TOPICS > Economy

Fed Ready to Strengthen Regulations Tied to Lending Practices

July 8, 2008 at 6:10 PM EST
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Federal Reserve Chief Ben Bernanke outlined new rules Monday that are intended to protect homebuyers from risky lending practices blamed for a nationwide housing crisis. Wall Street Journal editor David Wessel examines the move.
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RAY SUAREZ: In his remarks today, the Fed chairman laid out a series of prescriptions to deal with what he called the “ongoing turmoil” of the financial markets and to prevent future crises.

The Fed moves include issuing new regulations in the coming days to crack down on shady lending practices; considering extending investment banks’ ability to borrow money from the Fed; and calling on Congress to potentially give the Fed authority to collect information about the workings and holdings of borrowers, lenders, and financial firms.

David Wessel is the economics editor for the Wall Street Journal, and he joins me for more on this story.

Cracking down on risky loans, did the chairman get specific about what kinds of loans he wanted to see disappear from lenders’ product lines?

DAVID WESSEL, Wall Street Journal: Well, he didn’t get specific today, but the Fed has, over a number of years, really going back to 2006, been trying to figure out whether they should do more to limit some of the most egregious examples of subprime loans that turned out not to be in the interest of the borrower or the lender.

And now next week they’re finally going to issue the final regulations. It’s a little bit like stomping very hard to outlaw laws that — outlaw loans that nobody is making anymore.

But specifically they have a criteria for what constitutes a high-cost loan. And for these loans, the lender has to do such revolutionary things as make sure the person has the ability to pay it back and so forth.

RAY SUAREZ: Does the Fed have the ability to make that rule for any institution that makes a loan on a house…what kinds of banks?

DAVID WESSEL: Yes. One of the controversial things in the past was that the Fed had been a little reluctant to use the power that Congress had given it to cover people who make mortgage loans who aren’t in the banking business that’s primarily regulated by the Fed.

And now the Fed is moving beyond that. In a way, they’re saying, “These are things we wish we had done before in the years when Chairman Greenspan was in charge, but we’re going to do them now because we see how bad the things have gotten.”

Fed expands emergency window

David Wessel
Wall Street Journal
There is, I think, a lot of talk of re-regulation, but I think, in most circles, this is considered something prudent and the least that could be done, given the abuses that have now been exposed.

RAY SUAREZ: Is this kind of turning back the clock, the momentum of the last couple of decades, to start re-regulating, making new rules like this?

DAVID WESSEL: No, I think it's more like closing the barn door after the horses have all left. There is, I think, a lot of talk of re-regulation, but I think, in most circles, this is considered something prudent and the least that could be done, given the abuses that have now been exposed.

RAY SUAREZ: Also today, Fed Chairman Bernanke announced that the window, the emergency window, for lending from the Fed would be kept open into next year. Significant announcement?

DAVID WESSEL: Right. What happened here was that, for 75 years, the Fed has had the power to lend money directly to all sorts of businesses, even businesses that are not the banks they regulate, but they haven't used that power since the 1930s.

And then, on St. Patrick's Day weekend when Bear Stearns got in trouble, the Fed, for the first time since the '30s, opened this spigot. And they said they were doing under power -- the law says they can do this in unusual and exigent circumstances. And they said that that would be about six months.

So this window will close in September unless the Fed extends it. And what Mr. Bernanke suggested today was they're thinking about extending the life of this thing into next year.

I think it's a way of saying, "We're not sure the fire is out yet, so we don't want to put away the hoses."

Chair requests more authority

David Wessel
Wall Street Journal
What Mr. Bernanke said today, echoing some comments that are made by his colleague in New York, Federal Reserve Bank President Tim Geithner, is, if you're going to give us the responsibility, you've got to give us more authority.

RAY SUAREZ: Does he have to be careful that he doesn't give a signal that he thinks the crisis is going to continue into 2009?

DAVID WESSEL: Yes. I think that Mr. Bernanke has to be very careful about this. We are in a situation where there's a reality, which is pretty ugly, and then there's a lack of confidence. And he wants to tell people, "Look, I understand things are bad, and they're bad on Wall Street, and they threaten the U.S. economy. And I want to do that which I can to prevent this from getting worse."

But he doesn't want people to think it's so bad that he's panicking. So this is a very fine line he's walking. And he doesn't want to imply that he thinks that some investment bank is going to need this money, only that, if one needs it, the money will be available.

RAY SUAREZ: He also talked about asking Congress for what he called "explicit authority" to oversee the lending industry.

DAVID WESSEL: Right. So what happened here is the Fed had what they call a safety net, and that safety net has generally been believed to be under the banks, the banks where you and I can deposit money and write checks, the banks that are insured by the Federal Deposit Insurance Corporation.

When the Bear Stearns incident happened, the Fed expanded the safety net. And now it rests under big investment banks, like Merrill Lynch, Goldman Sachs, and so forth. But those institutions are not as tightly regulated as the banks.

And everybody knows this is not a good idea, not sustainable. The question is, how should the system be changed to take account of this new reality?

And there's a little bit of a turf fight going on between the Treasury and the Fed -- this is not the first time this happened -- about how much more authority should the Fed have, because it now is maybe on the hook for this money? And the Treasury says, "You should have overarching responsibility for financial stability."

And what Mr. Bernanke said today, echoing some comments that are made by his colleague in New York, Federal Reserve Bank President Tim Geithner, is, if you're going to give us the responsibility, you've got to give us more authority.

So I think he's pitching really to the next Congress, saying, because of what's happened, you've got to give me more power.

Bernanke defends Bear Stearns move

David Wessel
Wall Street Journal
I think he's trying to lay the case. He's going to be testifying before Congress this week and next. And he's sort of trying out his talking points in advance.

RAY SUAREZ: You mentioned Bear Stearns. And a large part of today's speech by the chairman was sort of an explanation of why he thought the Bear Stearns purchase by JPMorgan was necessary.

DAVID WESSEL: Right. What's happening here is that Mr. Bernanke is under attack, both from inside the Federal Reserve and from some critics of the Fed, both on left and right, for maybe doing too much to close this deal and bailing out if not the shareholders of Bear Stearns, then certainly the creditors.

And maybe Jamie Dimon, the CEO of JPMorgan, got a good deal because the Fed was so desperate. And so I think he's engaging in a deliberate act, action, or a series of speeches to say, "Look, this is why we did it. I want you to understand. We didn't do this lightly, but we thought the system was at risk. And we had to do some things that we actually weren't happy about doing, but they were better than the alternative."

So I think he's trying to lay the case. He's going to be testifying before Congress this week and next. And he's sort of trying out his talking points in advance.

RAY SUAREZ: That it was such a big part of the speech, does that indicate to you that there's still a lot of questions about that move on the part of the Fed?

DAVID WESSEL: Oh, yes. I think there are a lot of questions. I think that, in the financial community and among reporters on my beat, everybody knows this was a really big deal. It changed the rules of the game in a fundamental way. And the regulatory system is going to have to be changed as a result.

I think, outside that narrow circle, it's a question of people thinking, "Oh, the big guys always get bailed out and homeowners don't." And so he's trying to explain we bailed out the big guys here because we thought the entire economy and financial system was at risk. Yes, he's on the defensive.

Fannie Mae, Freddie Mac cause alarm

David Wessel
Wall Street Journal
I think it was a little bit of a false alarm, but it was a sign at just how jittery the markets are about real estate and mortgages in general, and particularly how nervous they are about these two pillars of the American household finance system.

RAY SUAREZ: Also in tumult over the last two days was the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, more familiarly known as Fannie Mae and Freddie Mac. What's going on there?

DAVID WESSEL: Well, Fannie Mae and Freddie Mac are these huge institutions that are not technically under the government protection, but everybody thinks of them as being under the government protection.

And they are very important to the mortgage business. And they have all their assets in mortgages or things like mortgages.

So you can imagine this is not a great time to be lending everything -- have everything tied up in real estate any more than it's good for any individual homeowner to have all his or her income tied up in a mortgage that may be greater than the value of the house.

So the markets are a little bit uneasy about Fannie and Freddie. And what happened was, at the beginning of the week, an analyst suggested that if the accounting rules were applied in a certain way, they would have to go out and raise gobs of money in the financial markets to bolster their capital. And the markets took this very poorly, because this would hurt the existing shareholders.

And then, today, their regulator came out and said, "Come on, we're not going to do that." So I think it was a little bit of a false alarm, but it was a sign at just how jittery the markets are about real estate and mortgages in general, and particularly how nervous they are about these two pillars of the American household finance system.

RAY SUAREZ: Well, they were talking about, what, $90 billion them having to come up with, right?

DAVID WESSEL: Oh, they're just huge. They're huge. And there has been a lot of talk over the last couple of years about what kind of tighter regulation should they have, how much capital should they have, and, really, the political winds have turned against them.

And they were about to get sort of tougher rules. And then the housing bust came, and now the government has turned to them and just begged them to buy more mortgages and stuff.

RAY SUAREZ: David Wessel, thanks a lot.

DAVID WESSEL: A pleasure.