Saturday, January 06, 2007

Bernanke’s Umbrella

Flying well “below the radar” was yesterday’s speech by Federal Reserve Chairman Ben Bernanke entitled “Central Banking and Banking Supervision in the United States.”

Although, this was not the type of event that could rival the day’s top headlines, even economic headlines, a closer inspection of the speech yields some uniquely relevant and timely information related to the plight of the housing market.

Namely, how the Fed and in particular, Chairman Bernanke, view the regulatory role of the Federal Reserve.

As was mentioned before, as part of it’s implementation of provisions of the Basel II accord, an international agreement which seeks to establish better management of systemic financial risk globally, the Federal Reserve recently published a series of regulatory recommendations that are to be implemented by the nations largest banking entities.

As a result, some institutions, such as New Century Financial (NEW.NYS), one of the country’s largest home lenders almost immediately implemented the recommendations.

The following is the list of changes announced by New Century in response to the Federal Reserves recommendations:

  • Tightening underwriting guidelines for its adjustable-rate mortgage programs for at-risk borrowers. This includes using the fully-indexed rate minus 1 percent as the qualifying rate for these borrowers.

  • Offering existing adjustable-rate mortgage (ARM) and interest-only customers who qualify the option of refinancing into a low fee 30-year or 40-year fixed-rate mortgage.

  • Implementing plain language disclosures that go beyond legal requirements in explaining terms such as prepayment charges, interest-only features, adjustable-payment features, escrows for insurance and taxes and other key features of a loan.

  • Enhancing its processes for confirming the income information provided on stated income loans. In addition to the closing certification currently employed, the company will introduce a new front-end confirmation early in the loan process to assist applicants in better understanding the terms of their loan.
This is no small achievement given that the new regulations could equate to a 20% to 50% reduction in loan originations, a substantial hit to their bottom line.

Other institutions, most notably, Countrywide Financial (NYSE:CFC), attempted to side-step the proposed regulations, at least in part, by applying for a change of status that would convert it to a federal savings bank unit of a savings and loan holding company.

This change, if approved, would put Countrywide under the regulatory oversight of the Office of Thrift Supervision rather than the Federal Reserve or the Office of the Comptroller of Currency.

This is where things may be heating up a bit.

Bernanke’s speech yesterday made direct reference to this type of organizational model stating:

“The Federal Reserve also serves as the umbrella supervisor of all bank holding companies and financial holding companies, which gives the U.S. central bank broad oversight responsibilities for these banking organizations. However, the bank and nonbank subsidiaries of such holding companies are often supervised by agencies other than the Fed.”

Bernanke goes on to assure that even in the case of subsidiaries of savings and loans, the Federal Reserve has certain regulatory oversight:

“At the operational level, the Federal Reserve System (including the twelve regional Federal Reserve Banks) works closely with other agencies to examine banking organizations and to ensure that they operate in a safe and sound manner and comply with the relevant laws and regulations. … I have already mentioned the Fed’s role as the umbrella supervisor, which affords it access to information (as well as direct or back-up examination authority) for all holding-company subsidiaries, nonbank organizations as well as banks.”

Bernanke then goes on to further outline the benefits of the Federal Reserve’s supervisory role as well recount some of the more notable financial crises’ and the Fed’s response.

In concluding his speech, Bernanke adds:

“I should be clear that my purpose today is not to make a comprehensive case that our current regulatory structure is ideal. To the contrary, we should always be looking for ways to make supervision more effective and less burdensome. My point today is a narrower one: that the supervisory authority of the Fed has significant collateral benefits in helping it carry out its responsibilities for financial stability.”

I think the key take away from this speech is that Bernanke has yet again reaffirmed his belief in importance of the Fed’s role as a regulator, and even went so far as to spell out in some detail the extent of it’s “umbrella” of regulation.

There is no doubt that Bernanke was suggesting that even subsidiaries of holding companies still fall under certain oversight of the Federal Reserve.


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