Bernanke on Subprime: Watch What I Do, Not What I Say April 3, 2007
Bernanke on Subprime: Watch What I Do, Not What I Say
The event on subprime lending put on last week by the DC
Chapter of PRMIA and the American Enterprise Institute drew almost 200 people. Many thanks to all who participated. The general tone of the discussion was bearish regarding the outlook for the housing market and the impact of a deflating real estate bubble on the US economy.
In our comments, we focused on how
extraordinarily low the credit default experience has been for different
types of banks: commercial lenders, mortgage lenders and subprime lenders.
We predicted that the default experience of most US banks would rise sharply in
the next 12-18 months and possibly test the peaks of the 1991
period. We noted in particular that the extremely-low default rates
of the larger mortgage and commercial lenders may be red flags for future
One highlight of the program was Nouriel Roubini of NYU, who continued to sound a warning
about sharply lower economic activity as a result of a generalized the
slowdown in housing sales, construction and related sectors. Nouriel's been
dead on target about the negative trends in the mortgage sector and caught a good bit of
"early bird" scorn and ridicule from Sell and Buy Siders, who did not want to
see the party end.
But now Roubini is clearly enjoying being right. He
gave a very concise, point-by-point rebuttal of Fed chief Ben Bernanke's "everything
is alright view." In fact, he did so just hours after Chairman
Bernanke told the Congress that the festering asset quality problems so apparent
in the subprime mortgage lending sector would not spread to other types of
lending and securitization.
The image of Bernanke
reassuring members of Congress that the subprime virus won't spread reminds us
of a bad science fiction movie, something
like Resident Evil where authorities
initially deny that a problem is escalating out of control, but then the
secret virus kills everyone on earth. While it may be difficult
to confuse Chairman Bernanke with zombie slayer Milla Jovovich,
there is no mistaking the rising tide of regulatory signals and very real activity coming from Washington to head off systemic problems in the banking sector.
For over a year, we have been getting reports from
former auditors and federal bank regulators about quiet appeals emanating from Washington asking them to come out of retirement. Why lure a retired bank examiner with 25 years bank audit experience back into service? To consult for small and medium size institutions facing internal controls problems. One case involved a community bank newly involved in C&I; lending. Another involves a regional bank with a case of toxic derivatives poisoning. But all of these triage samples involved one common malady: financial innovation.
More recently, subscribers to www.fbo.gov have
witnessed a flurry of proposals to enhance the flow of data and other resources available to federal bank examiners. In at least one case in 2007, a request for proposal came out of the Treasury that was intentionally structured to attract former regulators in a consulting capacity to act as advisors to their former colleagues. The new regulatory advisories regarding exotic mortgages, etc., fall into this category as well.
week, we even heard reports from several quarters that the RFP for the proposed modernization of the Shared National Credits survey is likely to be released before June. Now some three years since regulators published a proposal for public comment in the Federal Register to standardize and expand the data collected from regulated institutions, Shared National Credit or "SNC" is expected to be expanded to cover securitized loans, derivatives and counterparty risk reporting.
As we wrote in GARP Risk Review in December, moving forward with
the SNC proposal has been delayed for years because of the monumental disaster
regarding the implementation of Basel II, an ongoing train wreck that more
than one senior financial regulator has ridiculed publicly,
this even as the deadline for comments passed last week.
How departing Governor Susan Schmid Bies, who is responsible for
shaping the final Basel II proposal, can wax eloquent in the financial
media about her accomplishments at the Fed is beyond us.
The good news is that events in the credit markets are, as we predicted
some months ago, pushing theoretical musings about capital adequacy a la
Basel II into the background. With credit conditions softening and the
markets clearly jittery about liquidity problems regarding whole loans and collateralized debt obligations or CDOs, small surprise that the SNC program has suddenly risen from the dead. Indeed, if the proposed rule implementing SNC is published later this year, a rising tide of concern regarding the safety and soundness of banks may help to make the new reporting regime even tougher than anticipated.
One measure of the level of
anxiety surrounding the rapid completion of
the SNC project is the apparent decision not to employ eXtensible Business Reporting Language or XBRL in the first implementation of the new reporting regime. Sources close to the matter say that the decision was made to exclude XBRL in the SNC data gathering design in order to ensure that the project is completed "on time" once the government selects a vendor to perform the task.
With members of both major political parties in the Congress talking
openly about lenders offering forbearance to subprime borrowers, those
of us who've already seen this movie wonder how far Washington will go
in socializing the losses from the mortgage market debacle. If the magnitude of
the crisis is severe enough to challenge the bank loan default rates of the
early 1990s, it is possible that the Congress will be tempted to legislate
forbearance, perhaps forcing the GSEs to purchase the delinquent paper from
private banks and investors.
growing hum of activity in Washington surrounding the provision of enhanced bank supervisory resources and risk reporting generally should gradually make clear that everything is not really alright in the banking sector. Between now and when the markets generally
understand this fact, Fed Chairman Ben Bernanke needs to write a new, somewhat more compelling series of responses for that next set of questions about the burgeoning crisis in US asset quality.
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