Congress Grilled Bank Regulators on 3.4.08: Asks Why A Warning Bell Didn't Sound On Risky Lending Practices?

Implications: Senator Chris Dodd, Chairman of the Banking Committee grilled bank regulators on 3.4.08 to determine why regulators didn't intervene as loose lending standards led to a meltdown in the mortgage market and caused a credit crunch that could thrust the U.S. economy into a recession. Regulators Donald Kohn & John Dugan testified they were aware of the loosening of underwriting standards before the mortgage collapse and merely spoke to banks about it. Did borrowers with Ninja loans lead to the subprime crisis? No income, no job and no assets (Ninja) loans were geared towards subprime borrowers with a shaky credit history and as "teaser" rates reset subprime borrowers are defaulting on mortgages at record numbers. Subprime ARMs accounted for 43% of all new foreclosures in 3Q07 and Prime ARMs made up 18.7% of foreclosures started. The mortgage crisis has forced Wall Street banks to writedown more than $130 billion in assets and to obtain more than $100 billion in capital infusions.

Analysis: Senator Chris Dodd, Chairman of the Banking Committee and other ranking members grilled bank regulators Sheila Bair - Chairman, FDIC, John Dugan - Comptroller of the Currency, U.S. Treasury, John Reich - Director, Office of Thrift Supervision, JoAnn Johnson - Chairman, National Credit Union Administration, Donald Kohn - Vice-Chairman, Board of Governors, Federal Reserve System and Thomas Gronstal - Superintendent of Banking, State of Iowa, to asks "why didn't they do more and were they asleep at the switch when the alarm went off or did they just hit the snooze button?" These are valid questions as credit losses continue to mount in the U.S. as more homeowners struggle to pay their mortgages. Mortgage defaults and foreclosures have crippled credit markets and banks are pulling back on all kinds of credit, including mortgages, student loans and credit cards, resulting in a credit squeeze.

1. U.S. banks' "perceived" soundness could be in jeopardy when banks implement new capitalization and risk management standards under Basel II, the new global banking guidelines. Basel II guidelines rely more heavily on internal bank risks models, which may have contributed to the current crisis

2.  Years of loose underwriting standards may have come back to haunt the U.S. financial industry as homeowners fall behind and default on their mortgage loans. In 2007, lenders initiated roughly 1.5 million foreclosures and that number could creep up to over two million home foreclosures in 2008, as Subprime ARMs reset and mortgage payments balloon, which could prevent homeowners from making their mortgage payments

Takeaway:  Regulators are vying to do more in oversight  and regulation of U.S. banks to calm investors' fears and work with lenders  to restructure mortgages so that more homeowners can keep their homes, however, it may be too little too late. Many of the mortgage assistance efforts merely give borrowers a chance to pay off missed payments rather than lower their monthly payments, which only delays foreclosure. Some lenders are restructuring more mortgages by lowering or freezing interest rates and reducing the principal balance. These solutions are more likely to help homeowners save their homes.