Jesse Eisinger has a great artice in the NYT, “After Bailout, Giants Allowed to Dominate the Mortgage Business,”
which says a great deal about how the Fed looks at the economic world. Allow me to expand on Jesse’s work.
The problem with the Fed starts with a basic, very favorable disposition to large banks. This love affair stems from monetary policy, which is the main focus of all Fed officials. The neo-Keynesian socialism that passes for mainstream thinking at the US central bank assumes that large financial institutions are more stable than smaller players, especially since the functioning of the government debt markets is paramount.
The Fed is not really concerned about monetary policy any longer so much as maintaining market access for the spendthrift US Treasury. During the darkest days of the subprime collapse, the Fed forced mergers of securities firms with larger depositories not so much to avoid systemic risk as to preserve primary dealers. And the effort was a complete and total failure.
Not only is a cartel of big banks in control of the US mortgage market, but we have lost scores of smaller primary dealers and the sales and underwriting capacity they once brought to the markets. Not only are banks such as Well Fargo (WFC) and USBancorp (USB) now responsible for more than half of the mortgage market, but that market has shrunk because of the greatly reduced loan origination capacity in the US. This is the joint responsibility of the Fed and Congress.
Not only did the folks who pretend to be responsible for financial supervision at the Fed preside over the wholesale destruction of several large securities dealers – Washington Mutual, Bear Stearns and Countrywide – but Congress legislated the non-bank loan originators out of existence with Dodd-Frank. Since none of the large banks are buying third party residential mortgage production today, the capacity of the system to originate new credits has also plummeted – leaving the banks in complete control of a far smaller, less efficient market that is almost totally focused on government guaranteed products.
Today the markets are less liquid and comprised of fewer participants, many of which are just barely putting capital at risk in the housing sector. Banks such as Bank America (BAC) and Citigroup (C) have mostly withdrawn from the home loan market (C was never really there even during the boom). JPMorgan Chase (JPM) is focused largely on refinancing existing customers and subsidized loans such as HARP. If the central bank and Congress had set out to destroy the private market for mortgage finance, they could have scarcely done a better job.
The implementation of Basel III is an additional disaster for the housing industry, although in this case the impact on the large banks will be severe. Just imagine how Warren Buffet and the lesser souls who pretend to follow financials are going to react when they see WFC and even USB shrinking balance sheets and volumes in future quarters. That is precisely what is going to occur if the Basel III proposal is implemented. Over the past five years, large banks used the fact of the emergency 100% FDIC insurance coverage for transaction balances to grow their market share in deposits and mortgages. But the FDIC program, known as “TAG” for transaction account guarantee, apparently is finally going to lapse at the end of 2012 and with it the funding advantage enjoyed by WFC, USB and other large banks will recede.
Under Basel III, large banks are no longer going to be able to use their swollen balance sheets to warehouse mortgage servicing rights or MSR. What really needs to happen to clip the wings of the large banks is to end the definition of transaction balances as deposits at all, a move that would shrink the balance sheets of WFC, JPM, et al by 10-20%. Combined with Basel III, such a change would greatly reduce the effective leverage of the large banks and decrease their contribution to systemic risk.
Jesse errs in one case by calling the Fed a “victim” when it comes to the large bank monopoly in mortgages. True, the large banks and the overall reduction in mortgage underwriting capacity thwarts monetary policy. But the Fed is just getting the result they have always wanted, albeit unwittingly. This is why I have always believed we must get the Fed out of the business of supervising banks.
The Fed's Washington staff has never met a large bank merger that it did not like and has never been willing to deny such an application by a bank holding company, especialy a BHC that houses a primary dealer. Today what we need to see is the Fed breaking up large banking firms into smaller, more competitive pieces, a move that would help the consumer and the US economy considerably. But don’t hold your breath waiting for the folks at the Fed to start deconstructing the TBTF banks. That would be to risky, they will say, but the question is to whom?