Regulators – Our Nation’s Ball-less Wonders!
I sit here after over twenty years of being a banker and I shake my head. I know I felt and saw it all coming, but I was powerless to stop it. And believe me, within the scope of my job, I tried. I could not believe the risks the banks were taking in their credit underwriting.
So over the last months, I’ve dug down and read and learned and examined and tried to peek under the kimono to find the hidden secrets that would explain to me WHERE this all started. I’m not trying to place blame. Because there is seriously enough of that to go around. But if we don’t understand what happened here, then how can we fix it and ensure that we don’t go there again?
My readings have taken me far and wide. Well past my scope of understanding. And if I’m in the business for all these years and I still don’t get it, then I just can’t imagine how the average American, to whom banking itself is a mystery, must feel. I think, perhaps… betrayed, because they put their faith in their government and believed that it was doing the right things to protect them.
Recently there has been a lot of talk about the belief that there hasn’t been enough regulation to keep the banks in line. I, personally, have been blaming Congress for not having enacted laws that would arm the banking regulators with the means to control and monitor the activities of the nation’s banks and the power to impose penalties or take punitive measures when the banks stray from their legally defined mission. I assumed that the problems that led to our current economic crisis arose from issues that were not addressed – or inadequately addressed – in our laws and regulations.
Bank regulators are our first line of defense: Office of Comptroller of the Currency, Treasury, Board of Governers of the Federal Reserve System, FDIC, Office of Thrift Supervision. After Congress passes a law they leave it to the regulators to put the law into effect by writing and adopting regulations. Our regulators have one, and only one real purpose – to ensure that each and every bank operates in a safe and sound manner. In order to accomplish this, they send out teams of examiners – routinely, to every single bank in the country – to delve into the bank’s activities and check them against the requirements of regulations. This whole procedure, the laws, the regulations and the agencies to examine compliance with the regulations – was put in place to protect the depositors’ money, the banks that hold that money and – on a national scale, our country’s economic safety and soundness. This process began 75 years ago, after the banking industry collapsed and led us into the Great Depression.
Well, today I read Federal Reserve Regulation H — Subpart E entitled “Real Estate Lending and Appraisal”, a regulation born from the Federal Deposit Insurance Corporation Improvement Act of 1991. My eyes were opened!!! My premise, that Congress failed to pass laws to protect us, was completely wrong! This regulation, which has been in place for over ten years – sets forth all the appropriate guidelines and limitations that should have held the banks in check.
Now this question begs to be asked: Who is making sure that our banks are complying with the regulations that already exist? And when they are not in compliance, what actions are taken against them to bring them into line?
What I believe after reading this is that NO ONE is watching as the banks run amok in their quest for profits. Really…. no one. Did the controlling authorities perhaps forget that this regulation existed since they authored it over ten years ago? Or did they foolishly believe that the greedy bankers would, of their own accord, grow a conscience and behave in a responsible manner?
Federal Reserve Regulation H is a “uniform” regulation. This means that each of the other three agencies also adopted an identical regulation at the same time. They are found in 12 CFR 208.51; 12 CFR 34.62, 12 CFR 365 and 12 CFR 560.101. Links to each of these are provided at the end of this article. This is some of the content of Reg H and it is directed at all banks.
The Real Estate Lending Standards section requires banks to “adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens on or interest in real estate. Policies should be consistent with safe and sound banking practices; appropriate to the size of the institution and the nature and scope of its operations; and reviewed and approved by the bank’s board of directors at least annually.”
It instructs banks to monitor conditions in the real estate market in its lending area to ensure that its real estate lending policies continue to be appropriate for current market conditions.
And it requires that the adopted policies reflect consideration of the Interagency Guidelines for Real Estate Lending Policies established by the federal bank and thrift supervisory agencies.”
The Interagency Guidelines, which are part and parcel of the regulation, are extensive and I’ve provided links below to the full text document. But the following quotes will make my point.
“Each institution’s policies must be comprehensive, and consistent with safe and sound lending practices, and must ensure that the institution operates within limits and according to standards that are reviewed and approved at least annually by the board of directors. Real estate lending is an integral part of many institutions’ business plans and, when undertaken in a prudent manner, will not be subject to examiner criticism.”
“The institution should monitor conditions in the real estate markets in its lending area so that it can react quickly to changes in market conditions that are relevant to its lending decisions.”
“Prudently underwritten real estate loans should reflect all relevant credit factors, including—
- the capacity of the borrower, or income from the underlying property, to adequately service the debt;
- the value of the mortgaged property;
- the overall creditworthiness of the borrower;
- the level of equity invested in the property;
- any secondary sources of repayment;
- any additional collateral or credit enhancements (such as guarantees, mortgage insurance, or take-out commitments).”
Our regulators were armed with this law and these guidelines. And yet, when they examined the banks and discovered that they were not applying a credit review process that was consistent with safe and sound lending practices, in spirit or in fact, they failed to impose penalties that would have brought these horrific lending standards to an abrupt end. They had to have known that the banks were issuing no-asset and no-income-verification loans, delving into subprime lending markets, selling these toxic loans into the market and subsequently repurchasing them to hold in their capital accounts.
Instead of taking decisive action, they merely issued another interagency comment to the banks (see links below for full text), urging them to cease and desist in their unrelenting participation in the subprime lending market.
What should our regulators have done and what did they have the power to do? Our regulators could have called for the firing of CEO’s of the banks and replaced the Board of Directors. They also have the power to ban executives that are found to have violated banking regulations from ever working in the banking industry again. Our regulators could have refused to continue their FDIC insurance for failure to comply. If they would have made an example of even one bank by exercising their power, it would have influenced the entire industry and perhaps prevented the crisis we are in today.
It is interesting that one of the strongest banks in the nation, JP Morgan Chase, states quite clearly in their 2007 Annual Report exactly how pervasive the problems were. And we know already that the other banks behaved equally irresponsibly and equally in violation of the law and Reg H. Some of these banks no longer exist and others will soon disappear. After reading the following comments, can one imagine that the regulators were unaware of the banks’ violations these many past years? Or do you have to conclude, as I have, that it was our regulators, and not Congress, that failed completely in safeguarding our county? The law was there. The regulators simply did not exercise their powers to enforce them.
JP Morgan Chase 2007 Annual Report (released approximately one year ago)
… increasingly poor underwriting standards (e.g., loan-to-value ratios up to 100%, lax verification of income and inflated appraisals) added fuel to the speculation and froth in the markets. Many of these poor mortgage products were also repackaged and dispersed widely through various securities, thus distributing the problems more broadly.
…we still believe that subprime mortgages are a good product. We will continue to find a prudent way to be in this business.
We should have acted sooner and more substantially to reduce the LTV rates at which we lent, given the increased risk of falling prices in a market of highly inflated housing values. We also should have tightened all other standards (e.g., income verification) in response to growing speculation in the market and the increasing propensity of people to respond to aggressive lending standards by buying houses they could barely afford.
In the face of these comments and the banking industries apparent violation of Reg H, instead of being penalized, banks were rewarded through the TARP program. Our regulators have done nothing to ensure that the banks meet their fundamental obligation to lend money. They have merely asked them to do so. And finally, our regulators are still not forcing the banks to apply income verification processes to all forms of credit including auto loans and credit cards.
Somehow I don’t think the punishment has fit the crime. And now that I have the understanding I so desperately sought, I really wish I didn’t look so hard. I find myself even more saddened to know that while our country had the structure and laws in place to prevent this economic collapse, the regulators failed to protect us and the guilty continue to be rewarded for bringing this country to its knees.
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