Watchdog Fed Didn’t Bother Barking

Under our country’s fragmented and complex regulatory structure, the Federal Reserve has sole authority over one important category of lenders: bank affiliates.  These are companies – such as Wells Fargo Financial, CitiFinancial or Countrywide Home Loans – that are in the same corporate family as a bank but are not banks themselves.  Bank affiliates were major players in the subprime mortgage lending industry, accounting for about one-eighth of all subprime loans during the peak years of 2004-2007. 

And yet the Fed had a deliberate hands-off policy toward these lenders, a policy that it stubbornly maintained “despite repeated urging by consumer advocates across the country and even by other government agencies.”  The story is told in a must-read article by Binyamin Appelbaum in Sunday’s Washington Post. 

As Appelbaum reports,

On Jan. 12, 1998…the Fed’s Board of Governors unanimously decided to formalize a long-standing practice, “to not conduct consumer compliance examinations of, nor to investigate consumer complaints regarding, nonbank subsidiaries of bank holding companies.”  [See explanatory note on terminology at end of this post.]

This Fed policy was strongly criticized in a Government Accountability Office report in 1999 (and another report in 2004), in Congressional testimony from the National Community Reinvestment Coalition and others that same year, and in a joint HUD-Treasury report on subprime lending in 2000.  Community advocates met repeatedly with Fed officials, only to have their concerns invariably dismissed as “anecdotal.” 

Meanwhile, banking companies took advantage of the Fed’s hands-off policy to establish or buy affiliates to carry out most of their subprime lending, knowing that these affiliates could ignore existing laws and regulations with impunity.  In the words of former Fed Governor Edward Gramlich, “it is like a city with a murder law, but no cops on the beat.”

It was only in 2007, after the subprime mortgage lending industry had self-destructed, that the Fed finally reversed its policy. 

The Post’s article is accompanied by a well-crafted timeline that graphically shows the sequence of events.

Explanatory note:  The terms “affiliate” and “subsidiary” can be confusing.  Parent corporations, called bank holding companies, own both banks and other companies (these other companies are imaginatively called “nonbanks”).  One company owned by another is a “subsidiary”; two subsidiaries of the same parent company are “affiliates.”  An example may help:  CitiFinancial, a nonbank subprime lender, is an “affiliate” of Citibank; both CitiFinancial and Citibank are “subsidiaries” of Citigroup.

(Photo: Laura Padgett)