The Good Elizabeth Warren Will Do For the Banking System

To listen to bank lobbyists, one would conclude that Elizabeth Warren, recently appointed an adviser on consumer protection to President Obama and Secretary of the Treasury Geithner, must be a really bad person incarnate. They were planning to pull out all the stops to prevent her confirmation by the Senate as the head of the new consumer protection bureau at the Federal Reserve. President Obama's appointment of her as an adviser does not require Senate confirmation.

What Warren and the new consumer protection bureau can, and hopefully will, do is stop the lunacy in the banking system. The baseline reason for today's economic problems isn't the federal deficit, or the tax system, or the exchange rate between the yuan and the dollar, or the Fed's printing of trillions of dollars, or the new health insurance legislation. The baseline problem is that the banking system made a shipload of really stupid, indefensibly idiotic mortgage loans. Bankers loaned money without verifying borrowers' income, assets, or employment, and paid scant heed to credit histories. All many borrowers really needed was a pulse and a signature. Bankers utterly disregarded lending standards and risk management, blithely assuming that the risks associated with the lending insanity would be passed to the investors that bought this toxic financial waste. Because of the way the mortgage market worked, higher compensation was paid to mortgage bankers and brokers for underwriting riskier loans than for 30-year fixed rate mortgages to people who had downpayments and might actually repay the loans.

The end result was the accumulation of almost incalculable amounts of systemic risk, risk that exploded and imposed trillions of dollars of losses on banks, homeowners, businesses, laid off workers, and taxpayers. Sure, some (although not all) of the borrowers who took out nutty loans had some idea of what they were getting into. But they knew of their individual risks--that the interest rate might rise, that there would be a balloon payment at some point in the future. What they didn't know--and what nailed many of them and all of the rest of us--was that the entire system was poised for a fall because the indescribably imbecilic lending had taken place on a large-scale, nationwide basis. Indeed, even the most knowledgeable federal banking regulators were either clueless, in denial, or both when it came to the systemic risk presented by the morons of mortgage lending. We're still paying the price for this disaster and will do so for years to come. The absence of consumer protection left us all without protection.

The new bureau shouldn't just impose ritualistic disclosure requirements. When borrowers arrive at the closing and find thousands of pages of documents to plow through, disclosure requirements amount to regulatory failure. The new bureau should substitute its judgment for the dysfunctional judgment of bankers (and borrowers, too, since some of them were complicit in taking out loans they realized were foolish but took anyway in order to gamble on the real estate market rising). There was a fundamental market failure in mortgage lending, and sound regulation can fix such failures. Imagine banking without federal deposit insurance if you question this notion.

Mortgage loans are already unavailable to many less creditworthy borrowers, and rightfully so. It does them--and we taxpayers--no good if the banking system accumulates a mountain of bad loans that strip defaulting homeowners of their savings, credit ratings, and pride, and taxpayers of funds badly needed for other priorities. With today's tight underwriting standards and the overall unwillingness of banks to lend, it's unlikely that the new consumer protection bureau can reduce the availability of credit a whole lot. What it may do--and this is probably what bankers fear the most--is that as the economy recovers the consumer protection bureau may prevent the banks from returning to the highly profitable insanity in which they reveled earlier this past decade. Amen, say the rest of us.

Consumer protection in this case isn't about a bunch of liberals on federal salaries singing, "If I Had A Hammer." It's about imposing and enforcing prudential consumer lending requirements on banks that protect us all. Not just borrowers with eighth grade educations, or workers whose native language isn't English, but also the most well-educated, well-read, and wealthy of Americans, because we all have a stake in the well-being of the financial system.