I’ve embedded an important article by Amar Bhide which explains long-form how securitization has been a big leap backwards for the financial services industry.
Some Naked Capitalism readers may recoil at the idea of praising banking in any form, but that is a short-sighted view. There’s a reason that a banker is the hero of that hoary Christmas chestnut, It’s a Wonderful Life. Small community banks, and even back in the day, branches of big banks, played critical roles in local economies by providing small business and mortgage loans, as well as deposits and payment services. Back in those days, members of the financial services industry were also paid at the same level on average as people in the economy overall. It was only starting in the 1980s that the earnings of financiers moved considerably higher than those of ordinary workers.
Bhide has written other important critiques of the financial services industry. This one focuses on the damage done by securitization. Mind you, that is not to say (and I think Bhide would agree) that securitization on a more modest scale than we now see in operation might not have been salutary or at least not harmful. But regulators in the late 1980s threw their weight behind securitization as a way for banks to “recycle” capital. The same McKinsey banking partner that Bhide cites at the beginning of his article, Lowell Bryan, was also on behalf of banks touting a coming “banking profits squeeze” and urging regulators to do more to help those poor sufferin’ banks. As if banks ought or need to be profitable. As we’ve discussed, banks get such heavy subsidies from government that they should not be treated as private enterprises and should be regulated as utilities as they once were.
Bhide describes the consequences of bank regulators, as well as Fannie and Freddie, promoting the use of FICO scores, as opposed to other hard and soft forms of analysis that banks had used traditionally to make consumer loans. Not only do you have the loss of information that would help reduce loan losses (local knowledge of how the outlook for his employer and the local economy) but more homogeneity of approaches, which creates the possibility of everyone replicating the same mistakes, like assuming a national decline in housing prices was impossible. And as he explains, one of the big costs has been the near-death of small business lending, when small businesses are the drivers of job growth.
Naked Capitalism readers will recognize that Bhide’s critique doesn’t incorporate other negatives of securitization, such as poor incentives producing broken servicing platforms, poor to non-existent error customer service/error correction, and abusive and predatory servicing. And even when regulators have tried to force servicers to offer modifications, highly automated servicing platforms aren’t able to do that, and the lack of local knowledge and branch-level underwriting skills means banks would have to rebuild lost skills to do that. And they’ve shown no interest whatsoever in doing that. Paying the occasional fine is their path of least resistance.
I urge you strongly to read this piece in full.
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Interesting relationship between FICO scores and securitization. Those bankers know what they want!
This is an excellent article. The lack of locally underwritten small business loans harms communities by reducing p local goods, services and jobs and narrowing the ability of talented entrepreneurs to build their families’ financial assets.
Since the federal Community Reinvestment Act has not been enthusiastically enforced since the Clinton administration, most banks choose to maximize profits by not fulfilling their primary purpose. They have obtained the benefit of federal deposit insurance without delivering the local service insurance was intended to support.
There is an alternative source of local lending, federally certified community development financial institutions (CDFIs). They are attracting an enormous amount of talent and there are 1000 of them in the US, but their scale is modest, and inadequate. If someone would figure out how to either get local banks more incented to deliver local loans or lend their balance sheets, on a profitable basis, to the talent-heavy CDFI industry, it might be a fruitful avenue to pursue.