More Evidence of Regulators’ Limited Effectiveness

Faithful readers may have read our recent posts on the limits to the Fed’s regulatory authority, both relative to the subprime mess and to the proliferation of new instruments (see here and here and here).

We had the spectacle last week of Roger Cole, the Federal Reserve’s director of supervision and regulation appearing before the Senate Banking Committee and have its members take him to task about the Fed’s failure to head off the excesses in the subprime market. Cole made only a weak defense, and we commented that, given the Fed’s charter, which is the safety and soundness of the banking system, that it isn’t clear that they were terribly remiss.

Now we have some good and bad news, both from a post on Calculated Risk, “OCC ‘concerned in 2002 with the growth of exotic mortgages.” The good news is the the Office of the Comptroller of the Currency, which supervises national banks, was on to the dangers of speculative mortgages early on, and took aggressive measures to curtail them (and note how a difference in charter produces a difference in outcomes: one of the OCC’s four objectives is “To ensure fair and equal access to financial services for all Americans”). But their efforts were largely ineffective because companies insistent on profiting from these products simply operate outside the OCC’s purview (and recall the subprime originators like New Century weren’t even banks. Mortgage brokers are subject to state regulation).

From Calculated Risk:

Emory W. Rushton, Senior Deputy Comptroller and Chief National Bank Examiner of the Office, of the Comptroller Of The Currency (OCC) provided testimony today to the House Committee on Financial Services. From Rushton’s oral testimony:

OCC became concerned in 2002 with the growth of exotic mortgages that have the potential for a big payment shock, and we responded in an escalating fashion, both formally and informally, privately and publicly. By 2005, we were instructing our examiners to more aggressively address the risks of these products during examinations of national banks – at a time, I might add, when home prices were still rising – because we concluded that standards had slipped far enough. That intervention is one reason why you will find few payment-option ARMs in national banks today. Shortly after that, we initiated the interagency process that resulted in the nontraditional mortgage guidance that was issued last Fall.

And from Rushton’s written testimony:

[T]he vast majority of subprime loans are not originated in the national banking system or supervised by the OCC. While some national banks and their subsidiaries help to serve the credit needs of the subprime market, their subprime lending last year amounted to less than 10% of the total of subprime mortgage originations by all lenders. … National banks and their subsidiaries that engage in subprime lending are subject to extensive oversight by OCC examiners and must operate in close compliance with the OCC’s rigorous safety and soundness and consumer protection standards. … Some have said, perhaps not surprisingly, that there is a direct connection between the rigor of the OCC’s supervision of subprime mortgage lending and the low level of this activity in national banks. Indeed, there have been recent instances in which banks have decided against converting to a national charter for this very reason.

In some ways this is comforting; apparently the national banks engaged in very limited option ARM and subprime lending.

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