Causes, Consequences and Implications for Reform
Edited by Lawrence E. Mitchell and Arthur E. Wilmarth, Jr
Chapter 6: Federal Preemption, Regulatory Failure and the Race to the Bottom in US Mortgage Lending Standards
Patricia A. McCoy* INTRODUCTION In the debate over the Great Recession of 2008–2009, much attention has been paid to whether consumer financial protection should continue to be dispersed among state and federal regulators or transferred to a single federal agency dedicated solely to consumer protection, as the Obama Administration has proposed. In this chapter, I argue that the Administration’s proposal is essential for three reasons. First, during the housing bubble, our system of fragmented regulation drove lenders to shop for the easiest legal regime. Second, the ability of lenders to switch charters put pressure on banking regulators – both state and federal – to relax credit standards. Finally, banking regulators have routinely sacrificed consumer protection for the short-term profitability of banks. Creating one, dedicated consumer credit regulator charged with consumer protection would establish uniform standards and enforcement for all lenders and help prevent another death spiral in lending.1 The reasons for the breakdown of the home mortgage market and the private-label market for mortgage-backed securities are well known by now. In this chapter, I focus on lax lending standards for residential mortgages, which were a leading cause of today’s credit crisis and recession. Our broken system of mortgage finance and the private actors in that system – ranging from mortgage brokers, lenders, and appraisers to the rating agencies and securitizers – bear direct responsibility for this breakdown in standards. The story does not stop there. In 2006, depository institutions and their affiliates, which were regulated by federal banking regulators, originated about 54 per...