Yves here. This Real News Network interview with Bill Black discusses how the a provision in law rolling back some critical features of the already-weak Dodd Frank reforms would greatly weaken supervision of commercial real estate lending. That may not seem like a big deal, until you realize that the crisis before the 2008 meltdown, the savings and loan crisis, was a commercial real estate crisis. Moreover, the label is somewhat misleading. Remember that Citibank nearly went under and had to be rescued by Saudi investor Al Waleed? It was commercial real estate lending that brought Citi to its knees. It had made a lot of junior loans to commercial real estate office developments in Texas that turned out to be “see throughs” (no tenants). And unlike residential real estate, where there is normally a 40% recovery in the event of foreclosure (it was lower in the crisis just past due to gross mismanagement of the properties by many mortgage servicers), you can have a more than 100% loss in commercial real estate, since a failed development often needs to be completely removed for the land to be sold.
On top of that, the S&L crisis was far more serious than it appears in retrospect. Economists and pundits anticipate that it would inflict lasting damage to the economy. The big reason the US did better than expected was that Greenspan engineered a very steep yield curve, dropping short rates while (unlike Bernanke post crisis) allowing longer-term interest rates to stay relatively high. Banks were able to do dumb “borrow short, lend long” and earn exceptionally high profits by historical standards. That allowed them to rebuild their balance sheets much faster than anticipated.
GREG WIPERT: Welcome to The Real News Network. I’m Greg Wilpert joining you from Quito, Ecuador. The US Senate ended debate on a comprehensive financial deregulation bill on Monday. The bill reverses many of the regulations introduced through the Dodd-Frank Financial Reform Act of 2010. The vote to end debate sailed through the Senate with the support of 13 Democratic senators. We covered some of the bill’s main provisions when it was introduced last week. However, during the past week, senators introduced amendments to further expand some of the bill’s deregulatory provisions. For example, a new section would limit regulations on commercial real estate lending, another provision lowers the capital-to-debt ratio that some types of banks are required to have.
Joining me to analyze all of this is Bill Black. Bill is a white-collar criminologist, a former financial regulator and associate professor of economics and law at the University of Missouri-Kansas City. He’s the author of the book The Best Way to Rob a Bank is to Own One. Thanks for joining us again, Bill.
BILL BLACK: Thank you.
GREG WIPERT: Last week, we already discussed with you the implications of deregulating the so-called medium-sized banks with assets between 50 and $250 billion. So, let’s turn to some of the new provisions in this bill such as the limits on regulators’ ability to restrict banks’ commercial real estate lending. How does this bill limit regulators? And what are the consequences of this deregulation of commercial real estate lending?
BILL BLACK: I’ll take up them in the opposite order. So, the savings and loan debacle and the place that produced the massive losses and the massive frauds was all about commercial real estate. Commercial real estate is financing office buildings and it also, if you develop a whole bunch of residential real estate, like these 200-unit things, those are also classified as commercial real estate. And they were the place that blew up these really toxic assets of the savings and loan debacle. Now, in the 2008 crisis, the famous things that people have heard about are non prime loans, liar’s loans, subprime loans and things built from them like collateralized debt obligations. But what hardly anybody recalls about the 2008 financial crisis is because the big banks were bailed out, and they were mostly doing the kinds of loans I talked about, the banks that overwhelmingly failed were smaller and medium sized banks. And the thing that killed them overwhelmingly was commercial real estate loans.
And as bad as the regulators were in the run-up to the 2008 financial crisis, and they were plenty bad, they still had warned in really graphic terms on exactly the right points. They said, “Look, you’re making commercial real estate loans with really terrible underwriting,” that’s the process of seeing whether you’re going to get repaid,” and you are concentrating risk. You’re putting all of your loans in a single metropolitan area. So, if there’s a bubble in that area and it bursts, your bank is going to fail and you’re concentrating your loans among a very few borrowers.” That’s called “loan due on borrower” type restriction. Of course, this is the complete absence of diversification and extraordinarily risky.
The thing is the banking regulatory agencies refused to actually regulate. Instead, they warned, like you warn your 16-year-old not to do this or not to do that, then they nod nicely and then they go off and do what they’re going to do. Well, that’s what the bankers did. And the single biggest killer of banks therefore, in the 2008 financial crisis, was these commercial real estate loans. So, you might think, since we’re at the 10 year anniversary of Bear Stearns failure, which is the real kick start to the whole 2008 financial crisis, that Congress might actually remember some of this and actually care. And you might think that bankers would remember this, but no. This became, as soon as they stuck under the door with the legislation we talked about last time, they said, “Oh my god, if we can get away with that, think about the stuff we can get away with that’s really insane, like commercial real estate.”
By God, that’s what they brought us. They’re going to stick in these most toxic of the toxic loans and say, “That’s what bankers ought to be doing, and that’s what the regulators should lose much of their powers to restrict.” Again, the bankers didn’t, the regulatory agencies didn’t actually use their powers to regulate, but apparently they want to make sure that even if you found a regulator with a spine in the Trump administration, which isn’t very likely, that he or she will have no tools for restricting.
So, they’re saying, A, you ought to be able to do a higher percentage of your assets in commercial real estate, and B, that the regulators not only shouldn’t tell you, “No, hell no,” and forbid you to do that but the weak stuff that they kind of, sort of, did a little bit, which is raising your capital requirement a smidge if you had real heavy commercial real estate, Senate is actually going to ban that even though economic article after economic article by super conservative economists who said, “No, no, no, no. This commercial real estate is absolutely super toxic,” has always been super toxic. It’s super toxic here, it’s super toxic in other countries I’ve studied like Ireland, as well. By God, that’s what our Congress wants to do to us.
GREG WIPERT: Well, this leads me to the next question, which is that another part of the bill, which some have called even a bank lobbyist bill, is that it lowers the capital to debt ratio that custodial banks are required to hold. Now, what exactly does this mean? I assume it doesn’t just apply to commercial real estate. So, what does it mean and what are the consequences?
BILL BLACK: Custodial has nothing to do with commercial real estate. Custodial means that you hold funds in custody for others. This one is potentially less insane. You’re typically not a whole lot of risk to holding something simply in custody the way there is with commercial real estate, and so they wanted a special exception for custodials. But as soon as they did that, they were going, “Well, but there are other banks that are just as big but they don’t do much custodial, and that might create a disadvantage.” So, they’re rolling us, always, with the argument, “Oh, here’s something that might be not totally risky for one group. Let’s use it as an exception,” and then the exception becomes the rule for the rest of the institutions.
So, again, this is just the sneaky, slippery stuff that makes no sense at all. And while custodial isn’t particularly risky, it does have risks. In the event of a real meltdown of the system, you can end up with significant losses. So, the idea that you should have to have no additional capital for this kind of custodial account makes no sense at all.
GREG WIPERT: Now, this bill also includes a few provisions that are designed to appease the bill’s critics, such as Senator Elizabeth Warren. One of the provisions that was included is that they include in the calculations the foreign assets of foreign banks when calculating their size. Now, another measure is to allow for a new credit rating system so that people don’t have to rely only, that is lenders don’t have to rely only on Equifax or the others that are around. Do any of these concessions make this bill more palatable to you?
BILL BLACK: No. The second one might not be harmful, might be harmful, depends on who comes in. The more agencies have our proprietary information where we’re not the client, which is, of course, the case with the credit scoring agencies, if there were 20 of them say, instead of big three or big four, we would be much more at risk because every time there’s a security failure at these institutions, our information gets exposed. That one maybe, kind of, is viewed as positive by some folks but is actually probably negative.
The other one about foreign assets is a no brainer, so not much of a change. You were right, this bill is called, throughout Washington, even sometimes behind closed doors by its proponents, as “The Lobbyist Bill.” This is basically Christmas in March for the banking industry.
GREG WIPERT: So all in all, would you say that if this, actually, the official name is Economic Growth Regulatory Relief and Consumer Protection Act. If this bill passes both Houses of Congress, will it significantly increase the risk of another financial crisis?
BILL BLACK: Yes. The bill, the name of it, is a triple oxymoron drafted by regular morons.
GREG WIPERT: Okay. Well, we’ll continue to follow it as it moves its way through Congress. I was speaking to Bill Black, Professor of Economics and Law at the University of Missouri-Kansas City. Thanks again, Bill, for having joined us today.
BILL BLACK: Thank you.
GREG WIPERT: And I’m Greg Wilpert for The Real News Network.