industry was running amok, making loans — many of them fraudulent, with hidden fees and abusive terms — to just about anyone with a pulse. Most subprime loans had adjustable interest rates, which started low but then jumped significantly after a few years, making the monthly payments unaffordable for many homeowners. The lenders didn’t care because they sold the loans to Wall Street, which bundled them into mortgage-backed bonds and resold them to investors.

Curbing subprime-lending abuses should have been the job of the Federal Reserve, which has a consumer division. But the Fed chairman, Alan Greenspan, with his profound distaste for regulation, could not have been less interested. The other bank regulators, the Office of the Comptroller of the Currency, which oversees national banks, and the Office of Thrift Supervision, which regulates the savings-and-loan industry, should have cared, too. But their responses to the growing problem were at best tepid and at worst hostile. (The O.C.C. actually used its federal powers to block efforts by states to curb subprime abuses.) By the time Bair got to Washington, the O.C.C. had spent a year devising “voluntary subprime guidance” for the banks it regulated, but it had not yet gotten around to issuing that guidance.

The F.D.I.C. jumped into the breach. Bair knew the issue well, because during her time at Treasury, when the industry was much smaller, she tried, unsuccessfully, to get the subprime lenders to agree to halt their worst practices. Now she was hearing that things had become much worse. Bair instructed the F.D.I.C. to buy an expensive database that listed all the subprime loans in the mortgage-backed bonds that Wall Street was selling to investors. She was shocked by what she saw. “All the practices that we looked at back in 2001 and 2002, which we thought were predatory — things like steep payment resets and abusive prepayment penalties — had gone mainstream,” she said.

By the spring of 2007, she was holding meetings with industry executives, pushing them to raise their lending standards and to restructure — that is, modify — abusive mortgages so homeowners wouldn’t lose their homes when the housing bubble burst and large numbers of loans were bound to default. “There is nothing unusual about this,” she told me. “Restructuring is one of the tools the banking industry has at its disposal.”

One thing she learned from those meetings was that the mortgage servicers, generally divisions of the big banks, had the legal right in most cases to modify mortgages they managed for the investors who owned mortgage bonds. They just didn’t have the will. After doing some arm-twisting, Bair felt she had extracted a commitment that the mortgage servicers would do so.

She also pushed the O.C.C. to issue its voluntary guidance, even though it would help only marginally. The vast majority of subprime loans were issued by institutions outside the regulated banking system, out of the reach of the O.C.C. or the F.D.I.C. But those nonbanks depended on the regulated banks for their own financing. As a way to get at the unregulated lenders, Bair came up with the idea of applying the government’s subprime guidance to any company that was financed by a regulated bank. The banks, she says, “fought us tooth and nail.” She lost.

Much fun as it would have been to make the bankers pay the price for their wrong-doing, sadly the damage would not have been confined to them.

Posted by oj at July 14, 2011 6:22 AM
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