Written by John Lounsbury
The Chicago Fed just issued a report entitled "Risk Monitoring in the Seventh District – 1st Q 2013". It might be expected that we would learn what sophisticated new actions were underway or might be proposed to limit risk within the banking system. The first paragraph of the report lowered expectations a little when it mentioned they encouraged "each of our supervised financial institutions to remain informed about current and potential risks to its institution." Doesn't sound like the Chicago Fed was expecting supervision to be a significant force in the process.
Just to put the thoughts in context, here is the entire opening paragraph:
The Federal Reserve Bank of Chicago (Seventh District) Supervision group follows current and emerging risk trends on an on-going basis. This Risk Perspectives newsletter is designed to highlight a few current risk topics for the Seventh District and its supervised financial institutions. This newsletter is not intended as an exhaustive list of the current or potential risk topics and should not be relied upon as such. We encourage each of our supervised financial institutions to remain informed about current and potential risks to its institution.
The presentation remained rather unremarkable until we got to page 3 (of 4 pages). There we found a paragraph that was quite astounding:
The Consumer Financial Protection Bureau (CFPB) issued several new mortgage related rules in January 2013, one of which was the ABILITY TO REPAY AND QUALIFIED MORTGAGE STANDARDS UNDER THE TRUTH IN LENDING ACT (REGULATION Z). The CFPB also issued revised final rules in May 2013. These new rules are effective January 2014 and will impact the way financial institutions conduct business and the way mortgage markets operate.
What is this "Truth in Lending Act" and why have we not heard about such new legislation?
It is not new. The Truth in Lending Act was enacted in 1968 years ago and presumably has been the law of the land for 45 years.
The logical interpretation of the statement in the Chicago Fed report is that the Truth in Lending Act of 1968 has not until now included any regulation that loans must be made under the expectation that the borrower has the ability to repay. And actually it is not even required now: The new rules are effective 01 January 2014.
The Dodd-Frank Act of 2010 is cited as the authorizing event for expansion of consumer protection to include protection against consumers being "sold" loans they cannot reasonably be expected to repay. Prior to that there appears to have been an assumption under the law no lender would lend money without the expectation of repayment.
But such a presumably illogical act describes a central element of a type accounting control fraud conducted by the underwriters of mortgages and the issuers of MBS (mortgage backed securities). They were operating an extractive pay for procedure (commissions and fees) which they maximized by ignoring the risk of default. The default risk fell on the "muppets" to whom MBS were ultimately sold.
The Mafia could not have developed a better business plan than did the mortgage and mortgage securities originators. And this was the business of the largest banks and financial institutions.
Securitization is a great way to expand the investment funds pool for mortgage lending. If not properly structured it is a poor way for investors to use their funds. That is why investor money is no longer supporting the mortgage market securitization process. Instead the Fed is funding the market with more than $1 trillion MBS on the Fed balance sheet and more than $500 billion being added every 12 months.
The system that the Fed is supporting will not be required to lend based on ability to repay until 2014? Although the gross fraud of the housing bubble may not be occurring today, there is no regulation that would prevent (or criminally punish) it today if it were to occur? The need for the new CFPB regulation implies that such is the case. It would seem that lending and securitization fraud is still not illegal. And if it is occurring, it is being underwritten by the public (government) through their sub-contract agent, the Federal Reserve.
It may be that there is justification for the Fed action to buy MBS. However, it is hard to argue that the action should be undertaken without forcing structural changes to prevent the same abuses from the past happening again. That is the minimum quid pro quo that should be required.
An even better situation would be the criminal prosecution of those at high levels who executed the most egregious acts of fraud in the bubble. If there is no legal base for criminal prosecution of fraud in these cases, then the structural changes should include changes in the criminal law.
Distressing summary: There appears to be no political movement to criminalize accounting control fraud. The new CFPB rules make clear what is expected. But is there law to back up violations with criminal prosecution? If not then the new rules could simply do no more than add another cost of doing business for banksters. The toleration of such behavior seems like a holdover from the Dark Ages when the "Lords of the Manor" were subject to no law other than their own.
Note: Control fraud is a term defined by Global Intersection Contributor William K. Black.
- Highlights of Risk Monitoring in the Seventh District – 1st Q 2013 (Federal Reserve Bank of Chicago, no date displayed on the document)
- Ability to Repay and Qualified Mortgage Standards Under the Truth in Lending Act (Regulation Z) (Consumer Financial Protection Bureau, 10 January 2013)
- Truth in Lending Act (Wikipedia)
GS Exec: No More Ripping Eyeballs out of Muppets (GEI News, 14 March 2012)