The regulators weren’t even watching
To help understand why the Obama administration is pushing for greater financial regulation, it may help to examine the case of Orange County’s Ameriquest Mortgage Co., whose dizzying rise was followed by a monumental crash.
The company and its affiliates had grown to become the nation’s largest subprime mortgage lender when, in January 2006, Ameriquest coughed up $325 million to settle charges it misled borrowers and falsified loan documents. Representatives of 49 states, the District of Columbia and even Alameda County signed off on the deal.
But as Ameriquest and its parent firm cut the deal, Uncle Sam was noticeably absent. Ameriquest, based in Orange, wasn’t a deposit-taking bank or savings and loan, so it wasn’t subject to scrutiny by federal bank regulators.
In the annals of problems stemming from weak federal oversight, Ameriquest could easily serve as Exhibit A, not for itself alone, but for the largely unregulated financial company it kept.
Wall Street enabled Ameriquest and other nonbank lenders to thrive, providing funds for their loans.
It bought the loans and bundled them into what are now vilified as “toxic assets,” the poison at the “too big to fail” banks that have received most of the federal bailout funds. State-regulated insurer American International Group Inc., the largest bailout recipient, guaranteed billions of dollars of these mortgage-based bonds.
In proposing sweeping regulatory changes, Obama administration officials say the financial crisis would have been avoided or tempered had a federal agency been given the power to root out and halt such “systemic” threats.
Instead, the financial chain that began with subprime borrowers was overseen -- or not -- by a jumble of lesser federal and state regulators, many adopting a hands-off approach in the deregulatory era that began under then-President Reagan and continued during the Clinton and Bush presidencies.
The Securities and Exchange Commission, for example, provided little oversight of mortgage-backed securities or the credit rating firms that blessed them, said Chapman University law professor Kurt Eggert, an expert in this “securitization” process.
“Whole chunks of the mortgage business, including securitization, were almost completely unregulated,” said Eggert, a former member of a consumer advisory panel for the Federal Reserve.
Creators and buyers of these bonds sometimes bought guarantees for the securities, through direct insurance policies on the loans or complex financial contracts called credit default swaps, which were supposed to reimburse investors if the bonds went bad.
The insurance business was state-regulated and the credit default swaps were largely unregulated.
AIG was a big player in the insurance and credit default swap markets. It’s now suing Countrywide Financial Corp., accusing the lender of misrepresenting the quality of loans it insured. AIG was bailed out to the tune of $182.5 billion largely out of fears that huge financial firms worldwide would collapse if it didn’t stand behind the credit default swaps.
It also operated a small savings bank regulated by the U.S. Office of Thrift Supervision. In a November interview with ProPublica, an investigative news organization, an OTS official acknowledged that the Treasury Department agency had failed to grasp the threat posed by the complex swaps.
Policing those lofty financial realms is far beyond the traditional purview of most state officials.
State attorneys general generally have focused on the “front end” of the mortgage business, seeking damages for borrowers. Examples include the Ameriquest settlement and October’s agreement by Countrywide owner Bank of America Corp. to modify hundreds of thousands of loans to settle charges of lending abuse brought by California and other states.
“They get big settlements against the [mortgage] originators,” Eggert said. “But it didn’t touch the securitization at all.”
Robert Gnaizda, policy director of the Berkeley advocacy group Greenlining Institute, said he began lobbying the Federal Reserve and others in government in the 1990s to extend the same regulatory scrutiny to Wall Street firms and big insurers that deposit-taking banks and thrifts were subjected to.
Greenlining also asked the Fed to police nonbanks, which, like Ameriquest, were not overseen by bank and thrift regulators at the Office of the Comptroller of the Currency, the Office of Thrift Supervision or the Federal Deposit Insurance Corp.
The idea was to establish solid standards across the entire mortgage industry, banks and nonbanks. Instead, Gnaizda said, regulated savings and loans increasingly adopted the looser standards of the independent home lenders, joining a race to the bottom in lending practices.
Free-market advocate Alan Greenspan, the Fed’s chairman from 1987 to 2006, “had a stranglehold on all the thinking” and discouraged such regulatory expansion, Gnaizda said.
Occasional federal consumer-protection actions against mortgage lenders have not typically extended to the Wall Street connections.
An example is the Federal Trade Commission’s decision to pursue subprime lender First Alliance Corp. but not its major backer, Lehman Bros.
The FTC filed a fraud lawsuit against the Irvine lender, which collapsed into bankruptcy in 2000, and won a $75-million settlement from the firm and its founder in 2002.
But the FTC declined to sue Lehman despite the disclosure of internal memos at the Wall Street firm describing a First Alliance corporate culture that required employees “to leave your ethics at the door.”
Private attorneys sued Lehman instead, and a federal jury in Santa Ana decided in 2003 that the august firm was liable for aiding and abetting First Alliance’s fraud.
Lehman collapsed into bankruptcy in September, reeling from $60 billion in soured assets, after attempts to rescue the 158-year-old firm failed.
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