Felix Salmon

John Dugan, protector of predators

By Felix Salmon
March 30, 2010

In the wake of Andrew Martin’s searing profile of him last week, the last thing John Dugan needed was to be quoted in the American Banker looking like even more of a banking-industry shill. Yet here’s the quote he gave Cheyenne Hopkins for her (sadly firewalled) article on whether safety and soundness conflicts with consumer protection:

“One area that stands out is loan underwriting,” Dugan said in an e-mail. “For example, a consumer agency might think that down payments on house purchases should be limited to 5% to promote homeownership, while a safety and soundness regulator might believe a higher minimum could be needed to ensure lenders don’t make loans that won’t be repaid.

Given the significant role that loose underwriting played in the financial crisis, I think it makes sense to provide an exemption from the consumer agency’s jurisdiction for credit standards.”

Why on earth would a consumer protection agency ever limit down payments on house purchases? Does Dugan think that the government is going to step in and forcibly prevent people from paying cash for a property? Is he so confused about what consumer protection entails that he thinks it would involve setting minimum — as opposed to maximum — amounts of leverage? Has he already forgotten so much of the crisis that he thinks that homeownership is likely to be considered something unequivocally good for consumers, as opposed to the largest financial risk that most consumers will ever take?

The fact is of course that loose underwriting is as bad if not worse for consumers as it is for banks, and no consumer financial protection agency is going to condone it. After all, if banks lose money on bad underwriting, that’s because their consumers can’t pay back their loans — and if they can’t pay back their loans, that means they’re in bad financial shape. You don’t protect consumers by encouraging them to get into bad financial shape. This is not rocket science.

Yet Dugan wants to prevent the consumer protection agency from looking at credit standards! The reason of course has nothing to do with worries that the agency will force the banks to loosen up on underwriting, and everything to do with worries that it will prevent predatory lending and loan pricing based not on the likelihood of repayment but rather on how much money can be squeezed out of the borrower.

Honorable banks who want to profit from their customers’ financial well-being have nothing to worry from a consumer protection agency. Dishonorable financial institutions who want to squeeze their customers dry before moving on to the next sucker do have something to worry about. And its those institutions that Dugan is trying to protect. For shame.

Update: Many thanks to American Banker, which has now taken down its firewall for this story. So go read it!

7 comments so far | RSS Comments RSS

The quote is not artfully worded, but I think the suggestion is that the hypothetical regulator might require a minimum down payment of 5%, but not higher.

Posted by alkali | Report as abusive

@alkali, if one regulator says down payments should be at least 5% and another says at least 20%, then there is no problem, even if both regulators have authority: the minimum is 20%. In order to generate a _conflict_ you need to have one regulator say “you must offer loans @ 5% down because it will benefit the consumer” at the same time another says “you must require at least 20% because otherwise you will jeopardize the system.” So whichever way you interpret the quotation, it is nonsensical.

Posted by Greycap | Report as abusive

Oh, come off it. This is absolutely something that would have happened 5 years ago; “requring a 20% down payment is locking millions of people out of homeownership, so you *have* to permit looser standards” is *exactly* the kind of thing you heard. (Indeed, “sure they can afford a zero-down interest only loan; if interest rates go up, they can just sell the home for a huge gain!”) Don’t imagine that the crash was just a result of regulator negligence; there was a lot of regulator malfeasance under political pressure to make sure that poor people could get themselves financing that, yes, is now in hindsight called “predatory”, frequently by the same people who thought five years ago that any reasonable lending standards were undemocratic. In fact, the day will come again. Within 15 years, it will be elitist, anti-poor, and even racist to suggest that people who can’t afford to buy a home not buy a home.

Posted by dWj | Report as abusive

If only Greenspan had regulated sub prime mortgage lending when he had the chance back in 2003

Posted by Story_Burn | Report as abusive

While Dugan imaginatively imputes motives to the agency, he’s dodging the point. Fact: loose underwriting has been going on. Tons of it. And by no means randomly, Captain Renault.

For too long, it was the name of the game at major banks to put loans, lots of loans, on the board with little or no apparent regard for the likelihood of repayment. Loan underwriting was (and last I checked, still is) completely out of control in too many quarters, fronted by major banks.

Lenders lent in an out of control fashion to many people they ought not to have, to some who completely deserved it, to some that were bamboozled and doomed to failure, even to fictitious people who did not exist. These are the facts. Lenders who did not realize the risk they were taking a lot of the time were failing in their (ostensible) primary duty: to lend wisely. That, they too often did not do. So often, it beggars belief in the lending system itself.

See Gogol’s Dead Souls for an approximate comparison. Clearly, there was a market-wide projection-based incentive to lend, lend and lend again at no matter what eventual, inevitable, risk – so great was the rate of recklessness at which much pre-crisis lending was taking place. This is lending by expert professional lenders we’re talking about here.

It stopped being about real estate pretty soon after rampant lend-o-mania began. From then on in, it was about selling paper obligations that the banks dearly wanted to initiate, then resell to third parties with as little delay as possible, rotating numbers for the sake of numbers. Something made them want to do that so badly, they did it badly.

A consumer protection agency worth its salt is liable to want to know what that something is, or was, because its effects still haunt the entire market.

In my estimation, Dugan is fighting consumer protection now as a warm-up battle. What he fears most is a total retroactive audit. Impartial auditors can find all the bad loans and publish the story behind each one, which would be incredibly useful in understanding what provoked this crisis, and could obviously help prevent recurrence.

Honest borrowers have nothing to fear from roundhouse auditing, nor do honest lenders. But those aren’t necessarily the people whom Dugan most vociferously represents.

Posted by HBC | Report as abusive

Felix makes a good point about loose underwriting.

The ultimate exponent of this was Andy Hornby, chief executive of HBOS, the UK bank. He had a background in supermarkets, which thrive on a pile ‘em high sell ‘em cheap business model. The flaw with applying this logic to home loans is that loans are, of course, not consumer products. After a supermarket has sold its sixpack of beer to a consumer, it will not lose any money if the consumer proves not in a fit state to drink it (because they’re drunk already). After a bank has made the loan, it can still have a deleterious effect on the bank through non-payment.

This raises an even more interesting issue: why on earth did a big blue-chip company decide to hire Mr Hornby to be its new chief executive? Can a failed CEO play a useful role in society, beyond looking after their children and walking the dog? Mr Hornby has at least gone back to retailing (for Alliance Boots).

Any thoughts appreciated.

Posted by Yanbaru | Report as abusive

I read Mr. Duggan’s quote somewhat differently than Mr. Salmon apparently has:

“For example, a consumer agency might think that down payments on house purchases should be limited to 5% to promote homeownership,”

I interpreted that to mean that he was worried that a Consumer Protection Agency would try to limit the down payment to a MAXIMUM of 5%.

“while a safety and soundness regulator might believe a higher minimum could be needed to ensure lenders don’t make loans that won’t be repaid.”

Although I agree with you that abnormally low down payments present a hazard for the consumer as well as the lender, I can also see the possibility of a consumer protection agency coming out in favor of looser and looser standards.

They may come under political pressure or from potential homeowners themselves to try and force somewhat loosened standards to protect them from too rigid standards that would keep them from realizing their “American Dream”.

Posted by JeffDB | Report as abusive

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