As Subprime Lending Crisis Unfolded, Watchdog Fed Didn't Bother Barking
http://www.washingtonpost.com/wp-dyn/content/article/2009/09/26/AR2009092602706_5.html?sid=ST2009092602937The visits had a ritual quality. Three times a year, a coalition of Chicago community groups met with the Federal Reserve and other banking regulators to warn about the growing prevalence of abusive mortgage lending.
The hands-off policy, which the Fed reversed earlier this month, created a double standard. Banks and their subprime affiliates made loans under the same laws, but only the banks faced regular federal scrutiny. Under the policy, the Fed did not even investigate consumer complaints against the affiliates.
Most subprime affiliates began life as independent consumer finance companies, beyond the watch of banking regulators. These firms made loans to people whose credit was not good enough to borrow from banks, generally at high interest rates, often just a few thousand dollars for new furniture or medical bills. But by the 1990s, thanks to big changes in laws, markets and lending technology, the companies increasingly were focused on the much more lucrative business of mortgage lending.
As profits soared, hundreds of banking companies took notice, buying or creating finance businesses for themselves. Consumer advocates demanded that regulators take notice, too.
On Jan. 12, 1998, the Fed demurred. Acting on a recommendation from four Fed staffers including representatives of the Philadelphia, St. Louis and Kansas City regional reserve banks, the Fed's Board of Governors unanimously decided to formalize a long-standing practice, "to not conduct consumer compliance examinations of, nor to investigate consumer complaints regarding, nonbank subsidiaries of bank holding companies."
A 1999 report by the General Accounting Office warned that the Fed's decision created "a lack of regulatory oversight," because the Fed alone was in a position to supervise the affiliates.
Even inside the Fed, there was dissent. Gramlich was starting to express concern about predatory lending in his public speeches. He had voted for the hands-off policy in 1998, but by 2000 concluded that the Fed could demonstrate leadership by subjecting the lending affiliates to examinations. "A good defense against predatory lending, perhaps the best defense society has devised, is a careful compliance examination for banks," Gramlich later told a 2004 meeting of bankers in Chicago.
Alan Greenspan, then chairman of the Fed, recalled that Gramlich broached the subject at a private meeting in 2000. Greenspan said that he disagreed with Gramlich, telling him that such inspections would require a vast effort with no certainty of results, and that the Fed's involvement might give borrowers a false sense of security.
The last of the large finance companies was also snapped up in 2002, as HSBC agreed to pay $14 billion for Household International. The Chicago firm described itself as the nation's oldest finance company and boasted in its corporate history that it pioneered direct-mail loan solicitations in 1896. More recently, it had become the subject of a massive investigation by state attorneys general who charged that it routinely misled borrowers about the true cost of refinance loans. Immediately before announcing its deal with HSBC, Household agreed to pay $484 million to settle those charges.
By 2004, the consumer finance industry had largely been folded into the banking industry, and the finance arms of bank holding companies were making at least 12 percent of all mortgage loans with high interest rates, according to data reported by lenders under the Home Mortgage Disclosure Act.
Five months later (2007), the Fed took its first public enforcement action against an affiliate, fining Citigroup $70 million. In settling the FTC's earlier charges, Citigroup had agreed to a number of reforms. The Fed found that some practices had continued in violation of that commitment, and that employees had misled regulators.
Throughout the lending boom, consumer advocates trooped regularly to the Fed's monumental marble headquarters on Constitution Avenue to offer specific accounts of abuses in financial transactions. But what seemed powerful to advocates often was dismissed as anecdotal by regulators.
"The response we were getting from most of the governors and the staff was, 'All you're able to do is point to the stories of individual consumers, you're not able to show the macroeconomic effect,' " said Patricia McCoy, a law professor at the University of Connecticut who served on the Fed's consumer advisory council from 2002 to 2004. "That is a classic Fed mindset. If you cannot prove that it is a broad-based problem that threatens systemic consequences, then you will be dismissed."
"I stood up at a Fed meeting in 2005 and said, 'How may anecdotes makes it real?' " said Margot Saunders of the National Consumer Law Center's Washington office. "How many tens or thousands of anecdotes will it take to convince you that this is a trend?' "
The Fed's Board of Governors had voted in 2002 to require more detailed annual reports from mortgage lenders. When the first data were released in the fall of 2005, they confirmed that the largest banking companies had developed split personalities. The banks, subject to regular scrutiny, mostly made loans at market rates and concentrated their lending in white, suburban neighborhoods. The unwatched subprime affiliates mostly made loans at high rates and concentrated their lending in minority neighborhoods.
Wells Fargo Bank, for example, charged high interest rates on only 9 percent of its loans between 2004 and 2007. Wells Fargo Financial, which used the same stagecoach logo and the same red-and-yellow color scheme, charged high rates on 80 percent of its loans during the same period. The disparities were similar at Citigroup and HSBC.
Nationwide, the data showed that black borrowers making more than $100,000 were charged high rates more often than white borrowers making less than $40,000.
At the end of the March 2007 meeting of the Fed's consumer advisory council, during a slot reserved for presentations, two longtime advocates confronted the Fed's governors and staff with a study showing lending disparities in six cities including New York and Chicago.
"We thought it was pretty convincing evidence of discrimination," recalled one of the presenters, Sarah Ludwig of the Neighborhood Economic Development Advocacy Project, based in New York. "And afterward I remember nobody asking a question. I remember nobody making eye contact. Nobody called me from the Fed afterward saying, 'Let's talk about it.'"
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