Inside the Meltdown

Topics: Subprime mortgage crisis, Bank, Debt Pages: 124 (49753 words) Published: November 7, 2012

... FDIC [Federal Deposit Insurance Corp.], established 75 years ago in the Great Depression. ... How does it feel being head of FDIC during another grand crisis? It's a very important place to be right now. We're getting a lot of media attention, and I think that's positive because I think the FDIC is all about public confidence. That's how we maintain the stability with people having confidence in our brand and our insurance guarantee, and I think we've done that fairly successfully. We have seen a lot of stability. People are keeping their money in banks, which is good. ... I think we'll be judged by how history judges us, whether we continue to be effective in trying to stabilize the banking sector and maintaining people's confidence in the banking system. ...

You say in speeches that the FDIC and yourself saw a storm brewing over the last two years. ... When I came to the agency, we were still in a very benign economic environment, but the FDIC staff, our supervisors as well as our economists, were expressing a lot of concerns about what we call the underpricing of risk. There was just too much credit out there, and there was a risk premium being charged for the credit that was being extended. And that was particularly true in the mortgage markets. ... Most of the really weak underwriting occurred in loans that were packaged in securitizations by Wall Street and then sold off to private investors. So we bought a database that included these loans to try to get a handle on how bad the situation was. And it was pretty frightening what we saw, especially with the subprime market, these very, very steep payment [resets]. You had starter rates that were very high already, 8 or 9 percent. Then they would go up to 11, 12, 13 percent after two or three years. And they really weren't designed to be affordable after that reset. They were designed to prompt another refinancing, so you get another whole round of fees and, in some instances, prepayment penalties. They weren't designed to be a long-term sustainable product. Of course, you can only refinance if the housing market is going up, right? If you don't have any equity in your home, you can't refinance. And that's exactly what happened as the housing market started to flatten out and then go down. These folks were locked into these mortgages.

[That was 2006, but even back in 2001 you were one of the first voices saying we need to do something about subprime mortgages.] Sometimes did you sort of feel that you were out in the dark shouting, and no one was listening to you? Well, there were a lot of others. [The late economist and former Federal Reserve Governor] Ned Gramlich I think was really more vocal than I was, and he actually got me interested. ... But certainly people didn't listen more broadly. For years there were bills in Congress to try to address what they called predatory lending, perhaps that was a prejorative -- lax lending -- but it was bad lending, whatever type of adjective you want to put on it. And they just couldn't get the political momentum to get anything done. And I think that was because everybody was making money. Even borrowers were making money if they could keep refinancing. I think the hidden fees and costs of these loans were, to some extent, hidden from borrowers, especially subprime borrowers, where you're dealing by definition with borrowers who have limited credit experience or have had a past of troubled credit experience. ... They were still refinancing, still putting a lot of cash up. ... And there wasn't a lot of hue and cry except primarily from the consumer groups at that point. I think that was the problem. It's very, very difficult in Washington to get political will to move anything when everybody's still making a profit out of it. And nobody was holding onto the risk. That was the other problem with the securitization markets: These loans were being pooled and broken into securities and sold off to investors....
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