Letting Sleeping Watchdogs Lie

The business press rediscovers regulators

Reading business-press coverage of Henry Paulson over the past few months was disorienting. Something was missing, but you couldn’t put your finger on it.

“Paulson attacks ‘shameful’ lenders,” The Financial Times reported in October.

[Paulson] said the conduct of some mortgage market participants had been ‘shameful’ and called for consideration of a nationwide licensing and monitoring system for mortgage brokers.

USA Today also relayed Paulson’s concerns in a story headlined “Criticism Rains Down on Mortgage Industry”

Reading these accounts, it’s almost possible to forget that Paulson is treasury secretary of the United States, one of the nation’s two top banking regulators with broad powers to stop unsafe and abusive banking practices.

The USA Today story also says that Sheila C. Bair was “frustrated” at the “slow pace” of loan restructuring for subprime borrowers.

‘Washington needs to push hard on this,’ she said. ‘Our message is, “Prioritize these folks, if they can convert” (to fixed-rate loans). That will free up more time to deal with some of the more challenging cases.

That’s fine, except Bair heads the Federal Deposit Insurance Corporation.

She is “Washington.”

And here’s one more, from Dow Jones News Service, on a speech last May by John Dugan, comptroller of the currency, who reports to Paulson:

Income Checks Needed For Loans, Regulator Says (1)

The story says the comptroller testified that banks should check borrowers’ incomes before giving them loans. Apparently, this wasn’t done before. Wow.

The business-press is paddling hard to catch up to a mortgage crisis that, I’m guessing, is bigger than most non-business-press readers understand.

We have to consider the possibility that the housing price downturn will eventually be as big as that of the last truly big decline, from 1925 to 1933, when prices fell by a total of 30 percent.

Who wrote that? Hint: it’s not one of those radicals we have running around up here at Columbia. (2)

I think the press is now doing well on the mortgage story and seems fully alive to its responsibilities to shine a light on a financial problem of such rare scope that people who normally take no interest in this type of thing are turning to the business pages to find out what happened—this time—on Wall Street.

The business press has written about the mortgage crisis as a predatory-lender problem, a na├»ve borrower problem, a compromised rating-agency problem, an irresponsible debt-buyer problem, and, first and foremost, a problem manufactured on Wall Street, which fueled the subprime expansion with loans to front-line borrowers, sold the bad paper into the global markets—and, to keep the fee-engine going, bought much of its own product.

If the business press has a blind spot, it is that it failed to understand the crisis for what I think it really is: a regulatory failure of mammoth proportions.

Now comes The New York Times this week with a devastating account of regulatory failure, under the headline: “Fed Shrugged as Subprime Crisis Spread”

The piece is strong. It effectively pulls together material that had been in the public record and advances an equally strong piece from last May, and other work over the summer, by The Wall Street Journal.

One of its chief merits is that it reveals even more about Alan Greenspan’s failure to act on urgent private warnings. In one passage, he seems paralyzed by his own ideology as he explains why he had parried pleas as early as 2001, from the late Fed governor Edward Gramlich and the FDIC’s Bair, to use powers the Fed already had.

‘I got the impression that there were a lot of very questionable practices going on,’ he said. ‘The problem has always been, what basically does the law mean when it says deceptive and unfair practices? Deceptive and unfair practices may seem straightforward, except when you try to determine by what standard.’

The Times makes a point that has appeared elsewhere but is one that nonetheless bears re-emphasizing: supposedly independent watchdogs—this time government banking regulators, no less—are funded by those they regulate.

Because each agency receives its funding from fees paid by the banks or thrifts they regulate, critics have long argued that they often treat the institutions they regulate as constituents to be protected.

But even as we celebrate good work, it’s fair to point out that the piece comes fully eight months into the crisis, advances only marginally what is already in the record, and includes material that was publicly available at the time the events were happening. It is, in the end, a particularly well-executed example of explanatory reporting, a time-honored and respected journalistic form that has but a single limitation: it is, by definition, late.

No problem. But just as lenders, rating agencies, and regulators should draw lessons from the mortgage calamity, so, too, should business journalists. Is the lesson that only muckraking investigations have merit? No. But to move beyond its current role of financial coroner, drawing chalk lines around a financial system that has already hit the pavement, the business press must change its thinking: It must take regulators as seriously as it takes the institutions they regulate. This means sustained, active beat coverage of the OCC, FDIC, and the Fed’s regulatory function and other regulators.

The business press has for years treated regulators, I believe, with the soft bigotry of low expectations. I think I know why, and I’ll get to it. The point for now is that so little has been expected of bureaucracies that, by law, and in theory, have enormous power—power for good, by the way—that reporters and editors have treated them as an afterthought.

And yet, think of it this way: bad or compromised regulation helps explain the subprime story. And effective regulation could have prevented it.

The Times says watchdogs missed clues:

Had officials bothered to look, frightening clues of the coming crisis were available.

I would add that frightening clues of regulatory dysfunction also “were available,” in spades.

It’s not just that this lending bubble occurred in the context of a decades-long rollback of financial and banking regulation, something that is hardly a secret.

No, this particular regulatory collapse was preceded by the spectacle of federal regulators publicly fighting not banks or their affiliates over lending practices, but state banking regulators who were trying to come to grips with the very lending abuses that haunt the financial system today.

It started—who remembers?—when acting comptroller and potential Medal of Freedom recipient Julie Williams, siding with a group that includes J.P. Morgan Chase and other big banks, went to court to block then-New York Attorney General Eliot Spitzer’s attempts to enforce New York’s anti-predatory lending laws on nationally chartered banks. The OCC argued that national banks should be exempt from state lending laws.

The OCC is part of the Treasury Department, which Paulson now oversees:

This, Audit readers, started in early 2003. Nearly Five. Years. Ago.

As The New York Times reported in December of that year:

State officials and consumer groups have opposed the [OCC’s] move to override state laws aimed at protecting consumers, including those to curb ‘predatory’ lending practices.

These lending abuses include exorbitant fees and interest rates and
payments for undisclosed insurance products.

But the comptroller has the power to override state banking laws.
‘Federal pre-emption is not unprecedented,’ a spokesman, Bob Garsson, said.

And remember, the OCC wasn’t just fighting Spitzer. Actually, it was Michigan that challenged OCC preemption in a case that went to the U.S. Supreme Court, and attorneys general from all fifty states filed amicus briefs in support.

Business-news organizations covered the dispute between federal and state officials as a power struggle, a tit-for-tat fight. But something must have seemed odd even at the time. For one thing, The Wall Street Journal editorial page threw its federalist principles overboard and became a champion of federal regulation—seriously. In retrospect, the editorials are howlers.

The OCC has a large staff of economists whose only job is to perform the sort of sophisticated statistical modeling needed to discover relevant disparities between loan approvals and denials or in pricing. Any red flags are followed up with in-depth examinations of loan files. The agency also has staff members on-site at large banks to monitor lending practices.

And get this:

If the OCC hasn’t had a huge number of enforcement actions, one reason is because it has a chance to monitor behavior before it becomes a problem.

And the punch line:

It’s a shame more federal agencies haven’t taken their responsibilities as seriously as the OCC. (3)

That’s an embarrassment.

The states lost in the end. The administration’s legal argument was upheld just this year by liberal justices, led by Ruth Bader Ginsberg.

Whatever the legal arguments, does anyone who is not a WSJ editorial writer really think this fight was about who would regulate predatory practices? Wasn’t the fight really about whether the practices would be regulated in any meaningful way? Were state regulators usurping federal prerogatives? Or filling a vacuum?

My point is, these are questions business editors should have asked themselves. I don’t believe they did.

“Frightening clues” of the OCC’s dysfunction at the worst possible time “were available.”

The Journal, for instance, hinted that the OCC was a do-nothing agency in a good August 2005 story that introduced Dugan as the new comptroller, headlined “Bank Regulator Cleans House”

WASHINGTON — IN RECENT YEARS, the Office of the Comptroller of the Currency, the federal regulator of national banks, has developed a reputation as the watchdog that doesn’t bark — protecting the interests of banks over those of consumers. (4)

The story noted that the OCC had given the Riggs National Corp. favorable ratings for years;—until federal prosecutors in 2004 revealed the bank to be a money-laundering haven for corrupt foreign leaders. Riggs later pleaded guilty to a criminal count and was sold.

Good, post-crash explanatory reporting has finally confirmed that the OCC’s “reputation” was, in fact, well-earned. It was a do-nothing agency.

The best piece I’ve seen on regulators was by Greg Ip and Damian Paletta, of The Wall Street Journal, who back in March (5) made the smart and necessary point that half of subprime mortgages were issued by nonbanks, such as Countrywide Financial Corp. and Ameriquest Mortgage Co., whose perfidy was so vast it overwhelmed state regulators.

It goes on wisely:

Yet even where federal regulators have jurisdiction, they sometimes have been slow to grapple with the explosive growth in especially risky practices and quick to shield federally regulated banks from states and private litigants.

The story reveals the OCC’s fecklessness, illustrating it with the case of sixty-seven-year-old Dorothy Smith, of East St. Louis, Illinois, who lost her house after her crooked mortgage broker stated her income as $1,500 a month, three times her actual monthly government benefits, to support a $36,000 loan with a balloon payment of $30,000—when she was about to be eighty-three. The OCC wrote her: “We cannot intercede,” etc., etc.

One fault is that this and other post-crisis stories tend to pin blame on an easy target, the regulatory system itself (usually called a “hodgepodge,” or an “outdated” “patchwork,”) rather than on the errors and ommissions of individual officials, and, it must be said, on the policy choices of political parties and their intellectual supporters.

There is widespread agreement that the biggest shortcoming in the regulation of mortgages is the patchwork of state and federal oversight. Amid rapid evolution in industry practice…

USA Today offered the same formula:

To many critics, one big culprit is the loose patchwork of federal and state regulatory agencies that failed to do their jobs, abetted by a Congress that only now has called for reforms. (6)

But is the patchwork really the “biggest shortcoming” or even such a “big culprit”? Are federal regulators really so powerless? Hell, no.

Other good reporting over the summer revealed Fed regulators to be simply unwilling to use the powers they have. Craig Torres and others at Bloomberg did well writing about government reports and studies, including this dispatch from June:

The U.S. agencies that supervise more than 8,000 banks haven’t censured any them for violating fair-lending laws, three years after Federal Reserve researchers began assembling data showing blacks and Hispanics are more likely to be saddled with high-priced home loans

No violations. Zero.

In October, Bloomberg reported on Congressional testimony that the FDIC gave failing grades in only .3 percent of compliance reviews of bank lending in low-income neighborhoods. When banks don’t lend where they take deposits, as required by law, subprime outfits fill the vacuum.

The FDIC even gave passing grades to banks that the Justice Department later sued for redlining, Bloomberg reports.

Listen, it’s easy to be a critic and hard to make editorial and resource-allocation decisions in real time.

But I think rank-and-file business reporters and editors need to rethink certain assumptions that are, in fact, conservative biases in disguise.

Yes, business reporters harbor conservative economic biases.

This is not so surprising when you think about it, and it’s understandable. Most business reporters and editors now in senior jobs grew up in an era of conservative anti-government ascendance and liberal pro-government retreat, of Prop 13, Thatcher, Reagan, Nafta, Rubinomics, etc. For this generation (my generation), there really hasn’t been another way to run the economy: less government, more markets.

Hooked to an emotion-detector, it’s fair to say, most business journalists would respond positively to words like “markets,” “free trade,” and “deregulation,” and negatively to words like “government program,” “government agency,” and “regulation”

Hey, having a journalistic class aligned intellectually with its sources may be a good thing. The trouble is, commonly accepted assumptions have left reporters disarmed in the face of a story like subprime.

My point is simple: markets don’t always work. That’s why we have regulators. And since we have them, cover them.

1. Dow Jones News Service
23 May 2007

2. Robert J. Shiller, professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC, is a leading housing expert.

3. REVIEW & OUTLOOK (Editorial)
Spitzer Meets His Match
1 June 2005

4. Bank Regulator Cleans House —- New Comptroller of the Currency Makes Supervision a Priority
By Michael Schroeder
19 August 2005

5. Lending Oversight: Regulators Scrutinized In Mortgage Meltdown —- States, Federal Agencies Clashed on Subprimes As Market Ballooned
22 March 2007

6. Some subprime woes linked to hodgepodge of regulators ; ‘Fragmented’ setup can slow response to trouble
USA Today
16 March 2007

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Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014). Follow Dean on Twitter: @deanstarkman.