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Thursday, March 22, 2007

Cole Testimony: Cui Bono?

by Tanta on 3/22/2007 06:04:00 PM

New testimony of Roger T. Cole, Director of the Division of Banking Supervision and Regulation for the Federal Reserve, given to the Senate Banking Committee, is now available on the web here.

Most of it is quite familiar to CR readers and will hold few surprises—we’ve been on top of this story for a long time. I see nothing particularly dramatic in it; if you need to catch up on the whole context of banks, subprime lending, and new regulation, though, it’s worth a read. I found two parts of it worthy of note.

First, the message from the Fed seems to be that lenders are not going to be punished in examinations for trying to work out as much as is prudent with borrowers.

Although a rising number of borrowers are having difficulty meeting their obligations, regulated institutions do not face additional supervisory scrutiny if they pursue reasonable workout arrangements with these borrowers. Existing regulatory guidance does not require institutions to immediately foreclose on the underlying collateral when a borrower exhibits repayment difficulties. Working constructively with borrowers is typically in the long-term best interests of both financial institutions and the borrowers. Capital markets investors in securitizations have the same motivation as direct lenders in maximizing recoveries on defaulted loans. Thus, mortgage servicers will have an important role to play in working with delinquent borrowers. Established and well-rated loan servicers are usually given a range of options by investors in workout situations. These options could include modification of interest rates, payment restructuring, and extension of maturities. Working together, the federal regulatory agencies will continue to use their supervisory authority to ensure that regulated institutions have policies and procedures designed to treat borrowers fairly, both when seeking new credit and when working through financial difficulties.

I see no Fedspeak hint here of any bailout assistance to anyone; if there’s anything remarkable it is that the Fed is suggesting that depositories may not use the fear of regulatory punishment to deny reasonable workouts to borrowers, and that the Fed considers reasonable workouts to be consistent with safety and soundness. I don’t know to what extent this might be the Fed implying that banks made their beds and now have to lie in them; it’s not exactly inconsistent with the idea of potential bailouts. As stated, though, it suggests to me that banks had better give some serious thought to mitigating their losses—by taking the hit on some mods or forbearance agreements, if necessary—before they go expecting the Fed to vote for bailout relief.

The second thing I want to point out is the one place in this document where I think the Fed has really drunk a little of the Kool Aid:

Homebuyers have also benefited in this environment of financial innovation and market liquidity. More lenders are actively competing in the mortgage market, product offerings have expanded greatly, the underwriting process has
become more streamlined, borrowing spreads have decreased, and obtaining a mortgage loan has become easier. In short, securitization has helped to expand homeownership, which recently reached a record 69 percent. Not surprisingly, there have also been significant gains in homeownership for low- and moderate-income individuals. The development of the subprime mortgage market has been an integral factor in creating these homeownership opportunities for previously underserved borrowers.

It is not my purpose today to question the wisdom of uncontrolled increases in homeownership, although that’s an important debate. I am simply irritated in the extreme by the inclusion, without qualification, of “streamlined underwriting processes” and “easier” obtaining of loans under the heading of benefit to homebuyers. First, as we’ve already noted here at CR, all this streamlining and easing has often made potential homebuyers prey of unscrupulous lenders and sellers, as well as having made lenders and sellers prey of unscrupulous homebuyers. But I want us to take this a little further. What I see here is the Fed falling for advertising slogans and confusing it with public policy. Like Queen Victoria, I am not amused.

Come on. How streamlined and easy does the mortgage lending process really have to be? Look, I like innovations in grocery shopping, like scanners, self-scan aisles, express lanes, debit card readers, and so on, because I have to shop for groceries a lot, and it’s drudgery. But how often do you buy a home or refinance your mortgage? Is it really such a terrible burden to you to get your documents out of your desk drawer, drive down to the local bank, and plop yourself down in a chair across the desk from Louise Loan Officer for an hour? Is saving that kind of time and effort ultimately important enough to you that you are willing to accept the risks to all of us, to our economy, of unsafe and unsound lending by federally-insured depositories that is the effect of these “benefits”? I’m not at all sure I am.

The issue of access, specifically, is certainly important. If you live in Podunk, you might not be able to drive to the office of a national lender with a really good interest rate. If you live in certain urban neighborhoods, you might not have easy access to the suburban jewel-box banks on every corner. So having kinds of telephone, internet, or brokered access to credit from depositories, with the “alternative documentation” processes they often require, may be an important part of keeping access fair.

But that’s not at all the same thing as saying that “speed” and “ease” are always true benefits to borrowers.They’re benefits to lenders. The story is that lenders pass on the efficiency savings to borrowers, in the form of lower rates and fees. Forgive me for shooting some Kool Aid out of my nose here, but I think I see these “savings” going mostly to executive bonuses, originator commissions, and investment in overcapacity, which just begs for more loose loan writing to keep the mortgage mills busy. If you agree with me on that, and you want to let your regulators know how you feel, you might want to mention to them that you don’t care to have benefits to lenders confused with benefits to borrowers, or that you’d be willing to have to use up another hour of your time and a gallon or so of your gas if it meant saner lending policy.

At some point we’ll have to let them know that marketing slogans are just marketing slogans. We don’t all secretly crave drive-up McBanks offering Happy Loans, even if the lenders’ marketing departments seem to think we do, or seem to want to convince us that we do. At least, we don't crave this so much we're willing to bet a couple hundred billion taxpayer dollars on it working out OK in the end.

Besides that, how much is Health and Human Services spending on this "war on obesity" business? Do we need to insure the risk of borrowers who are too damned lazy to dig up the W-2s? Somehow I don't think so.