Former Comptroller of Currency Protests Too Much on Inability to Prevent Credit Crackup

by: Tom Brown

You’ll get no argument from me that the primary culprits behind the banking industry’s recent credit problems were the banks themselves. Lax underwriting practices and excessive loan concentrations (primarily in commercial real estate) at a minority of the country’s banks nearly brought the whole system down.

That said, I find it amazing that so many people believe that the best way to ensure the credit crackup doesn’t happen again would be to give regulators — who, remember, oversaw the reckless underwriting and buildup of loan concentrations in the first place — even more power than they already have, and for Congress to pass a massive bill (Dodd-Frank) that will lead to a huge new set of rules and regulations that will govern the banks.

News flash: prior to the crackup, bank regulators had all the power they needed to prevent the catastrophe from happening. They simply didn’t see it coming. A lot of people didn’t. I get annoyed, though, when, after the fact, regulators try to re-write history by arguing that they were powerless at the time, and that things would have been different if only more rules had been in place. That’s nonsense.

(I also get annoyed, while I’m on the topic, when regulators overcompensate for the prior laxness by clamping down on the banks once the crisis is over, and so take a bad situation and make it worse. That’s what happened after the big real estate collapse in the early 1990s and by all accounts it’s what’s happening again.)

Which gets me to an interview the former Comptroller of the Currency, John Dugan, recently gave to Bank Director magazine. Here’s what he said:

[T]o me, poor underwriting standards is not a consumer protection issue—it is a safety and soundness issue ... The heart of the problem was that we should have had better underwriting standards at the point of sale with the consumer ...

I definitely think that the regulators should have done more in the area of minimum underwriting standards. I think we just lost our way as a country. But in defense of the bank regulators, I would say that underwriting standards were always much better for the loans that the banks held on their own books. Where the standard was not as high was on loans they sold to third parties. It was harder to enforce minimum mortgage underwriting standards on institutions that were selling loans to third parties. And if we had enforced a minimum underwriting standard the banks would have complained that they would lose the business to third parties who were underwriting substandard loans ... [Emph. added.]

If self-deception were a performing art, Dugan would be up for an Oscar. Here’s a man who was the country’s preeminent bank regulator, on whose watch the entire financial system nearly collapsed, and he still can’t bring himself to admit there was anything his agency might have done to avert disaster. If only better underwriting standards had been in place! I read the Dugan interview straight through. His comments aren’t an ex post facto rationalization designed to put the best face on what was, we all now know, a huge underwriting and regulatory lapse. He really seems to think his hands were tied. I especially like the last part I bolded up there: “If we had enforced a minimum underwriting standard the banks would have complained that they would lose the business to third parties.” How quaint! I suspect that, these days, not many bankers dare complain to their examiners. And the ones that do are seeing their complaints fall on deaf ears. How times change.

John Dugan ought to be ashamed of himself. In the fullness of time, we now know that if his OCC had forced some underwriting discipline on the nation’s banks at the peak of the cycle—if the agency had, say, forced banks to be more judicious in writing certain no-doc loans, or option ARMs, or sub-prime mortgages—the magnitude of the credit crunch would have been much, much less than it turned out to be. Yes, banks would have lost some business to non-bank lenders. Good! In all, fewer bad loans would’ve been written, and many fewer would have been written by the (federally insured) banking system. That’s the sort of things regulators are there for to make sure happens. Dugan’s OCC didn’t. They were a bunch of incompetent oafs, and they blew it.

Remember, Dugan was in charge of safeguarding the banking system’s safety and soundness. He shouldn’t have cared about a bank’s loan volume or market share. And given what’s happened, by now you’d think that he’d have realized he shouldn’t have cared. That he persists in arguing that he couldn’t crack down on banks more because, in essence, he couldn’t mess up the bank’s business plan, is a disgrace.

In any event, mark me down as skeptical that the raft of new agencies and regulations lately being created to prevent the next meltdown will do much good. There were already plenty of rules in place that could have prevented what happened. The problem isn’t the rules. It’s the people.

What do you think? Let me know!