Fed Faulted for Lax Mortgage Regulation Before Financial Crisis
The Federal Reserve failed to forestall the housing bubble or prevent the abusive lending practices that contributed to it, the Financial Crisis Inquiry Commission said in a report, embracing a lesson that legislators have already tried to correct with new laws.
The central bank didn’t “recognize the cataclysmic danger posed by the housing bubble to the financial system and refused to take timely action to constrain its growth,” the report said. It also “failed to meet its statutory obligation to establish and maintain prudent mortgage lending standards and to protect against predatory lending.”
Congress wrote hundreds of pages of new financial regulations in the Dodd-Frank Act signed into law last year. The law established a Financial Stability Oversight Council, comprised of the Fed and other regulators, to identify and curb systemic risk. It also established a new Consumer Financial Protection Bureau.
Delinquencies and defaults on home loans created havoc on Wall Street as the housing bubble collapsed, contributing to the demise of Bear Stearns Cos. and Lehman Brothers Holdings Inc. and sparking the most severe financial panic since the Great Depression. More than 8 million Americans lost their jobs in the longest recession in seven decades.
The report took aim at the buildup of risky mortgage lending during former Fed Chairman Alan Greenspan’s tenure. Loans to borrowers with scant or damaged credit history rose to $625 billion by 2005, the highest in the 1999-2009 period, from $100 billion at the start of the decade, according to data from Inside Mortgage Finance. Today, 26 percent of those mortgages are past due. Greenspan was chairman from Aug. 1987 until January 2006.
Predatory Lenders
“The Federal Reserve would not use the legal system to rein in predatory lenders,” the commission said. “From 2000 to the end of Greenspan’s tenure in 2006, the Fed referred to the Justice Department only three institutions for fair lending violations related to mortgages.”
Greenspan declined to comment, said his spokeswoman, Katie Byers Broom. Fed spokeswoman Michelle Smith also declined to comment, saying she hadn’t seen the report, which is scheduled to be released today. A copy was obtained by Bloomberg News.
Some types of loans “facilitated the national policy of making homeownership more broadly available,” the commission quoted Greenspan as saying. He said law enforcement was the right response to mortgage fraud, not more supervision. He also said that the Fed lacked the resources to fully supervise the subprime lending subsidiaries of bank holding companies.
Supervision Versus Enforcement
“The Federal Reserve engaged in real-time assessment of developing risks in the subprime and non-traditional mortgage sectors,” Greenspan told the commission in April 2010 testimony. “Regulations and guidelines, however, do require enforcement, and the structure of the Federal Reserve during my tenure was much more focused on regulation and supervision than on enforcement.”
The commission noted that the Fed funds itself from interest earned on its assets, such as Treasury bonds. The Fed’s total assets now stand at $2.43 trillion.
Fed Chairman Ben S. Bernanke told the commission in Sept. 2010 testimony that “innovations in mortgage lending and the easing of standards” had a bigger effect on house prices than monetary policy. He also said that the Fed was “slow to identify and address abuses in subprime lending, especially those outside the banking firms that the Fed regulates directly.”
Banks Overseen
In 2005, the commission’s report says, the Fed and other agencies conducted a “peer group” study of mortgage practices of six companies that together originated $1.3 trillion in mortgages in 2005, almost half the national total. There were five banks whose holding companies were under Fed oversight, including Bank of America Corp., Citigroup Inc., and Wells Fargo & Co., the report said.
The study showed “a very rapid increase in the volume of these irresponsible loans, very risky loans,” Sabeth Siddique, the former head of credit risk at the Fed Board’s supervision division, told the commission. Once the agencies put out guidance on risky mortgage lending, “we got tremendous pushback from the industry as well as Congress as well as, you know, internally,” Siddique told the commission.
Scott Alvarez, the Fed’s general counsel, told the commission that the “mind-set was that there should be no regulation; the market should take care of policing.”
Bernanke and Fed Governor Daniel Tarullo are now working to redesign the Fed’s oversight and have dozens of macroeconomists, payments experts, examiners and lawyers focused on risks to the financial system.
To contact the reporters on this story: Craig Torres in Washington at Ctorres3@bloomberg.net; Lorraine Woellert in Washington at +1- lwoellert@bloomberg.net.
To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net
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