With Regulations, Be Careful What You Wish For
We are fast approaching the tenth anniversary of The Great Recession, The Credit Crisis, whatever you’d like to call it. In mid-September Lehman Brothers collapsed, but events were occurring for many months prior to that as bankers and mortgage bankers who were working back then remember. Could the financial system, which has been on the mend, and many would say prospering, go through it all over again?
Many argue that the answer to that largely depends on whether the Trump Administration undoes the best protection that we have against such an event: 2010’s Dodd-Frank law. It was passed after thirty years of financial deregulation, and most lenders I speak with do not want to go back to the “cowboy days” of lending. Prior to the Great Depression, our financial system crashed regularly. For the fifty years afterward, it didn’t crash at all.
But effective precautions create the illusion that they aren’t necessary. Think about citizens saying that a fire department that experiences no fire alarms because it conducts effective inspections and has excellent fire codes is not necessary. Leading up to 2008 many in the government, and in industry, felt that the existing regulations were outmoded. Why constrain the size of a bank? Why reign in their trading activities? Why limit what they can invest in? Why limit the loan-to-values, or ability to repay a loan, if investors were willing to take on that risk?
Lenders can say what they will about Dodd-Frank, about TRID, QM, and so on, but it placed unregulated new markets under government supervision and by requiring big banks to behave less riskily, reversed the swing of the pendulum. The capital markets have approved of the regulatory environment. After all, there is less risk, and if they want more risk to increase their yield, they can find it: non-QM. Bank statement loans. High LTV products.
But on a broader scale the potential for another crisis still exists. And political analysts wonder if the current President and Congress could react quickly and efficiently. There is always political uncertainty, but they argue it exists now more than ever, and problems are more difficult to manage. Yes, the banks are healthier, but income inequality, regional economic differences in well-being, and the government’s faith in the markets are all unsettling. Do we really want to do away with Dodd-Frank?
After the Crash ten years ago, the government helped banks by stepping in. People who lost their jobs or their houses largely didn’t recover, of, if they did, it took several years. Various areas recovered more quickly, others less so. Political analysts will say that this issue, and the undercurrent of resentment, helped Donald Trump win the election. And helped the Brexit Referendum pass in the United Kingdom.
There was, and is, plenty of blame to go around. Brokers blamed bankers, bankers blamed brokers and investors, investors blamed the rating agencies, who in turn blamed investors for not doing due diligence. Liberals blamed deregulation and poor supervision of the big banks while conservatives blamed subprime mortgages.
Those in the industry know that subprime loans, which arguably have existed for centuries, weren’t the only culprit. But there were no incentives for LOs, branch managers, etc., to not originate subprime loans. In fact, quite the opposite. And they were poorly evaluated by the rating agencies and fell outside of the scope of the government’s securities regulators. And they were bought and sold by institutions using borrowed money. Do I want my bank using my deposits to buy securities backed by faulty mortgages?
When was the last time you heard “too big to fail?” Today’s banks are larger than ever, and mergers and acquisitions are increasing the average size of banks. Financial power is more concentrated than ever. Is the government, and current political climate, capable of continuing to regulate the big banks?
Mick Mulvaney is now the interim head of the CFPB. The forgotten intent of the CFPB was to be an independent agency, outside of direct government influence. Critics of lightening up on regulations ask, “How’s that working out?” Mulvaney has weakened its safeguards against predatory financial activity. The rule of the CFPB will change, and many of its regulations chipped away until we once again have systemic risk. Will banks be allowed to hold less capital? Doing so would make them much more susceptible to a moment of panic since less capital coupled with greater systemic risk is not a recipe for success.
STRATMOR’s successful clients know that financial deregulation occurs step by step over many government agencies. Certainly, banks and the lending industry are keeping tabs on developments. Lenders don’t want to spend millions of dollars adhering to rules from one Administration and then spend millions during the next removing them from the loan process. No one wants to be subjected again to the devasting financial events from ten years ago. Be careful what you wish for.