Sunday, September 27, 2009

The Fed and Subprime Lending: The Watchdog that Didn't Bark

by Bill McBride on 9/27/2009 09:21:00 AM

From the WaPo: As Subprime Lending Crisis Unfolded, Watchdog Fed Didn't Bother Barking

... Under a policy quietly formalized in 1998, the Fed refused to police lenders' compliance with federal laws protecting borrowers, despite repeated urging by consumer advocates across the country and even by other government agencies.

The hands-off policy, which the Fed reversed earlier this month, created a double standard. Banks and their subprime affiliates made loans under the same laws, but only the banks faced regular federal scrutiny. Under the policy, the Fed did not even investigate consumer complaints against the affiliates.

"In the prime market, where we need supervision less, we have lots of it. In the subprime market, where we badly need supervision, a majority of loans are made with very little supervision," former Fed Governor Edward M. Gramlich, a critic of the hands-off policy, wrote in 2007. "It is like a city with a murder law, but no cops on the beat."

... since its creation, the Fed has held a second job as a banking regulator, one of four federal agencies responsible for keeping banks healthy and protecting their customers. ... During the boom, however, the Fed left those powers largely unused. ... The Fed's performance was undercut by ... the doubts of senior officials about the value of regulation ...
The failure of oversight was a serious and unfortunately common problem during the boom. For more examples see: Inspector General: FDIC saw risks at IndyMac in 2002 and Federal Reserve Oversight and the Failure of Riverside Bank of the Gulf Coast.

The WaPo title reminds us of the conversation between Colonel Ross and Sherlock Holmes in Sir Arthur Conan Doyle's "Silver Blaze":
"Is there any point to which you would wish to draw my attention?"
"To the curious incident of the dog in the night-time."
"The dog did nothing in the night-time."
"That was the curious incident," remarked Sherlock Holmes.

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