In the wake of Attorney General Eric Holder’s resignation last week, a former Obama administration official made an incredible statement. The Washington Post reported that Jim Parrott, who advised the Obama White House on housing policy during the first term, said Holder’s “tough” enforcement actions on big banks harmed the economy, with the implication that his replacement should just back off.
First of all, the idea that Eric Holder led a hard-charging onslaught against bank malfeasance is a fantasy. The Justice Department never led one top executive to jail for the mountain of fraud that caused the Great Recession, and much of the misconduct that was never fixed continues to this day. Big banks were so wounded by the DoJ crackdown that their stock prices rose whenever they announced a settlement.
Maybe Parrott’s current work, advising financial institutions on housing finance issues, fully explains his perspective. But it’s worth examining his assumptions, because they appear to be epidemic in Washington.
Parrott makes a connection between the Justice Department’s actions and the banks’ willingness to lend. Arguing that lenders are uncertain whether more investigations and fines will be forthcoming, Parrott told a Bipartisan Policy Center conference this month that “there hasn’t been enough of a connection between that clamoring (for retribution) and the clamor for access to credit.”
This is part of a larger myth, blaming government’s efforts to clean up the mortgage market for the slow housing recovery and sluggish economy. This idea that banks are so petrified about burdensome regulations that they’ve decided to scale back their business model of lending to people seems far-fetched. Americans aren’t buying as many homes these days because most of them don’t have the money to do so.
But the mortgage industry doesn’t want you to believe that. They want you to think the fearsome hands of government hang around their throats, making it impossible for them to risk lending to anyone with less-than-perfect credit. They tell sob stories about people seeking their slice of the American dream who just need a chance. But government agencies will come after them if they try to help out. CEOs like Wells Fargo’s John Stumpf and JPMorgan Chase’s Jamie Dimon have played this “blame the government” card.
The real motivation here is to roll back regulations and return to the go-go era where anyone who can fog a mirror can get a loan. We know how that turned out the last time.
But policymakers have foolishly paid attention to this self-serving argument. Two weeks ago, administration officials met with mortgage bankers in the White House about increasing access to credit. The new head of the Department of Housing and Urban Development, Julian Castro, said recently that “the pendulum has swung too far in the other direction” on lending requirements. The Federal Housing Administration and mortgage giants Fannie Mae and Freddie Mac have sought to clarify when they will force a lender to buy back loans for not following the rules. And the Treasury Department wants to revive the moribund market for mortgage-backed securities, the same instruments that fueled the housing bubble.
At the heart of the myth is a theory about Fannie, Freddie and the FHA, who back up the housing market by either purchasing loans or buying insurance. If the loans are found not to conform to their guidelines, and subsequently fail, the agencies ask the lenders for their money back. It’s bizarre that “enforcing a broken contract” constitutes an outrageous imposition on Wall Street, but that’s life in the big city.
Unfortunately for the proponents of this myth, two government reports released in the past week put the lie to their claims. The first comes from the inspector general for the Federal Housing Finance Agency, who oversee Fannie and Freddie, the government-sponsored enterprises (GSEs). The IG report looked at how the GSEs deal with the thousands of lenders from whom they buy loans.
It turns out that, before they purchased loans, Fannie and Freddie used to require third-party assurance that they conformed to their origination standards. Now, the GSEs merely rely on the lenders to self-represent their own compliance. It’s as if the IRS did audits by having individuals analyze their own tax forms, and give a thumbs-up that everything checks out.
The GSEs do some monitoring of the mortgages they buy after the fact, but they only look at 10-15 percent of the loans purchased, so shoddy ones can easily slip through the cracks. Most other agencies use third-party specialists to independently assure compliance. And since a 2013 regulatory change that allows the GSEs to only seek repurchase of bad loans for three years after they buy them, this sets up a major flaw in their systems. Fannie Mae admitted in its 2013 SEC filing that, due to these rules, “We are exposed to the risk that a mortgage seller … will engage in mortgage fraud by misrepresenting the facts about the loan.” Despite this, FHFA disagreed with the IG report, and will not seek a third-party review of its loan sellers.
The HUD inspector general report issued last week is even worse. The report analyzes how lenders profited under the noses of the FHA through a loan modification scheme.
The FHA has a loan modification program to help people with FHA-insured loans stay in their homes. However, it delegates the responsibility for the modifications to the lenders. These lenders figured out that, once a loan went 90 days delinquent, they could buy it back at face value from FHA. At that point, they could modify the loan, package it with others, and flip it to another government program known as Ginnie Mae, making money off the spread between the purchase price and the higher price Ginnie Mae paid. Lenders made $428 million in 2013 using this tactic.
According to the report, FHA imposes no limitations on this scheme; in fact, it paid the lenders $50 million themselves to modify the loans (as if the lenders needed the incentive, when they could make seven times that through a resale). The point is that this looks nothing like an overbearing government regulator browbeating lenders. In fact, they’re allowing lenders to game their programs for profit, even at a time when the FHA has serious deficiencies in its own insurance fund. FHA also responded to this report, and like FHFA, didn’t see any problem that required changes to how they do business.
These are the very agencies that Wells Fargo and JPMorgan like to complain about – the GSEs and the FHA. Together, these IG reports rebut the argument that they place arduous regulations upon the mortgage market. In both cases, the agencies primarily rely on self-policing from the lenders themselves. It looks a lot like the celebrated "This American Life" piece about bank examiners at the New York Federal Reserve. The story showed how senior supervisors failed to challenge Goldman Sachs and deferred to them almost unilaterally. That’s not an isolated case.
Mortgage lenders not only know this, they feel emboldened to characterize what little regulation does exist as unnecessary and oppressive, in a bid to work the refs to loosen them. And the regulators, top policy officials and even the press, sadly, often go along with it.
When Jim Parrott says that the government is holding back the economy, he’s really speaking for the industry, who thinks they should be allowed to do whatever they want to make money. That attitude will bring us to the brink of another crisis someday. I hope Jim Parrott is thinking about how he’ll explain himself.