“When Regulation Reshapes Markets: The Migration of Corporate Lending” by Vice Chair for Supervision Michelle W. Bowman
At the Hoover Institution Annual Monetary Policy Conference, Stanford, California
“Today, I will address a challenge that emerges at the intersection of these two responsibilities. That is, when regulatory requirements become disproportionately burdensome relative to risk and banks simply curtail the targeted activities. This leaves a deficit between demand for banking services and banks that are willing to provide them. When banks are no longer willing to provide specific services, nonbanks step in to meet those needs, and the activity is essentially pushed out of the regulated banking system.
This includes the migration of corporate lending from banks to non-banks. Therefore, my remarks will focus on private credit funds, and business development companies (BDCs), and will consider the circumstances that lead to this outmigration, the implications of banks exiting these services, and the Federal Reserve's policy response.”
“There is no mystery about what drove the shift in corporate lending away from banks. While post-2008 financial crisis reforms strengthened bank capital and liquidity—which were necessary to promote the safety and soundness of banks and U.S. financial stability—they did so with unintended consequences. Attempts to address legitimate gaps resulted in some requirements becoming excessive relative to underlying risk, forcing banks to pare back on some corporate lending activities or to raise the cost of credit to borrowers. The effects of the current framework become clear when we examine the incentive structure that it creates. Current capital rules create a perverse incentive—ironically, banks receive a more favorable treatment for lending to private credit funds than for lending directly to creditworthy corporations. This treatment encourages banks to finance intermediaries rather than directly serve end-borrowers.” ~ Supervision Michelle W. Bowman.
(portrait ® curtesy of ABA Banking Journal)
Historically my personal take on this: when we have more Equity Firms investing in both real estate and development, by borrowing from the banks under Equity firms financing we re-shifting entire capital into non-banking system market and make it 10 times more vulnerable for external take over. WHy? subprime lenders and equity firms make money on acquisitions and commercial mergers. Usually this means selling off debts and some assets, almost constantly. This leaves a huge legal loophole, of not being able to control the debts sale properly or track it beyond original financing via direct landing bank. In other words - you have a lack of control over your permanent collateral and debt.
This is also how and where, commercial and private equity real estate fraud, crawls in. This is partially, why crisis of 2008 happened on the first place: subprime landing via side financing inc., or re-purchased assets, by the main corporate bank, like citibank ®, for example. We were giving out … second mortgages in amount of $1,5 + to $3,5 + Millions on existing homes, that were barely valued at $400k, As a subsidy of the main bank. What happened next? Bay area became … unaffordable for most. With the still exact same properties, that should have not been valued at more than $400K to now all being sold and re-sold at min $1.5M. Why?
We did not have to do any inspection prior to second mortgage or re-financing. Legal Loophole #1.
If borrower goes bankrupt, secondary mortgage (our loan) has to get paid first, before the first mortgage lender does, during the foreclosure proceeding. Legal Loophole #2.
property Insurance, usually automatically transferred existing primary policy without extra inspection, in already adjusted new value based on new mortgage amount. Legal Loophole #3.
Bad Legal Loophole for the borrower? Increased interest rate, from 6.75% to almost 15% in some cases, and there for monthly payment amounts increase. In some cases from $1,800.00 a month to almost $3,500.00 a month. Ironically, people were willing to do it, even after we explained all of the risks. Many of them actually took out, imaginary equity, we had created by inflating property values, to? … pay for their kids private schools or adding new pool. This was a major reason for borrowing between 2007 - 2010, in the branch I worked for.
This created economic burden not only for the bank itself, in the future, because none of the properties will probably ever be sold at higher than $700K on auctions; but also for borrower, who will not be able to refinance as easily in the future or cash out for a while.
Borrower’s loophole exit? There is one. their only option will be to wait for the better rates & re-finance without cashing out, with only one lender. Basically - get rid of secondary mortgage.
There are many, many legal loopholes in our banking system. Like absence of the requirements for exact house plan (blue prints) with all electrical and plumbing mapping locations being included with the mortgage or created during the inspection before final funding. Our lending system does not consider this important I guess. Why not? YOu include the map drawing of the parcel lot, why not include the house plan?
So many things that legally do not yet make sense within our banking, mortgage & real estate financing system. I learned some interesting aspect of German real estate lending system. YOu are requested not to sell the house you finance or buy, for at least first 5 years from the purchase, in order not to inflate local market & keep local housing affordable for their citizens, rather then speculative foreigners. Otherwise, they will charge you a very high tax on top of sales price. We can learn a lot from international banking community. Many countries have different & sometimes, more conservative banking laws.
I began working for Citifinancial inc., as Arcadia Auto in 2003, & moved from Back end remarketing & repossessions to citifinancial inc.account branch manager position in private subprime lending. I left Citifinancial Inc. subsidy of citibank ®, in may of 2009, due to mS disability & permanently retired as of May of 2010. CitiFinancial Inc. was Acquired by OneMain Financial, in 2009, as part of Citigroup’s divestment of non-core consumer finance assets & ceased to exist in 2017. CitiFinancial Auto was sold to Santander Consumer USA, who agreed to purchase $3.2 billion of its auto loan portfolio in June 2010, while also servicing an additional $7.2 billion of car loans retained by Citi ®. This was by far my favorite job ever.
To be honest, sometimes, I wish I would have convinced people who came to borrow not to do it. I could have denied them, But my job was to: locate & repossess unpaid vehicles, sell loans & open bank accounts, & so I did. Yes I felt absolutely horrible at times, to leave a single mother with 3 kids with … no car, to sleep in. repo agent’s, in most cases, where kinder than banks, they offered them a housing, groceries or the hotel, at least overnight, but WE? … billed it as an “extra transponder keys fees”, between $75.00 to $125.00 per key, to make ourselves feel better …
YOu have to remain human, when your job is to take something essential to ordinary person’s lifestyle away. Sometime, good people do simply get in a bad situations, & we have to consider human circumstances. Not everyone who is defaulting on car loans are criminals, illegals or gamblers drug addicts. Far form everyone. actually, ironically, only few, would fit this profile. About 75 % of the defaulting loan clients are ordinary middle to low class citizens, who got into unfortunate life circumstances or period IN live. Small business OWNERS, like body shops, nail salons with private loans, or single moms, with day care at home llc. You feel like an ... asshole. You know she/he has no home or place to sleep, but? your own welfare depends on your paycheck. AND YOU APPROVE REPO, APPROVE FORECLOSURE, BUT YOU PAY AN EXTRA FEES. Reality is not always black & white, it’s actually mostly grey. SOME OF US HAVE TO DO THE DIRTY JOB, NO ONE ELSE WANTS TO DO. As a banker - try to consider human side beyond profits.
Watch movie The International, february 13, 2009 release.
