The US Financial Crisis Inquiry Commission’s 2011 report on the Great Recession concluded the recession was avoidable!
Regulate vs Deregulate
As Congress and the Trump administration begin to dismantle the regulatory agencies, timing in the financial markets may spell trouble down the road. As the economy begins to slow and rates begin to gradually increase, pressure will mount on top executives to find and expand into new income streams. Meaning, they begin to loosen guidelines and requirements to expand their pool of potential new borrowers. As this is going on the Administration is rolling back parts of the Dodd-Frank act and weakening regulatory oversight of the very industries that pushed us into the Great Recession.
I’m not advocating that all regulations are good and absolutely needed nor am I advocating for loosening or eliminating regulations that are in place because of an experience. We all experienced the last recession and would prefer not to have a repeat of it.
Congress has begun to water down the regulations and passed in May of 2018 the first Rollback. The change affects small to medium size banks with less than $250 billion in total assets. As few as 10 major banks may be required to comply with the Dodd-Frank Act once this is enacted. Without oversight, lenders and banks will not have to be subject to the Federal Government’s “stress test”. This could allow a Lehman Brothers scenario where their balance was leveraged at times 30-40:1. For every $1 dollar in assets Lehman managed to borrow $30 to $40 dollars, leaving no room for a market correction. This allowed more aggressive risk tactics for investing, but in the end was Lehman’s down fall. Congress has argued the regulations have hampered economic growth in the financial markets and depressing their earnings growth and stock valuation. Without the roll back, the first quarter of 2018 the financial institutions, banks, and credit unions and small community savings banks posted an astonishing net combined income of $56 billion dollars. That’s just in 3 months, to squeeze a few more pennies out, is it worth the risk? Considering this will allow thousands of banks to engage in risky loans with much less government oversight. It also included language exempting some small lenders and home loan mortgage originators from being required to give certain disclosures to consumers and not collecting of certain data. The data previously required allowed regulators to ensure lenders were not engaging in discriminatory practices that we saw take place in the mid-2000s.
There’s already been an uptick in amount of non-qualified mortgage loans being written. Wells Fargo has been slowly gearing up its production of non-qualified mortgages. The programs and guidelines resemble programs Long Beach Mortgage would underwrite and purchase. Few may remember but Long Beach Mortgage was a division of Wells Fargo and was fined multiple times for predatory lending practices. The exotic mortgage underwriting guidelines are creeping back into existence. I recently read about a woman purchasing a $600,000 house using a no income product to receive the loan. The product was referred to as the 12- month bank statement program. Income is derived by adding up all your deposits for the last 12 months and dividing by 12 giving you a base monthly cash flow amount which is than used as your monthly income. Soon the 6-month bank statement program will be rolled out and not far behind that will be the NINJA-No Income-No-Job-No Asset verification. The lender will have no ability to verify ability to pay and we have come full circle. It is predicted the non-qualified mortgage loan origination will grow nearly 400% over the next year. Many financial institutions are planning expansions into this market. Currently the non-qualified mortgage only represents 3% of the total mortgage origination market, but that number can grow rapidly, snaring borrowers in loans they cannot afford nor fully understand.
At a time when the market is expanding non-qualified mortgages regulators should be preparing to keep a close eye and rein in risky lending practices before they get out of control. Instead the current administration has decided to simply cut without any real studies having been done. The Treasury’s Office of Financial Research, which is tasked with tracking and finding indicators that would help the US Government see a financial crisis before it takes hold, has seen its’ funding cut and the office staff cut dramatically leaving it unable to carry out its original purpose, warn the American people of a pending crisis.
Recently Chuck Mulvaney was appointed by President Trump to lead the CFPB. Mulvaney has made it clear from the outset, he is not a fan of the CFPB and what it does. Mulvaney would like to see the agency’s authority limited with a much broader overview by Congress and forcing the agency accountable to the American people. President Trump has made it no secret he is not in favor of the CFPB and like most of the government agencies that protect the American consumer, his administration has taken direct aim to weaken or eliminate regulatory oversight.
The timing of a market swing toward higher risk loans may require more vigilant oversight, but that’s not what the American people are getting; and the outcome could be costly all over again.