It is easy to point to a one of the Nation’s mega-banks and claim it is the anti-Christ. With the complexities involved in the world of finance, the ability to grasp cause and effect of major financial problems is beyond the understanding of most Americans. The general distrust of the motives of bank executives, the perception that greed drives all of their actions and the picture that is painted of these individuals by the press all contribute to a general acceptance that they are evil. There is no doubt in my mind that for some of these individuals that assessment is true. Leveraging the distrust of the big banks, the Democrats have skillfully manipulated the spin and used the energy created by economic collapse to create a whole new level of government regulation. Pointing to their chosen scapegoat they have offered the soft and comforting arms of the Federal Government as a sanctuary to the consumers who are otherwise unprotected from the banker’s aggression. It may have provided assurance to consumers and helped stabilize an economy reeling from the collapse of the mortgage market, but has it gone too far?
The Dodd–Frank Wall Street Reform and Consumer Protection Act resulted from the tumultuous events caused by the collapse of the mortgage market. It contains numerous laws that forced significant change upon an industry integral to the economic health of the world. It also was foundational in the creation of the Consumer Finance Protection Bureau; an agency of the Federal Government designed to fill the “Strict Daddy” role. If one of their naughty children gets out of hand, the CFPB swoops in and smacks them soundly on their butt using negative publicity and significant monetary penalties in lieu of a paddle. The agency only works if they fill the role of enforcer and bring to light activities that appear to be underhanded. The Act itself was sponsored by the Obama Administration and is foundational in growing the scope of the Federal Government under his watch.
In a world where the scope of the Federal Government is already too far-reaching, what has the Dodd-Frank Act done for the typical consumer? On its face, Dodd-Frank appears noble and right. It was to promote the financial stability of the nation, improve transparency in the financial system and end the “too big to fail” banks. It was to be a lifejacket to protect consumers from abusive lenders who sold products too complicated to understand to customers who were not financially savvy enough to protect themselves. What it really amounted to was a very expensive way to close the barn door after the horses had escaped.
The foundational causes of the economic crisis could be boiled down to good intentions gone wrong. For the sake of the improving their standing with voters, the political forces, under the guise of promoting home ownership, began to alter the fundamentals of lending. The story was an excellent topic for a politician speaking to their constituents. They could vocalize their support for first time homebuyer programs that required less cash down payment for homebuyers who hadn’t owned a home in the past three years. These programs offered through the quasi-governmental agencies of Fannie Mae and Freddie Mac became popular and a new batch of buyers entered the market. This increased the ability of borrowers to qualify for a new home and for a period, the demand exceeded the supply in many markets causing the prices of housing to rise. As current homeowner’s sold their homes to this new batch of buyers, they took the equity caused by increasing prices and invested it into bigger and better homes. Prices continued to rise and an artificial sense of security in the real estate market emerged.
Due to the good payment performance of the mortgages done with reduced down payment, more of the basic fundamentals were changed to open up the door to even more homeowners. The ratio of debt payments to income were allowed to rise and down payments were reduced to zero. Loans made under these terms continued to have very good payment performance because a homebuyer who got into trouble financially, could generally sell their home for significantly more than they paid for it and avert trouble.
With the plunge in the stock market caused by the events of 9/11, real estate appeared to be one of the only safe-havens left for investors. Money exited the stock market and was invested more heavily in real estate causing additional demand for homes which further increased the prices. Homeowner’s were finding they had more equity than they ever dreamed of caused by the appreciation in the value of their home. Leveraging their new found wealth, consumers discovered that they could take out a home equity loan and invest the monies in second homes and rental properties. This created even more demand and more appreciation and builders rushed to increase the supply of housing to this perceived demand.
Because the loans continued to perform, the markets developed to purchase mortgage backed securities where the income and assets of the borrowers in the underlying loans were not verified. The sub-prime mortgage market became a player at that time as well. Sub-prime mortgages were offered at a higher interest rate to borrowers who did not have good credit, lacked employment history or had some other problem that disqualified them from a “prime” mortgage. Lenders rediscovered the pay option arms with negative amortization possible to get homebuyers into more and more expensive homes. These loans allowed a customer to get into a home for no down payment with a very low monthly payment that didn’t even cover the interest due. The loan balance would grow by the amount of interest not covered by the payment until the balance was 125% of the original loan. At that time the borrower’s payments would increase to a level necessary to pay the loan off in the remaining term. In many cases this meant the payments could triple or worse. Securities were created using these mortgages and investors continued to buy them.
The house of cards being constructed was huge and fully reliant on the appreciation in the value of the homes to glue the cards together. The financial crisis occurred when the demand petered out, when far too many homes had been built, when prices got too high and appreciation stopped. In some markets that had been badly overbuilt, the value of homes plunged 50-60% and those late to the game found themselves so far underwater that drowning was their only option.
The Dodd-Frank Wall Street Reform and Consumer Protection Act did little to address the real causes of the financial crisis. Greed was foundational to this problem and the greed was not limited to lenders. Consumers thought this was a means to greater wealth and willingly participated in this fiasco. Politicians were so busy promoting home ownership that they failed to keep an eye on or understand the fundamentals of lending that were being violated. A politician who was most foundational in creating this problem is ironically named in the act. Barney Frank was key player and having his name on an act that “fixes” this is a little ridiculous.
Donald Trump was elected to the Presidency in part due to his promise to dismantle the Dodd Frank Act. Chairperson Yellen, you are protesting that the world needs the protection implied within this group of laws and one wonders if the same good intentions that caused the problem in the first place are evident in your rhetoric. You appear to be comfortable with the role of the Federal Government having control of a larger part of the lives of its citizens but don’t want to acknowledge that the Act has failed to correct the core issues.
Look at the scorecard:
- Mega-banks are still too big to fail
- Rules generated from the Act have hamstrung lenders, causing them to deny financing to customers who don’t fit into a very strictly defined box.
- The Community Bank has become a dying breed while the Mega-Banks continue to grow and prosper. Unable to absorb the cost of compliance, many smaller banks have abandoned the mortgage banking niche where they were previously able to compete by looking at compensating factors to overcome deficiencies in a customer’s financial profile.
- It is no safer for the consumer to buy a house nor has the level of disclosure made the products more understandable.
- Fannie Mae and Freddie Mac, key players in the crisis, have been left virtually untouched by the act. The drastic undercapitalization of these conduits represents a major risk point even today.
The act was passed to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end “too big to fail” banks, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices and for other purposes. On most counts, Dodd-Frank should receive an “F”. If Dodd Frank is to survive in any form it should be overhauled to focus on the key issues and to lessen the impact on investors, small business owners and other consumers. Let President Trump work with Congress to manage the overhaul. Quit playing politics and recognize that there is lipstick on this pig that is fooling no one.