Economics, Financial Services

Who is the Scrooge?

Image Credit: Shutterstock

Image Credit: Shutterstock

The WSJ on December 24 had a front page story entitled “Push for Cheaper Credit Hits Wall”.

The story’s main theme is that “economists posit that banks are keeping rates artificially high, boosting profits and depriving the economy of the full benefit of the Federal Reserve’s efforts.” Charles Dickens could not have done a better job making banks out to be Scrooges.

How about letting some facts get in the way of opinions posited by economists? The article starts on solid ground by pointing out that mortgage loan rates are about 57 basis points higher than the norms of 2003-2005 (a basis point is 1/100th of a percent), but quickly founders by failing to apportion this increase among various possible causes.

It turns out the biggest contributor to “artificially high rates” is not lender rapacity, but government action. First, it is well known that Fannie and Freddie (the GSEs) had been seriously mispricing credit risk for a couple of decades. This is the reason Congress, in 2011, ordered the Federal Housing Finance Agency, the GSEs’ regulator, to assure that the GSEs’ guarantee fees “appropriately reflect the risk of loss, as well the cost of capital allocated to similar assets held by other fully private regulated financial institutions.” As a result, guarantee fees have increased from an average 22 basis points per year in 2003-2006 to about 54 basis points per year today. This increase of 32 basis points accounts for 55% of the 57 basis point rate increase.

Second, it is also well known that increased regulations have added substantial time and expense to the loan origination process and that this has to get reflected in the rates charged. While hard to precisely quantify, I would conservatively put this added expense at 12-15 basis points. So the reality is that government actions account for 44-47 basis points or about 80% of the increase. That leaves maybe 12 basis points or about 20% attributable to Grinch-like banks accused of stealing Christmas. The truth is, thanks to direction from Congress, credit risk is on the road to appropriately reflecting the true risk of loss and capital.

The bad news is that since the Government Mortgage Complex continues to account for 90% of mortgage credit risk, the bulk of these fees are effectively paid as dividends to Treasury, whereupon they are immediately spent. They should be accruing as capital and contingency reserves held by private sector mortgage guarantee entities. Instead we have a government-dominated $10 trillion housing finance system with virtually zero capital behind it (correction: with the FHA’s insolvency, the total is actually negative) and taxpayers are being left once again to pick up the tab. Contrast this to a healthy private housing finance market that would be backed by about $300-$400 billion in core capital, which capital would be supported by appropriated priced loan guarantee fees.

15 thoughts on “Who is the Scrooge?

  1. “While hard to precisely quantify, I would conservatively put this added expense at 12-15 basis points.”

    You do that Ed. Because not being able to “precisely quantify” never stopped you from running your mouth before, and it won’t now.

    • So, Max. Do you think that government regulations have no impact? Sarbanes Oxley has had huge impacts to business. Yet, when Jon Corzine testified that he had no idea where the $1.2 billion went, he showed that this enormously expensive regulatory regime was a paper tiger. ALthough federal investigators stated that “chaos and porous risk controls” were actually at fault http://dealbook.nytimes.com/2012/08/15/no-criminal-case-is-likely-in-loss-at-mf-global/, this is the sort of thing SarOx was supposed to stop. And if it didn’t stop it, what use was the regulation, except to provide more government squeezing of the economy.

      A better solution is to break up the banks, as well as some of the huge corporations that resulted in S-O to begin with. ENRON was way too big (and too much associated with govt rent seeking). Many of the big WS funds are the same…. Smaller is better. Simple, clear rules are better. Overregulation is not.

      • I’m really not sure how to answer your reply, as it doesn’t seem relevant.

        But I’ll tell you what I believe: when banks- or any industry- starts abusing their public trust, they are, quite literally, “asking for it.”

        Dealing with the public requires holding to an ethical standard. “High standards of commercial honor” is the term the SEC uses, and unfortunately, too many private enterprises don’t hold to it, and they bring regulations down on them.

        When Greenspan testified he didn’t think banks would wilfully take risks that would lay waste to the financial system, I’m sure he was quite sincere- but they did it anyway.

        I’ve read nearly a dozen books on the makings of the crisis, and the lunacy these firms engaged in never ceases to amaze. You might as well have fed poison to your dog, or thrown a newborn out of a plane- no one gave a crap, so long as they got theirs. That’s how reckless they were. Corzine won’t get punished, and neither will Standard & Poor’s. If you get caught stealing gasoline, you’ll go to prison. That’s how your “democracy” works.

        Just because regulation doesn’t always work, doesn’t mean you should abandon it. By that standard, we should abolish marriage, since we have a 50% divorce rate.

        • Its completely relevant. You mocked the estimation of the basis points added by government regulation. I asked whether you think such regulations add to the cost of doing business. I then pointed to the largest regulation that has had huge economic impacts – a regulation put into place as a political show to harm Bush. A regulation that basically is toothless to protect investors – the very folks it was supposed to protect.

          It is in fact one thing for businesses to charge what they think the market will bear. It is another to punish them for being successful. My solution is to break up many of these large industries and create more competition, which will bring prices down. Industries that abuse their customers will be driven out. Its only when there is no competition – when government and business form unholy alliances of I’ll scratch your back, you scratch mine – that individual consumers are harmed. Grievously harmed. This was a truth that the trust busters learned in the 19th century, and one that we will need to relearn. Big business and big government are both bad for the little guy. Neither are bad when they are limited and controlled – business by the marketplace, government by focusing on what it does best, instead of trying to regulate each aspect of the economy.

          • “You mocked the estimation of the basis points added by government regulation. ”

            I mocked the estimation because
            1) it IS mockable, and ludicrous to attempt to, and
            2) the person who made the estimate is a despicable asshat.

            “I asked whether you think such regulations add to the cost of doing business.”

            They DO have a cost, and as I work in perhaps the most regulated industry of all, it does not mean we shouldn’t have them.

            ” I then pointed to the largest regulation that has had huge economic impacts – a regulation put into place as a political show to harm Bush”

            I don’t think that was the impetus behind SarBox, and Corzine got off because he’s Corzine, just as Goldman, UBS, and HSBC will get off with paying fines and no one will do any hard time, except the small fry being tape recorded on a phone call. Jail is for those who aren’t politically connected. You didn’t think the “justice” system treated everyone equally, did you?

            “My solution is to break up many of these large industries and create more competition, which will bring prices down. Industries that abuse their customers will be driven out.”

            I think many agree with you that the banks should be broken up. Don’t forget all these mergers occurred thanks to a law passed during the Gingrich Congress in 1994, and were exacerbated by Paulson rolling failed firms up into TARP’ed ones.

            When I ask anyone, including some well known voices you see on TV that I converse with on Twitter, exactly HOW they plan to accomplish this, I get radio silence.
            So before we do this, we have to come up with an effective mechanism that won’t do any harm to the system, which is just getting it’s ass off the ground.

            While the banks are certainly to blame for a lot of the economic carnage, we’ve also asked a lot of them in terms of re-regulation, including Basel III. So how we go about splitting up Bank of America, for example, while everyone is still suing them for their past malfeasance, needs a good hard look.

            It’s very easy to say these things. Putting them in practice is another matter.

  2. Even the alleged 12 Grinch-like points may mostly be attributable to building capital against future Fannie/Freddie putbacks. Residential mortgages were being priced as a virtually risk-free asset for decades.

    • It’s the spread between the 10 year T (which most mortgage products are priced off) and the rate borrowers are paying.

      Theoretically, when the 10 yr T hit about 1.50%, the mortgage rate should have dipped into the “2′s.”

      • The question remains.

        When rates are being kept artificially low by the central bank, how can banks be keeping them artificially high?

        What we have here is a problem that you seem to run into frequently, Max: theory doesn’t fit reality.

        • “When rates are being kept artificially low by the central bank, how can banks be keeping them artificially high?

          What we have here is a problem that you seem to run into frequently, Max: theory doesn’t fit reality.”

          Sir, you’re a flaming idiot. The rates are high RELATIVE to the cost of their funds, which as was explained, is keyed off the 10 year Treasury, which is common industry practice. In retail terms, they’re making a higher markup, and there is nothing wrong with that so long as booming demand from re-financing is there.

          You really had that much trouble understanding the thrust of the piece?

    • I mean, rates are artificially low as it is (Fed actions). To say they are artificially high because they are not as low as you want makes zero sense.

      There are far more factors here that people are not considering: risk, expected inflation, and, not least of all, profit.

      I mean, think about it: bank’s abilities to profit off of fees are, for better or for worse, curtailed. They are facing tighter restrictions on securities, further limiting profits there. Maybe their interest rates are just higher simply because they want to make money. Maybe it’s not just Scrooge behavior (an unjustified characterization of a fictional character, but that is a different story) that the banks are “keeping” rates “artificially” high. Maybe they are just trying to earn a living.

  3. Hi Ed- why don’t you look at the charts on securitization history in this article, and tell us how you back up your claims on Fannie and Freddie?

    http://www.housingwire.com/sites/default/files/editorial/securitization%20activity%20jumbo%3Anon-jumbo.png

    And here’s today’s DealBook page calling you out as a loon- for precisely the same reasons I did, weeks ago.

    http://dealbook.nytimes.com/2013/01/09/new-target-in-finger-pointing-over-housing-bubble/?smid=tw-share

    Pretty good, huh, Ed? That’s why you don’t want to play with me- because I’ll cut you and Fat Peter a dozen new ones.

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