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Housing Bailout: Crony Capitalism Comes to America?

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Subprime Safeguards We Needed
Washington Post
By Nicholas Bagley
Friday, January 25, 2008
As the federal government scurries to prevent the subprime mortgage crisis from sending the economy into a deep recession, people are asking why it waited so long to intervene. But, in fact, a few years ago an obscure federal agency torpedoed legislation from a handful of states that would have made institutional investors far more chary of buying mortgages that were likely to fail. If the legislation had been permitted to take effect, the crisis we now face would probably look a lot less grim.....To combat this surge in predatory lending, some state legislatures decided to stanch the flow of easy credit to subprime lenders. In 2002, Georgia became the first state to tell players in the secondary mortgage market that they might be on the hook if they purchased loans deemed "predatory" under state law. Before, downstream owners of mortgage-backed securities might see the value of their investments drop, but that was generally the worst that could happen. Under the Georgia Fair Lending Act, however, players in the secondary mortgage market could face serious liability if they so much as touched a predatory loan....Enter the feds. Some of the biggest players in the secondary mortgage market are national banks, and the states' efforts to curb predatory lending clashed with banks' fervent desire to keep the market rolling. So the banks turned to the Treasury Department's Office of the Comptroller of the Currency. The primary regulatory responsibility of the OCC is ensuring the safety and soundness of the national bank system, but almost its entire budget comes from fees it imposes on banks, which have the option of incorporating under state law. Put another way, the agency's funding depends on keeping the banks happy. Little surprise, then, that the OCC acted when the national banks asked it to preempt subprime-mortgage laws such as Georgia's, arguing that they conflicted with federal banking law...Despite the banks' thin legal arguments, the OCC issued regulations in early 2004 nullifying the state laws as they applied to national banks. The agency reasoned in part that the states just got it wrong. As the then-comptroller explained in a 2003 speech: "We know that it's possible to deal effectively with predatory lending without putting impediments in the way of those who provide access to legitimate subprime credit."

With the state laws nullified, national banks and their subsidiaries were free to engage in the practices the states were hoping to stamp out. (Indeed, Georgia scuttled its law because it didn't want to give national banks a competitive advantage over its state institutions.) Facing pressure from subprime lenders and Wall Street, and left without a real chance of holding investors responsible for purchasing ill-advised loans, state legislatures gave up on trying to meaningfully expose downstream buyers to liability for facilitating predatory lending...As federal officials move to clean up the subprime mess, it's worth remembering that they helped to create it.