Rarely does a merger of two companies encapsulate the utter failure of government regulators to protect the U.S. economy and average Americans from the wilder throes of the free market, especially when those very failures are responsible for what currently threatens our immediate national prosperity. Bank of America Corp’s $4 billion purchase of Countrywide Financial Corp. and the lack of substantive efforts to stabilize the housing market define these two failures.
The merger itself highlights the macro-economic problem of “too big to fail.” The beleaguered housing market underscores that there are numerous homeowners who together are “too small to fail.” Countrywide is on the verge of bankruptcy due to its undisciplined and at times unscrupulous mortgage lending operations, which helped contribute to the current housing crisis that now threatens to drag the country into recession. Allowing Countrywide to slip into bankruptcy, however, would threaten millions of homeowners who would see the housing market further unnerved by such a dramatic collapse, which in turn would certainly roil our already fragile economy.
That suggests that BofA’s purchase of Countryside is probably good for the housing market and good for the economy in the short term. Problem is, BofA might be able to technically avoid violating the statutory limit of 10 percent of nationwide deposits for any one bank if the deal is approved by regulators, but the law’s aim of avoiding excessive concentration of banking assets will obviously be undermined by this merger.
The upshot: U.S. taxpayers may well bear the ultimate risk as U.S. regulators allow the financial services industry in this country to become more and more concentrated in the hands of fewer and fewer megabanks. BofA, the nation’s largest bank after a string of multibillion dollar deals over the past few years, exemplifies that trend.
The details of the purchase and the antitrust issues it raises are complex, but the overarching issues are clear. Undisciplined mortgage lending and the securitization of many of those loans now leave U.S. regulators with a huge financial mess that could well get much worse much more quickly if Countrywide opted for bankruptcy. That presents a Hobson’s choice for regulators at the Federal Reserve. Either they risk letting Countrywide fail, with potentially serious ripple effects throughout the already beleaguered mortgage markets. Or they let one of the nation’s megabanks get even bigger, exacerbating the too-big-to-fail problem.
Indeed, the Fed brought this problem upon itself. It did nothing under the Home Ownership Equity Protection Act to provide better regulation of non-bank mortgage lending of the sort that the larger, non-bank part of Countrywide does. The Fed failed to provide effective consumer protection while all the banking regulators failed to provide effective prudential regulation.
BofA’s purchase of Countrywide certainly will help U.S. financial regulators cope with the mortgage crisis, but the so called “moral hazard” it raises for the entire U.S. financial system is alarming. The subprime mortgage crisis is the latest example of financial institutions promoting risky products to too many people and then leaving it to U.S. regulators to help them stave off financial trouble when those risks prove to be too great for their balance sheets to bear.
Nobody is seriously suggesting letting Countrywide fail, which of course leaves it to the regulators to figure out a way to save the company. Yet the subprime mortgage crisis has created a situation where many of the players in this formerly lucrative marketplace are collectively too big to fail, while at the same time creating a wider economic situation in which individual homeowners are collectively too numerous to fail.
Further declines in housing markets may mean we will reach the point where homeowners who have no trouble paying their mortgages make the rational decision to walk away from their mortgages because the underlying asset isn’t worth the cost. Negative equity isn’t simply a barrier to refinancing anymore; it’s a serious threat to everyone with a house or holding mortgages. While financial markets and regulators may breathe a sigh of relief that we need not fear the problem of too big to fail, at least temporarily, there has been little done to solve the problem that numerous homeowners are too small to fail.
Helping beleaguered homeowners cope with the housing market downturn is the immediate issue at hand, of course, as the U.S. economy teeters on the edge of recession. But it has to be handled carefully. Our proposed Family Foreclosure Rescue Corporation is one such solution, which in tandem with other measures could help stabilize the housing market in the coming months.
Tackling the larger financial regulatory issues related to financial institutions and financial markets that are “too big to fail” will require more careful consideration. One place to begin, though, is to examine closely conservative regulatory dogma that led to unbridled markets and securitization run amok.