What Really Happened?

It is difficult to get a clear or consistent account of what went wrong between banks and their regulators in the run-up to the crisis. So many accounts in the press are evasive and muddled – if you stop to look more closely.

According to a story in The New York Times, for example, the problem was lack of time: “At bank after bank, the examiners are discovering that state and federal regulators knew lenders were engaging in hazardous business practices but failed to act until it was too late.” But was it really a matter of being too late? “At Haven Trust, for instance, regulators raised alarms about lax lending standards, poor risk controls and a buildup of potentially dangerous loans to the boom-and-bust building industry. Despite the warnings — made as far back as 2002 — neither the bank’s management nor the regulators took action.” If the banks were warned in 2002, how could that be seen as “too late” for them to act? (See, “Post-Mortems Reveal Obvious Risk at Banks.”)

The article goes on: “Given the past lapses, some wonder whether examiners will spot new troubles in time.” But again, is time really the problem? Did they really speak up loudly and forcefully enough to be heard, or to compel action? How would more time have helped?

The article does go on to suggest additional reasons: “Many bank examiners acknowledge they were lulled into believing the good times for banks would last.” That sounds more plausible, but isn’t that just what regulators are supposed to do, pointing out that banks can’t just believe what they want. Bankers may be lulled into ignoring risk, but regulators are there to point out the problems they have neglected or ignored, to blow the whistle.
“They also concede that they were sometimes reluctant to act when troubles surfaced, for fear of unsettling the housing market and the economy.” But shouldn’t the buyers and sellers of housing be “unsettled” if the market is dangerous? Don’t they need protection, at least warning? Perhaps, though, they were not the only ones who might be unsettled?

A hasty reading of this account might lull the reader into accepting this tissue of mystifications and banalities. A closer look suggests a form of collusion between the banks and their regulators. Did the regulators identify too strongly with the bankers, blurring the distinction between their roles as they rooted for more and more returns in the industry? If regulators hoped for jobs in banking, did they soft peddle their comments so as not to antagonize potential employers? Were they demoralized and understaffed, unwilling to go out on a limb and risk complaints and criticism for taking unpopular stands?

We seem to need some more aggressive digging into the subject. It would be really useful to have clear answers – but that might take too much time.