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Our (Mis)Trusted Financial Regulators (October 5, 2006) Frequent contributor Albert T. alerted me on September 27 to several obscure yet important regulatory changes which affect lending practises. Re: The Financial Services Regulatory Relief Act of 2006: Senator Crapo's website description of the bill and marketwatch's story. 
I will confess that the consequences of these changes seem much harder to assess than the recent regulatory changes which "tighten" the incredibly lax standards of "no document" loans (e.g. I tell you I make $200K a year and you write the mortgage without asking for any documented evidence of my income). Given today's feeding-frenzy mortgage market (i.e. the predatory lenders/piranhas are feasting on fat, dumb and soon-to-be unhappy borrowers, banks are loading up on mortgage debt, etc), the salient points are: 
1) The extremes in the current lending/mortgage/real estate markets are unprecedented. As this chart of bank reserves reveals, the risk of lenders being unable to cover losses due to foreclosure or non-payment of loans is high, as their reserves against losses have fallen to all-time lows. The chart above shows that bank assets are now heavily concentrated in mortgages, making them very vulnerable to any downturn in the value of housing and/or borrowers' ability to keep making payments. Yet regulators are, eight years into the housing boom, still doing next to nothing to limit these appallingly obvious risks. 2) Regulations are tweaked all the time, as these new regs show, so there are simply no excuses for either regulators or lawmakers to have ignored these lending risks for eight long years 3) Not all regulations actually aid consumers; in some cases, easing regulatory burdens may lower costs and enable a more competitive market for financial services but do nothing to protect consumers from misleading practises 4) The regulations governing lending, loan reserves and mortgage origination are complex and operate across a number of regulatory agencies 5) "Caveat emptor" (buyer beware) is always a good idea, but loan documents of 30+ pages provide plenty of opportunities to mislead a typical non-attorney borrower. Just as buyers of used cars cannot be expected to be experienced mechanics who could spot hidden trouble spots in a car, borrowers deserve regulatory protection from predatory rates and penalties as well as from subtle forms of misleading or purposely obscured information--tiny print, critical data buried in pages of legalese mumbo-jumbo, etc. 6) Given the high number of non-traditional loans which have been written in recent years, regulators have clearly been asleep at the wheel. 
7) As the above chart from the FDIC reveals, that agency has long known that subprime and exotic/non-traditional mortgages like option ARMs present grave risks to the nation's least-secure borrowers. Yet only now, eight years into the housing bubble, are the most egregious lending excesses being reined in. Talk about closing the corral gate after the horses have thundered out... Let me state what I believe is the fundamental reality of this gross regulatory mismanagement: consumers are only protected from predatory practises when the situation grows from a regulatory problem into a political problem. I think this sudden rush of regs to limit the worst lending practises is a 9th-inning attempt to "inoculate" the regulatory agencies from the fully justified accusation that they did nothing while the U.S. lending industry ran amok. The inoculation will fail as rock-ribbed Republican voters start getting foreclosure notices, gigantic ARM re-sets, higher property taxes bills, etc. At that point, the politicians will be forced to appear concerned, and a raft of heavy-handed and probably misguided regulations will be passed "to fix the problem." But their "fix" will be far too late, as the damage has been accumulating for years. The fallout will be neither brief nor pretty. For more on this subject and a wide array of other topics, please visit my weblog. 
copyright © 2006 Charles Hugh Smith. All rights reserved in all media. I would be honored if you linked this wEssay to your site, or printed a copy for your own use.
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