Much of the country, and especially California, has yet to fully recover from the Great Recession, which officially ended in June 2009. But recent federal government actions may be leading us into another financial crisis.

That was the warning from Securities and Exchange Commissioner Daniel Gallagher at a panel discussion last week in San Francisco sponsored by the Pacific Research Institute, CalWatchdog.com’s parent think tank.

A prime cause of the financial meltdown in 2007-08 was subprime, low-down-payment mortgage lending to marginally qualified borrowers who defaulted when the housing market collapsed, sticking financial institutions with securities full of junk loans.

In the aftermath, lending requirements were tightened.

“In 2011, they proposed a 20 percent down payment, some high loan-to-value ratios, some things that otherwise would have been deemed just prudent lending standards,” said Gallagher. “I know they are the ones that apply to me and that I always comply with in the couple of mortgages that I’ve had.”

Another reform was the credit risk retention provision in the Dodd–Frank Wall Street Reform and Consumer Protection Act.

“It says that when you securitize asset-backed securities that, unless a carve-out applies, unless the exemption applies, you have to hold back 5 percent,” said Gallagher. “You have to have skin in the game if you’re the securitizer. And that will make you do more diligence. That will make you, unlike what we saw happen in the years leading up to the crisis, put better quality assets in [investment] vehicles.”

The tighter lending requirements have resulted in many low-income, credit-risky borrowers no longer being able to obtain mortgage loans. And that resulted in an outcry from the same groups that had pushed for easier lending practices before the subprime mortgage crisis.

“The push-back, bipartisan on the Hill, across the board from community activists, lobbyists for the home builders, was so intense that last year we re-proposed the rule,” Gallagher said.

The proposal was to re-define what comprises a “qualified residential mortgage” for the purposes of the credit risk retention provision.

“I don’t think the government should be mandating risk management, so let me take a step back and say [this] is folly,” said Gallagher. “But if you’re going to engage in it and you have to define QRM [qualified residential mortgage] and if it’s a carve-out from a risk management standard, you’d think you’d want to codify some prudent lending standards.”

Definition

The definition of a qualified residential mortgage was proposed to be the same as that of a “qualified mortgage,” as defined by one of the new Dodd-Frank regulatory agencies, the Consumer Financial Protection Bureau. That definition requires mortgage lenders to make a good faith effort to ensure borrowers can repay their loans, but it does not require a down payment.

“So basically we outsourced a definition to a group where it’s held by agencies overseen by one person, unaccountable to Congress, it’s within the Fed [Federal Reserve System],” said Gallagher. “And their definition says no money down. So our QRM that was made final today, the federal government has said you are making qualified mortgages even if there is zero down.

“In a 3-2 vote of the commission – you can guess where I came out – we were one of the six agencies that codified this rule. This is probably, of the nine 3-2 dissents I’ve had to endure in three years [on the SEC], this one hurts the most.

“Because I really do think this was the cause of the financial crisis. And the SEC is an agency that’s sort of on the edge of some of these systemic risk issues. This was our chance to play the hero and say, ‘No, no, no, we are not going to go along with this.’ The mandate says we all have to do this at once. If we don’t do it, then no one does it and we can never put something in the code of federal regulations that says a qualified mortgage can be a zero-dollar-down mortgage. And guess what? They succumbed to pressure. The president called them all in to the White House a month ago to impart upon them how important it was.”

Planned

That prompted panel moderator and former U.S. Rep. Chris Cox to joke, “The good news is that you can now just take out your cell phone and call 1-888-NODOWN.”

Gallagher laughed along with about 100 people at the Oct. 22 luncheon in the Omni Hotel in San Francisco. But he’s seriously concerned about the return to loose mortgage lending practices.

“At the same time we did this rule-making, and believe me it was planned this way, [it was] announced last week that Fannie [Mae] and Freddie [Mac] will now be loosening their standards to provide more credit,” Gallagher said. “They only control right now 80 percent of the mortgage market. When you add Ginnie Mae … you get to 99-plus percent of the mortgage markets. There is no private mortgage in the United States right now, and we codified it today.”

Former SEC Commissioner Paul Atkins agreed that it’s looking like mortgage crisis déjà vu: “So we are hurtling down again for a repeat of ’08, of course. Just like leading up to that, between Fannie and Freddie they held far and away the majority of the Alt-A and the subprime mortgages at the time. So that’s a repeat of it obviously.”

Potentially adding to economic turmoil is a long-delayed but inevitable interest-rate hike by the Federal Reserve. That would be a boon to small investors currently earning 0.5 percent interest or less on their savings accounts, but it threatens to roil the stock market and will explode federal debt payments.

“Like many, this year I had hoped to see the first interest rate rise,” said Gallagher. “What we saw when [Ben] Bernanke was still [Fed] chairman last summer, when [he] mentioned the potential for an interest rate rise at some point in the future, the markets dropped 700 points that day, big swoon, scared the heck out of the administration.

“That caused them to walk so far away from potentially raising rates in a prudent manner in the near term. Then, of course, Bernanke leaving and [new Chairman Janet] Yellen being much more dovish, I don’t expect [interest rate hikes] any time soon. They are indicating next summer.

“Until we get to that point, we will have this irrational activity in the markets where folks are seeking out yield, taking on risks that they might not understand, and a distortion in the markets that shouldn’t exist because the government shouldn’t be there.”

National debt

Cox noted that the artificially low interest rate has also caused a distortion in how the national debt (currently $17.9 trillion) is being perceived and handled.

“From a fiscal policy standpoint just looking at the federal government’s finances, even at today’s interest rates, interest on the debt is the number one entitlement program,” said Cox. “And it’s a lot of taxation. It represents almost the entirety of individual income taxes. We just take that money, light it on fire and it pays the interest carry on our currently extant debt, which has grown rather rapidly every year.

“If interest rates climb, then very quickly – it doesn’t take much – you find that at today’s level of spending you can account for the entirety of the federal budget with just interest on the debt. Within the parameters that we’ve experienced, you don’t have to go back to the ’70s to have those kind of rates to get you there. So [there’s] a lot of cost in raising those rates. The Fed is going to be looking at any way not to do that. But they don’t control interest rates entirely. The market still has account.”

The panel also focused on warnings about the potential over-reach of another Dodd-Frank agency, the Financial Stability Oversight Council. The panelists are concerned that FSOC regulations will hurt the competitiveness of the capital markets. Currently three companies are in its cross-hairs – AIG, GE Capital and Prudential Financial – with Met Life likely next in line.

The panel was moderated by FCD Chair Chris Cox, a former chairman of the Security and Exchange Commission and former longtime U.S. congressman from Orange County. Cox said the Nov. 4 election “will have an impact on everything, from health care to financial regulation.”

He pointed to the 2010 Dodd-Frank financial reform, which passed without a single Republican vote in the Senate or House. Although the bill was supposed to make another financial crash less likely, instead it imposed 2,379 new pages of regulations on banks and other businesses – yet just yesterday spurred the relaxation of housing lending.

The spotlight passed to Daniel Gallagher, one of two members of the U.S. Securities and Exchange Commission who yesterday objected to the new relaxation. “Three U.S. agencies signed off on relaxed mortgage-lending rules Wednesday, helping complete a long-stalled provision of the 2010 Dodd-Frank financial law,” the Wall Street Journal reported this morning. “Two Republican SEC commissioners, Daniel Gallagher and Michael Piwowar, objected to the rules.” The three approving agencies were the Federal Reserve Board, the Securities and Exchange Commission and the Department of Housing and Urban Development.

The paper quoted Gallagher, “Today’s rule-making takes the untenable housing policy that injected irrational exuberance into mortgage lending and, as a result, caused a catastrophic financial crisis and chisels that failed policy into the stone tablets of the code of federal regulations.”

At the event in Costa Mesa, Gallagher said that, when reforms were proposed in 2011, a 20 percent down payment was going to be required for loans. But yesterday’s action dropped that to zero percent. “Here was a chance to make right what was wrong in the sub-prime bubble” of a decade ago, he said, when a similar easy-money policy first hit the housing market, then cascaded through the capital markets.

Gallagher also said the Dodd-Frank bill made the mistake of regulating the capital markets, which raise investment money, the same as banks. Which means bank regulators will be in charge of investments. The problem, Gallagher said, is that “bankers don’t understand other types of regulation.”

Fatal Conceit

Dodd-Frank’s deficiencies also were highlighted by Paul Atkins, CEO of Patomak Global Partners and a former SEC member. He referred to “The Fatal Conceit: The Errors of Socialism,” the final book of Nobel economics laureate Friedrich Hayek.

For Hayek, the “conceit” was that a group of really smart people could run millions of people’s lives better than they can themselves. Dodd-Frank’s fatal conceit, Atkins said, was to “get all the best people in Washington together and make the capital markets stable. But they’re inherently unstable. That’s the underlying falsity of the Financial Stability Oversight Council,” one of the new bureaucracies Dodd-Frank created.

Atkins was seconded by Brian Cartwright, a senior advisor at Potomak and former general counsel at the SEC. “The powers of the FSOC are broadly and vaguely enumerated,” he said. He pointed back to 50 years ago, when banks were the primary investment vehicle in America. By contrast, today “80 percent of financing comes from capital markets, not banks. There is a tension between traditional banking and capital markets, and it’s not just the U.S., it’s global.”

He said banking regulation was “fairly good,” and has to be because banks “leverage” deposits – meaning leading out money – at 10 times deposits. So stiffer regulation is needed to make sure the deposits are lent out responsibly.

By contrast, capital market leveraging is much smaller. “The notion you would impose bank regulation on this is pretty wild stuff,” he cautioned. “I’m hoping this won’t happen.”

Rep. Ed Royce

“This is worse than the Fatal Conceit,” charged Rep. Ed Royce, R-Calif., the senior member of the House Committee on Financial Services and the chairman of the Committee on Foreign Affairs. “It’s not just a bank-centric model of regulation, it’s more like a utility.”

By that, he meant government was allowing banks to gain a certain profit for a highly regulated service, such as electricity or water. But that means, “You’re not allowing bankers to be bankers. And you’re putting such additional costs on local community banks, you’re allowing them to be gobbled up” by the big banks that more easily can absorb regulatory costs.

Royce said now is the time for reforming the Dodd-Frank reform because “my Democratic colleagues are getting skittish about waiting for the economic recovery.” His analysis of the economic situation was confirmed a couple hours later at the latest Cal State Fullerton Center for Economic Analysis forecast. “Mediocre growth seems to be the new norm,” said director Anil Puri, as reported in the Orange County Register.

Royce continued that the over-regulation of Dodd-Frank was “seeping out into the rest of the capitalist system,” retarding growth.

Royce said some action could come in the lame-duck session of Congress after the Nov. 4 election. But if Republicans take over the Senate, the real action would come next year. President Obama could veto any potential straightening out of the Dodd-Frank regulations. But if some Democrats join with the potential Republican majority to comprise 2/3 of both houses, “presidents tend to take a second look at such legislation.”

Location: The Westin South Coast Plaza, 686 Anton Blvd., Costa Mesa, CA 92626.

According to the flyer (see below): “FCD Chair Chris Cox will moderate an in-depth discussion with SEC Commissioner Daniel Gallagher and Paul Atkins, CEO of Patomak Global Partners and former SEC Commissioner, about the Financial Stability Oversight Council, which was established by the Dodd-Frank Wall Street Reform and Consumer Protection Act.”

Registration: FCD Members: $50.00. Non-members: $85.

rsvp: www.cvent.com/d/14qgby/4W

PRI guests, enter code: PRI2014FCD on the payment page to receive member discount.

“The reason that Obamacare is going to fail, it is not just a symbol of this radical liberalism, it is the embodiment of it,” said Krauthammer, who also is a medical doctor and psychiatrist. His column runs in the Orange County Register and his new book, “Things That Matter: Three Decades of Passions, Pastimes and Politics,” has sold more than 1 million copies.

“It is not just an aspiration, they finally achieved something they wanted to do for a hundred years, and they finally enlisted the United States in the roster of enlightened countries that have nationalized health care. Now everybody can see it and everybody can feel it. Five million Americans have already lost their insurance over this. Others have been thrown into all kinds of disarray. And health care itself is in disarray.”

Optimistic

Although quipping that after the Republicans lost the presidency in Nov. 2012 he had to put on his psychiatrist’s hat and prescribe anti-depressants to some in the GOP, Krauthammer remained optimistic, “We have institutions like PRI that can prepare, the same way the think tanks in England prepared for that generation [of Baroness Thatcher]. Now it turns out that everything that you predicted here at PRI about Obamacare is coming true. And we also have the fact that we have a center-right country.”

Before Krauthammer spoke, PRI Chairman of the Board Clark Judge brought up how PRI President and CEO Sally Pipes “is the one who has formulated the alternative to Obamacare that almost surely will be enacted the next few years. Sally has been a national force, and with that PRI.” Pipes, who has headed PRI for more than two decades, is the author of three books critiquing Obamacare, most recently, “The Cure for Obamacare.”

Judge also praised the work of Lance Izumi, PRI Koret senior fellow and senior director of education studies, in particular for the film, “Not As Good As You Think: The Myth of the Middle Class School.”

And Judge commended CalWatchdog.com Editor-in-Chief Brian Calle and Managing Editor John Seiler for reversing “the decline of reporting in Sacramento.  They have broken story after story. They are bringing investigative reporting back to California.”

Bill Simon

The dinner gave its Second Annual Baroness Thatcher award, named after the late prime minister of the United Kingdom, to William E. Simon, the Republican nominee for governor in 2002. The award was presented by James Piereson, the president of the William E. Simon Foundation.

Piereson pointed to Simon as “a leader in the world of philanthropy, who climbs mountains and runs marathons.” Simon also is a visiting professor at the University of Southern California and the University of California, Los Angeles.