The Congressional session will resume this month pretty much where it ended before the holiday recess, with lawmakers trying to decide how to reshape the financial regulatory structure.
But the focus will shift from the House, which has approved a bill, to the Senate Banking Committee, where Democrats and Republicans are trying (reportedly, with some success) to craft a bipartisan approach to two complicated and inherently divisive questions: How strictly depository institutions should be regulated – and by whom.
There was no hint of bipartisanship in the Wall Street Reform and Consumer Protection Act the House passed, without any Republican support, before the recess. Still, passage was not nearly as smooth as the legislation’s supporters and most analysts had predicted, leading industry executives to hope, and some analysts to predict, that the push to soften the sharper edges of the legislation will continue in the Senate.
As in the House, the debate in the Senate will highlight the philosophical divide between liberal Democrats, who say too little regulation of the banking industry allowed abuses that harmed consumers and nearly wrecked the financial system, and Republicans, who contend that too much regulation will undermine the country’s economic recovery in the near term and threaten the competitive viability of U.S. banks over time.
Sen. Christophe Dodd (D-CT), chairman of the Senate Banking Committee, had drafted legislation that was tougher, in some respects, than the House measure. But after moderate Democrats joined Republicans in urging Dodd to try again, he assigned two-person bi-partisan teams to try and hammer out agreements on specific issues, and those efforts appear to be bearing fruit.
Just before Congress adjourned for the holiday recess, Dodd and Sen. Richard Shelby (R-AL), the ranking Republican on the Banking Committee, issued a joint statement announcing that the bi-partisan discussions had been “extremely productive, with members providing great insight and demonstrating a desire to get this done right.” Dodd and Shelby said they had agreed in principle on six key issues:
- The need to end the “too-big-to-fail” approach to regulating systemically important financial institutions;
- The need to strengthen consumer protections;
- The need to ensure that the Federal Reserve focuses on “its core responsibility”;
- The need to modernize and streamline the regulatory structure “while preserving the dual banking system;
- The need to modernize regulation and oversight of the derivatives market; and
- The need to avoid future taxpayer-funded bailouts of the financial industry “by enhancing our resolutions regime.”
The joint statement did not disclose the details of any specific agreements negotiators have reached, but industry analysts agree that a consensus bill will require multiple compromises—most of them by Sen. Dodd. “What we will see will be something very, very different from what Dodd put out initially,” Mark Calabria, a former aide to Shelby, now on the staff at the conservative Cato Institute, told American Banker recently. “The topics will be the same,” he said, “but the approaches will be different. There will be a lot of compromises made.”
Return of Glass-Steagall
While bank lobbyists have been more successful than industry executives had expected in softening some of the toughest provisions of the toughest financial reform proposals, they are finding themselves fighting a rear guard action on a battle the industry won more than a decade ago: Elimination of the Depression-era Glass-Steagall Act barriers that separated banking and non-banking activities.
Sen. John McCain (R-AZ) and Maria Cantwell (D-WA) are co-sponsoring a bill that would bar depository institutions from underwriting securities, engaging in proprietary trading, selling insurance or owning retail brokerage operations. Rep. Maurice Hinchey (D-NY) has filed a similar bill in the House. Both measures would require the unwinding of acquisitions consummated at the behest of regulators, or with their encouragement, during the financial crisis.
Supporters of these “back-to-the-future” bills trace many of the forces responsible for the financial meltdown to the adoption of the Gramm-Leah-Bliley Act — a 1999 measure that overturned Glass-Steagall, stripped many of the regulatory restraints on banks related to it, and permitted the evolution of institutions that, critics contend, became too unwieldy to regulate and ultimately too big to fail.
Banking industry executives are aiming their lobbying guns squarely at those arguments, warning that recreating the old barriers restraining banks will reduce their flexibility, make them more dependent on limited revenue sources, more vulnerable to financial crises, and less competitive in the financial marketplace. Proposals to reinstate Glass-Steagall aim at the wrong target, according to critics, who contend that it was not the activities in which banks engaged but the failure to regulate those activities effectively that triggered the financial crisis.
“Changes in Glass-Steagall did not precipitate this crisis,” James Leach, former Republican Congressman from Iowa and the “Leach” in Gramm-Leach-Blilely, argued at a recent conference on bank reform. Most of the banks that stumbled, he said, got into trouble engaging in activities that were authorized without the Glass-Steagall reforms.
Not surprisingly, consumer advocacy groups and liberal Democrats are lining up behind the push to revive the old Glass-Steagall restrictions. But support is coming from less predictable sources as well.
Industry executives were more than a little stunned by the recent comments of John Reed, the former chairman of Citibank, who engineered its merger with Travelers Insurance Co. – one of the first major steps on the road toward creating mega-financial institutions Reed has had serious second thoughts about the wisdom of that strategy, however. In an interview with Bloomberg News, he apologized for his role in building the banking conglomerate and said he erred in supporting the repeal of Glass-Steagall, which made Citibank’s evolution possible.
“We learn from our mistakes,” Reed said. “When you’re running a company, you do what’s right for the stockholders. Right now, I’m looking at this as a citizen.”
Rethinking Loan Modification Strategies
A recent study by economists at the Federal Reserve Bank of Boston also questioned the structure and focus of the Obama Administration’s HAMP initiative. The program aims to reduce mortgage payments, but loans that are “unaffordable” at origination are not the primary cause of defaults, according to the study, which contends that job losses and declining home prices are much stronger indicators of default risks.
The study estimates that a 10 percentage point increase in a borrower’s debt-to-income ratio increases the probability of a serious (90 days or more) delinquency by 7 percent to 11 percent; a 1 percentage increase in the unemployment rate, by contrast, boosts default risks by from 10 percent to 20 percent, and a 10 percentage point decline in home prices increases the risk by more than half.
“An important implication of our analysis,” the authors suggest, “is that policies designed to reduce foreclosures should focus on ameliorating the immediate effects of job loss and other adverse life events, rather than on modifying loans to make them more affordable on a long-term basis.”
The Federal Deposit Insurance Corporation (FDIC) is also focusing on the impact of job losses on foreclosures. The agency is “encouraging” banks that have acquired failed institutions to provide temporary relief to borrowers who have lost their jobs or suffered salary reductions, by reducing their loan payments to “affordable levels” for up to six months.
“This is simply good business,” FDIC Chairman Sheila Bair said in press statement announcing the plan, “because foreclosure rarely benefits lenders and would cost the FDIC more money, not less. “With more Americans suffering through unemployment or cuts in their paychecks,” Bair added, “we believe it is crucial to offer a helping hand to avoid unnecessary and costly foreclosures.” Bair described this approach as “a win-win for the borrower, who can remain in his or her home while looking for a new job, and for the acquiring institution, which continues to receive payments on the loan.” The FDIC also benefits, she said, from the reduction in losses the agency must absorb.
Reflecting a similar mindset, Sen. Jack Reed (D-RI) has proposed legislation aimed at helping homeowners who “experience a sharp reduction in income through no fault of their own.” Reed’s bill, co-sponsored by Senators Sheldon Whitehouse (R-RI), Dick Durbin (D-IL), and Jeff Merkley (D-OR), would provide more than $6 billion federal funding for revolving loan funds stands can use to offer grants or subsidized loans to homeowners who have suffered employment-related setbacks. The legislation would also add enforcement teeth to the HAMP program, by requiring lenders to evaluate a borrower’s eligibility for a modification before initiating a foreclosure action, limiting the foreclosure-related fees lenders can charge, and making noncompliance with the statute a defense against foreclosure.
“More and more households are finding that even with a fixed-rate mortgage that they could afford before the recession, they are just one pink slip away from losing their biggest investment,” Reed said in introducing the “Preserving Homes and Communities Act.” “My bill provides targeted relief to qualified homeowners so that more families can keep their homes, protects communities from suffering even greater financial losses, and sets us on the path to stabilizing the housing sector as a foundation for a lasting economic recovery.”
An Academic Debate
The debate over federal preemption authority continues and, like the debate over how to structure loan modifications, it is being waged in academic journals as well as in Congressional committees. A study published by the Center for Community Capital at the University of North Carolina found evidence (which the study’s authors acknowledges is only preliminary) that in states with strong anti-predatory lending laws in effect, national banks originated more high-risk, subprime loans after 2004, when the OCC adopted its broad preemption policy. In 2006, the study estimates, “at least 26 percent of high-priced loans in APL states were originated by banks and federal thrifts and their subsidiaries covered by federal preemption….[Preemption] fundamentally changed the legal structure for national banks and thrifts,” the study suggests, “softening lending restrictions at a time when underwriting standards overall were declining.”
A white paper produced by Empiris, a Washington, D.C. consulting firm, views preemption in a more favorable light. “Preemption has been an important policy tool for opening up markets and increasing competition, benefiting both banks and their customers,” this analysis by Hal Singer, president of Empiris, and Joseph Mason, a partner in the company, contends. Without preemption and the “uniform regulatory environment” it creates, they argue, “there would be no federal check on state regulators and legislators who may be swayed by local businesses or political interests and costly local protectionist measures would proliferate.”
Singer and Mason fault lenders for pursuing abusive policies and fault regulators for failing to curb them. But preemption was not to blame for the “consumer protection failures associated with predatory lending and the subprime crisis,” they insist. And providing adequate protections for consumers “does not require policy makers to eviscerate [a policy] that has provided a substantial basis for banking industry stability and economic growth since 1863.”
A Troubling Survey
A recent study by the Federal Deposit Insurance Corporation (FDIC) estimates that more than 25 percent of American households — about 30 million of them —are either unbanked (have no banking relationships) or under-banked, meaning they have at least one mainstream account but still rely on alternative services for some transactions. And a disproportionate number of these underserved households are minorities.
More than half of African-American households and more than 40 percent of Hispanic households use banks minimally or not at all, the survey found. Nearly three-quarters of households with no access to banks have incomes of less than $30,000, compared with less than 1 percent of households with incomes above $70,000. Although only 4.2 percent of moderate-income households (with incomes between $30,000 and $50,000) are unbanked, households in that income category are almost as likely as low-income households to be under-banked, according to the FDIC report.
This is actually the second study the FDIC has published pursuant to a 2005 law requiring the agency to monitor bank efforts to serve “unbanked” and “underbanked” consumers and to develop “a fair estimate” of the size of that market. The results, while not surprising, were nonetheless, disturbing, according to FDIC Vice Chairman Martin Gruenberg, who described the disproportionate number of unbanked minorities as “dramatic and troubling,” indicating, he said, that “a substantial segment of American households [have] financial services needs that aren’t being adequately met.”
“Access to an account at a federally insured institution provides households with an important first step toward achieving financial security — the opportunity to conduct basic financial transactions, save for emergency and long-term security needs, and access credit on affordable terms,” FDIC Chairman Sheila Bair added.
Discussing the survey results in a conference call with reporters, Bair pointed out that the responses indicate that use of alternative financial services often reflects “rational economic decision-making” rather than a lack of other options. Many of the un-banked respondents said they did not see a need for banking accounts (because their incomes were too low or because they wrote too few checks), or said they found bank service charges and minimum balance requirements too high. Under-banked consumers cited “convenience, speed and cost” as their primary reasons for using alternative services for some transactions.“Our challenge is to make sure banks have the appropriate range of products and services that meet the needs of all low-income communities, and have the right fee mix that is cost-effective,” Bair told reporters. The key, she said, is “finding that intersection of products that are also cost-effective” for financial institutions.
