The Occupy movement expressed disapproval of the bailout of the banking system while seemingly ignoring private citizens. Bank-bashing is certainly in fashion, as headlines continue to increases in statewide foreclosures to nearly 3%. Many applaud the Dodd-Frank act’s massive rewrite of the financial system. I am not among them.
With little fanfare, a rule tied to mortgage “simplification” was submitted by the Consumer Financial Protection Bureau. This rule is 1099 pages long. As the former head of a division charged with interpreting and implementing bank regulations, allow me to give you some of the details of this rule that will inevitably limit credit availability to small business.
1. Unintended Consequences
Commercial lending provides short term financing for small business that range from financing inventories to seasonal cash flow. These loans are generally relatively small, averaging under $60,000. While these loans are relatively expensive (currently in the vicinity of 7%), they provide the cushion many businesses need to weather bumps in their long term growth.
These loans are generally short term, averaging five years or less, and many are secured by real estate owned by the business. If the business needs the money longer than the term of the loan, interest is collected in the form of a “balloon” payment, and the loan is renewed.
Under the new mortgage simplification rule, however, these loans are considered abusive because of their high rates and balloon payments. That leaves these businesses with the only alternative to go to huge banks which syndicate these loans through Fannie Mae and Freddie Mac. Their estimated bailout cost, by the way, is $124 billion.
2. Economies of Scale
The 1,099 page mortgage simplification rule may not be as difficult to implement for JP Morgan/Chase or Bank of America as it is for small or regional banks. Huge banks have huge compliance departments. Small regional banks don’t.
If, for example, Huge Bank has a 40 person compliance department, each person can be responsible for under 30 pages of the new rules. Tiny Bank may have only 1 person responsible for compliance, who will be responsible to implement 1,099 pages. Faced with this daunting task, Tiny Bank B is very likely to do one of two things.
One, Tiny Bank may suspend its small commercial lending that is secured by real estate. Their customers will be forced to bank with Huge Bank.
Or two, Tiny Bank may add personnel to its compliance department. That will increase its costs, lower its profit, and ultimately damage its financial viability.
3. Jobs
Small businesses create more jobs than large corporations. This new rule is yet another financial obstacle for small business. Consequently, it is bound to affect job creation.
Interestingly, a tiny bank you’ve likely never heard of, the State National Bank of Big Springs, Texas, has filed suit with the Competitive Enterprise Institute and 60 Plus Association, two free-market entities in Washington D.C., alleging that Dodd-Frank is unconstitutional because it forces its good customers to go to big banks and its poorer customers to be declined credit under this rule.
Yes, there were abuses by big banks. Yes, bank-bashing is all the rage. But without careful consideration of what regulations we pass, we may find the effect to be smaller banks selling themselves to larger ones who have compliance departments large enough to implement our regulations. Or worse, we may damage small business’ access to cash.
Stay tuned.
I had to chuckle because misery loves company! I've been in a funk for days now. I call all these types of things "the mosquitos" of life. It's like one more thing and you're going to pull the trigger. What I hate and this seems to apply to m
Oh my gosh! I felt your inner pain ... and I apologize for the fact that when I got to the part about setting your hair on fire, I laughed. I'm so glad you weren't hurt, and hair grows back. Perhaps a new hair-do would not only rectify the situation 
There is no such thing as a legal separation in my state..The only way I can get husband out of the house is to force him out..He refuses to leave..I would have to file for divorce and get temporary orders including a restraining order..
I feel so
Oh Kitty, I have to disagree with you on this one. (Painful for me, because I have always agreed with your writing in the past and really look forward to each new one!)
Considering how egregious the banking industry’s behavior was, and still is, I am grateful somebody has the guts to go up against the banking industry and set new lending and reporting requirements.
In the long run, I believe they will benefit small business and be much safer for small new businesses.
I don’t think we have to worry about the need for gigantic compliance departments overwhelming small banks and credit unions because even small banks and credit unions have layers who can tell them what changes they have to make. And perhaps, the reason well run credit unions and small regional banks don’t need large compliance departments might be because they are not ‘cooking the books’ or making risky loans.
Anyway, my point is, the way the banks (and Wall Street) were operating was dangerous and created a global economic meltdown. These new rules, agreeably verbose, are one tiny step towards what has preventing another meltdown and protecting each of us as we get loans and credit in the future.
Hi Adoptsalot, and thank you for your comment. Please don’t hesitate to disagree with me (or anyone else for that matter), as a discussion on these matters is exactly what we need for a competent solution. If only Congress could learn to disagree and compromise…
In response to your comment, I give you two considerations to ponder. First, the idea that there is something “not well run” about investment banks vs. banks that make “good” loans is, in my view, inaccurate. The cause of the financial crisis was too much debt, primarily secured against property. These loans were made by so-called “good” banks (and credit unions). Investment bankers played a role, but that role was secondary.
Second, you may remember that Lehman Bros. and Bear Stearns “went under” during the financial crisis. Diversified banks (with both commercial and investment banking arms) like JP Morgan survived because they had diversified business models. It helped, not hurt, the financial recovery.
Banking is risked-based. “Good” bankers loan to people and companies that they assess as having the credit history, the ability and the willingness to repay. We’ll never take risk out of banking. We can, however, require banks to have financial “buffers” in the form of money set aside for problems based on the amount of risk they take. Crippling banks by over regulation has had, and will have unintended consequences to healthy individuals and businesses who want to, but cannot get, capital from banks.
I thank you again for your comment, and welcome your response.
Kitty I respectfully disagree with you. My background is in banking, finance, trust management, mortgages – all with licensing. The repeal of Glass-Steagall in 1999 lifted the regs from the banking industry & gave free rein to greed & avarice. Alan Greenspan made the incorrect assumption that banks would not be so stupid in their greed to flush their own companies down the toilet, but they did. i.e. Lehman Bros. The regulations go much further than making bad “liar loans” on real estate, all bad & misleading loan products invented by banks that had figured out how to sell these loans in such complex financial instruments that they themselves no longer knew what they were buying or selling. The ratings agencies put Triple A ratings on instruments that contained large percentages of junk loans. These deceiving financial instruments were sold all over the world to countries such as Greece, Portugal, Spain, Norway & I could go on with the list. AIG sold so much to so many countries that countries were telling the US Govt that they better bail out AIG or they were going to put the world economy in the tank. The lack of regulation & the signal to go easy on the banks caused the SEC to sit on their hands and/or not staff themselves with people who even understood the games the banks were playing. I offer the Madoff ponzi scam as evidence for just one example. The complexity of regulation is necessary because the banks have invented such complex schemes to hedge risk etc. I offer JPMorganChase recent loss of several billion dollars when a bad hedge scheme blew up in their face. This was possible because parts of Dodd Frank have not kicked in as yet because the present Congress is doing everything it can to stop it because they are in the pockets of big banks. The proof of need for complex regulations can be documented in the economic crash that occurred under the Bush Admin lack of regs in the last decade & will take a long time to rebuild & repair & make sure it doesn’t happen again. Especially when the GOP are doing everything they can to return things to the way they were. To say that complex regs will stifle the industry is simplistic. Simple regs do not address complex schemes. There are people on Wall St looking for loopholes in regs as a full time job, trying to invent schemes that can slide through the cracks to make them millions & billions. If they fail, we, the taxpayers crash & burn along with them. That is why we need complex regs & the Consumer Financial Protection Bureau to protect us & advocate for us. We need Dodd Frank on steroids to take on the Goliath of big banks who do not care about us – only themselves & their multi million dollar bonuses. No Morality reigns them in.
My reply is very short and sweet: The Big Banks need to be taken down. Sorry if I can’t give a more detailed answer with a lot of jargon about compliance departments and such.
Hi kwilczyk, and thanks for your comment. Without knowing exactly why you say that big banks should be broken up, I can’t really respond, other than to direct you to the comment above.
If you’d care to tell me why you feel the way you do, I’d be happy to discuss it with you, but in any case, I appreciate your comment.
This response is for maplav, to whom I extend sincere thanks for a thoughtful and thorough response. It’s been my pleasure to be discussing this issue with two visiting friends: one of whom is a former Southern CA thrift CEO; and the other, a principal in a LA law firm which specializes in real estate law. It appears that your primary argument takes exception to the concept that numerous regulations stifle industry. To the extent that economies of scale result in increasing costs for smaller institutions to comply with those regulations, I would point out that an unintended consequence is to increase costs for those smaller financial institutions, making them less profitable (or less apt to offer the highly regulated service), which would seem to stifle them. Basically, I’m concerned that the expense will cause them to sell themselves to bigger banks, making the big bank problem even worse than it is now.
Of course, many (including me) are angry at the behavior of some bankers. We all agree about that. My CEO friend agrees with you. She is actually in favor of breaking up the banks. My lawyer friend is not in favor of breaking up the banks, but is in favor of Basel III risk based capital requirements, which would assign different capital requirements based on level of risk. I think it’s a moot point. The genie’s out of the bottle. If the whole world have combined commercial and investment banks and we don’t, our investment banking business will go to London. Or Asia. We need them here, properly capitalized.
As far as the regulations specifically cited in this article, I still think there are unintended consequence . We need better protective mechanisms, but this is poorly written and I think it will cause more problems than it solves.
Sincere thanks for your comment, and I’d love to hear what you think of the “expanded” discussion. As with most things in life, very intelligent people can disagree. It’s the brilliant ones who find common ground and make progress.
Hi Kitty – I appreciate your comments. I agree with you that we have to have investment banking. Big banks such as Goldman Sachs (which became a bank to benefit from bailout – was strictly an investment bank before) JPMorganChase, etc. all have huge divisions in London attracting EuroZone investors etc. No problem there. The problem comes into play when the banks are doing proprietary trading for their own account as well as trading for their clients. What happens when the two are taking opposite sides? Before the crash, Goldman Sachs was trading Mortgage Backed Securities for their own account & shorting the market. Down the hall (literally) they were selling Mortgage Backed Securities to their clients as a great investment. They were also selling Credit Default Swaps as a non regulated instrument that fell between the chairs between the insurance industry and the equities industry. the CDS was a supposed insurance policy to make investors in MBS securities feel that they were not only buying a Triple A security but had insurance on it as well. So everything sold like hotcakes. AIG Ins Co. sold at least $78Billion in CDS. I say at least because nobody knows really how many more billion were really sold. Noone thought there would be a crash in the housing market & all the investors would be claiming on their CDS insurance policies at the same time. Countries were claiming. I remember seeing a report on 60 Mins about a Norwegian town that had received a sales pitch from a London office of a Big Bank & bought MBS and CDS & ended up bankrupt after the crash. All of these instruments were outside of regulation, and it was not by mistake that they were. The CDS were invented by JPMorganChase. They slipped through the cracks of regulation and the bankers knew it. Even after the crash & after the creation of the Dodd Frank bill, unbelievably these activities continued because all features of Dodd Frank had not kicked in as yet. So the lesson was not learned and the millions of dollars of profit are too alluring. The banks can’t kick the habit. The JPMorgan hedge that recently blew up was so complex it has taken months to unwind the trade & the total cost is not as yet known. Only a few expert traders even spotted the trade and knew it would go bad and took the other side of the trade and made a profit. Bottom line, Dodd Frank is not perfect but you have to start somewhere. I get weekly reports of interpretations of the bill and decisions as to how it is going to be applied, so it is being reviewed constantly and details worked out. It is a miracle we got anything as there were big forces against any regulation. Big banks are one of the biggest lobbies on Capitol Hill. Small banks need to be able to make Fannie and Freddie approved loans in their territory so that they can sell loans into the marketplace and have money to make more loans as well as to balance their portfolio. The problem was that loan standards went to pot because Wall St was demanding more loans – no matter the quality – to throw into the MBS instruments. Subprime loans got mixed in with higher quality loans and a Triple A rating thrown on the whole basket of mortgages & CDS sold to insure it and huge profits were made. It got so bad as these instruments moved mortgages all around like a shell game that when foreclosures started it sometimes happened that a servicing bank foreclosed & they were asked to prove they owned the loan, they couldn’t come up with the original note and mortgage. They didn’t know where it was! So small banks got hurt, big banks flushed themselves down the toilet, Washington Mutual and Wachovia happened. Lehman Bros happened etc. and so on. Reeling the whole mess back into control and under regulation is a giant task that I would not want to be in charge of, especially with the forces working against fixing the system. The greedy liked it fast and loose. More billions to be made. But regs are needed but I don’t think small banks will suffer in the long run and will still have Fannie and Freddie to sell their loans to and GinnieMae for their FHA loans and VA for the vets & their commercial loan biz, auto loans etc. I am an old school banker and as a mortgage banker, I pride myself that I never made a single “liars loan” because I cared about my client the most rather than the money I would make and I made sure my client could actually afford the loan. I did the extra work for my self employed clients and got their tax returns and balance sheets and P & L statements and waded through them and presented the loan with all the proof and got them a much better interest rate & knew they could afford the loan. Other loan officers did not do the work or even know how to do the work & took their clients to Stated Loans at high interest rates so the loan officers could make more money for less work & faster closing. A lot of those loans blew up. I focus now on trust management & investments, but at some point will go back into mortgages as well when the banks get straightened out & mortgage instruments get regulated. I hope lessons are learned from this giant mess. If it took JPMorgan months to unwind their complex hedge trade that went bad, think how long it takes to bring the country back onto solid ground. You cannot turn a giant steamship around on a dime or stop it on a dime. Big banks are already spinning off divisions into independent entities so they can avoid Dodd Frank & continue massive profits. Huge forces are working against fixing the system. I guess I better stop talking but I hope you see where I am coming from and that I feel there are no simple answers to these complex problems. Buuut – regs are needed, with constant updating to keep up with the sharks :)
Hi maplav, and thanks for another thoughtful, considered and well informed comment. I find it interesting that we see the premises differently, but agree, for the most part, about the conclusion. Things need to be fixed.
I’d love your reaction to an article I wrote a while back about Goldman. http://womensfinancialplanning.blogspot.com/2010/07/case-against-goldman-sachs-epilogue.html
Also, another on financial reform. http://womensfinancialplanning.blogspot.com/2009/07/obama-administration-financial.html This one is a series.
Time and interest permitting, I’d love your thoughts.
Hi Kitty – I enjoyed your papers – very comprehensive. The Goldman paper & the question of analysts is an area of agreement between us. I think it is a very odd concept that I would take a position because Warren Buffett or John Paulson invested in it. Either would be an interesting piece of info, but banks & pension funds have analysts who are doing in depth analysis of their own. On any one day I could read 15 papers on one particular stock & some would be pro & some con. I have to be a sophisticated investor & decide what my investment goals are & which analysts make sense to me & then make my own choices. I used to handle investments for the Trust Dept of a bank. We did our own analysis, talked to many sources, presented our findings to a Trust Committee & decisions were made. The part I found immoral about Goldman was when they were doing proprietary trades for their own account & shorting the MBS market while at the same time telling their clients to invest in MBS securities. That was completely an “in house” matter. To reveal whether or not John Paulson was shorting was insignificant. What would have been significant is if clients knew Goldman was shorting. I hope they paid a big fine for that, though I am afraid they did not. I do not have respect for ratings agencies or many analysts. How much use is a rating agency that is paid by the client they are rating or whose instruments they are rating? The SEC needs to step up & hire expertise that can recognize the games that are being played. Big banks and pension funds are supposed to be sophisticated investors. If they are not, then what use are they? I personally answer that question by doing my own work and management & if I fall, at least I can say I did my own investigation. It is when you get taken out by banks & pension funds etc. playing games & high risk poker with your money with no regard for a reasonable concern for risk & crash the world economy that you get really angry.
Regarding your article on regulation & supervisory agencies, your narrative re AIG etc. & the problems of designing regulation are right on. There is an old saying “Give a committee the job of making a horse & you will get a camel”. Certainly if you are creating regulation via politicians, many of whom are in the pocket of banks, insurance companies, special interests etc. you are lucky if your camel even has 4 legs. The term “unintended consequences” is going to come up when that 3 legged camel falls over & crushes someone on the way down. The problem is, that is the system, and you have to start somewhere. I think that very often banks complain about unintended consequences but then find a way to make an even bigger profit, usually off the backs of consumers. How do you take the politics out of it? What happens when you put in regulatory agencies & tell them to do their jobs & then the next administration tells them to back off & get out of the way of the “free market”? How do you give them power that they can keep & exercise regardless of which party is in power? It’s complicated, but you have to start somewhere & work through the problems. I have a real problem with legislation that is written by ignorant people with no regard for true facts & figures. Congressman Akin’s idea of how a woman can shut down during a rape & therefore not get pregnant is an example. What medical school did he attend? Now we have ideology creating budgets rather than solid economics. Paul Ryan has a Bachelors in Economics & Political Science. No Masters or PhD in Economics. How many actual hours of Econ did he attend. His budget numbers don’t add up & is missing many specifics. The CBO has to accept some ridiculous assumptions to even begin to try to score his budget. Why is everyone so impressed with him & call him a Wonk? We have ideology creating regulations or politics creating regulations rather than common sense. But you have to start somewhere
It is a very difficult situation & the temptation of riches is too great to conclude that banks can operate with little regulation. They go for the profit first & foremost. Long term stability is not their first priority. Now that they have gotten accustomed to making billions, they are having a hard time getting back to reality.