Did the repeal of Glass-Steagall contribute to the 2008 financial crisis, and how does the Volcker Rule seek to prevent another crisis?
No, Glass-Steagall was repealed in 2000, but these problems began long before then. I don’t see any sign that behaviour got less responsible in 2001 than it was in 1999. The Volcker Rule is not a reinstitution of Glass-Steagall — there were things banks can do with the Volcker Rule that they could not have done under Glass-Steagall. The Volcker Rule is an effort to reduce the risk of a depository institution failing, so it protects the FDIC.
One of the problems with Lehman Brothers and AIG is that they threatened the whole economy. There is also the secondary threat to the FDIC, the insurance fund. The Volcker Rule is aimed more at the systemic threat. But it is also a step towards reducing the size and complexity of the bank, which is why I think the Volcker Rule is a good thing. The banks really have gotten out of control — literally no one person can run them, so it is a good alternative to breaking them up, because I don’t know how you would break them up.
The Volcker Rule was secondary though. The major thing we did with Dodd-Frank was to regulate the way that derivatives are transacted — which is putting them on exchanges, making them publish the price, and making them have capital and margin. Where derivatives are traded is more important to the stability of the economy than who trades them or how they are traded, and there are a set of rules in Dodd-Frank that regulates this, and then you also have risk retention. Risk retention, in the first place, means that the assets that are bundled into the securities, which can be the basis of derivatives, are less likely to default, and then the derivative trades themselves are much better regulated.
Do you think there is a bubble being generated in the subprime auto space?
I don’t study it as much as I used to, but I think The New York Times has done an important investigation. Whether or not it is a systemic threat yet, autos are important to people but they are not as important as houses given their overall economic effect.
You do not usually get the chance to test something on a control group in public policy. Over our objections, automobiles became the control group that was exempted from the Consumer Financial Protection Bureau’s regulations on lending. It is the area with the most lending abuses.
What’s your basis for saying that there are a lot of automobile loans to borrowers who shouldn’t qualify for them?
Performance is still strong, but that doesn’t mean that there aren’t abuses. The CFPB is not primarily concerned with stabilisation of the economy. Even if there is strong performance, the question is at what cost it is to borrowers.
Do you see the private-label securities market coming back?
I don’t know. If it does, it does. If we have risk retention, then that is all I worry about. As long as we have corrected the lack of incentive on the lender to worry about the quality of the loan, then I will leave it all to the market.
Do you see the risk retention exemptions for RMBS being removed at some point?
My hope is that risk retention will be restored to residential mortgages at some point. I think that will be only after it’s been shown to be necessary.
Does the fact that risk retention has been exempted for RMBS concern you that we are moving further and further down the credit stack?
That is the serious issue I have. We have put other things in Dodd-Frank, derivatives being traded in a more reasonable way and capital has been enhanced, but the RMBS exemptions for risk retention will still be damaging. Systemic risk arose because there were bad loans traded, and derivatives and no capital.
We did not need risk retention right away because people were so traumatised by the financial crisis that there was never going to be an immediate return to the bad practices.
Originations backed by the Federal Housing Administration and Fannie and Freddie are subject to a level of regulation imposed by the agencies that mitigates risk. My preference would be to have less risk mitigation by that and more by risk retention. I think risk retention would be a market solution and LTV and downpayment requirements are the regulations.
Are the FHA and the FHFA competing for market share, and increasing systemic risk as a result, as current House financial services committee chairman Jeb Hensarling has said?
I am troubled by that. There is a concern that things got too tight, that it was too difficult to get a mortgage. I don’t see the evidence but I don’t study this too closely. They have other protections besides minimum down payments, and no one factor should be determinative. I think their policies are more driven by having similar concerns than competition with each other, but I’m not sure.