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.”

By Dave Roberts

SAN FRANCISCO — The left, which has championed the media and legislative crusade against bullying, is itself engaged in the bullying of one of the few groups you’re still allowed to demonize in this country: corporations. Not content with dominating the media, academia, unions, the courts and much of the government, leftists are now trying to shut down the free speech of businesses.

“What they are trying to do is to cow corporations from supporting free market-oriented groups, including trade associations and even government affairs type of operations,” said former Securities and Exchange Commissioner Paul Atkins, speaking at a Pacific Research Institute luncheon in San Francisco on June 27. “In the wake of Citizens United, the unions and state pension funds and shareholder activists have been agitating because they are, of course, not happy about Citizens United.”

The Supreme Court in that 2010 case upheld the free speech rights of corporations and unions to make political contributions. So, having lost in the highest court, leftists are taking the low road, a chapter out of the Saul Alinsky playbook, in an attempt to muzzle opposition to their political agenda. Alinsky advocated getting individual and institutional shareholders in corporations to assign their proxy votes to leftist groups in order to pressure boards of directors to do their bidding.

The latest campaign seeks to push corporations into disclosing their contributions to political action committees, advocacy organizations, trade associations and any other political or quasi-political activities. That information will then be used to organize boycotts, shareholder meeting protests and other campaigns in an effort to shut off corporate contributions to groups and causes with whom they disagree.

“They are basically trying to subvert the shareholder proposal process in order to try to influence corporate behavior,” said Atkins. “Usually corporations, especially in the retail area, want to try to avoid controversy. Because they are pulled and tugged by people on both sides. And so they don’t want to be subject to boycotts or negative publicity or things like that.”

Target boycott

A good example is the 2010 boycott against Target. The retail giant had committed the “crime” of contributing $150,000 to Minnesota Forward, a political group that supported the campaign of a gubernatorial candidate who opposed gay marriage. In response to the boycott, Target apologized for the contribution.

“Going forward, we will soon begin a strategic review and analysis of our decision-making process for financial contributions in the public policy arena,” said Target CEO Gregg Steinhafel in a letter. “Target will take a leadership role in bringing together a group of companies and partner organizations for a dialogue focused on diversity and inclusion in the workplace, including GLBT issues.”

Caving into leftist groups like Moveon.org worked — the boycott fizzled out. Target’s website notes that, while the company continues to belong to trade associations and other policy-based organizations, “the positions they take do not always reflect Target’s views.” A Target pie chart shows nearly equal contributions to Republican and Democratic PACs.

Attacking ALEC

Having tasted Target’s blood in the water, the leftist sharks recently went after corporations that had joined the American Legislative Exchange Council.

“It’s kind of a nerdy group, sort of behind the scenes,” said Atkins. “They work towards building model statutes for state legislatures, things like tax reform, regulation and health care and all sorts of things. Among the things they were asked to help with was ‘Stand Your Ground’ laws and also ‘Voter Identification.’ So, in the wake of the Trayvon Martin shooting, Van Jones’ group called Color of Change and another group figured out that Pepsi and Coke and Wendy’s and McDonald’s and a few other companies had contributed to ALEC. So they blew all this up and said, ‘Ah ha, look, Pepsi, Coke and all of these other companies are helping Voter ID, so it’s racial profiling’ or whatever their charge was.”

More than a dozen corporations have reportedly dropped out of supporting ALEC, producing more blood in the water.

Now some companies are considering buckling under to the latest pressure to disclose their contributions — or perhaps get out of politics altogether in order to make the sharks go away. But Atkins is hoping that the companies stand their ground.

“Sure you have some corporations that might support something that might not be in the best interest of their shareholders,” he said. “But overall, for the most part, corporations really do support things like a push for a better tax system, push for a better regulatory system, support things like the National Association of Manufacturers, the Chamber of Commerce, the American Petroleum Institute and things like that, which really do a lot of good.

“For example, in Washington right now, one of the big issues before the SEC is the Conflict Mineral provision of the Dodd-Frank rule. The American Petroleum Institute is doing a great job in trying to argue against this particular provision of Dodd-Frank, which will be very harmful to business and cost shareholders a huge amount of money. The reason why you have trade groups is so they have the guts, hopefully, to stand up. Because one individual corporation can always get cut down and have pressure put against it. That’s why you need the trade groups to get into it, or groups like PRI or others who are supported by corporations, or the Competitive Enterprise Institute in Washington, which has filed suit against Dodd-Frank and they had sued against the public company accounting oversight board in Sarbanes-Oxley before that. So, these groups are very valuable with respect to some of the disputes with government and regulation and those sorts of things.”

PRI, the Pacific Research Institute, is CalWatchDog.com’s parent think tank.

One of the challenges for corporations in resisting leftist pressure is that the issue is framed in terms of the laudable goal of seeking more information and transparency for shareholders.

‘Materiality’

“Why not just put all the chips out on the table and let the chips fall where they may?” asked Atkins rhetorically. “Well, the thing is when we talk about disclosure with public companies, the main rubric behind the securities laws and behind SEC rules is ‘materiality.’ Materiality means what a reasonable, rational investor would take to be an important fact that he would want to know in trying to decide whether to buy, sell or hold a particular company’s stock. This materiality concept goes back and is embedded in the Securities Act and been upheld by the Supreme Court time and again as giving a standard by which companies should decide what to disclose and what to put into their prospectus and annual report and what to leave out.

“So these sorts of contributions by public companies are clearly not material. They don’t rise to any level that would affect the corporation as far as the bottom line. A number of these shareholder activists argue, ‘Well, it’s material in that it could be controversial, and shareholders need to know it because it might cause a boycott like you saw with Target or whatever.’ But that’s very much a circular argument. Because the very same groups who are arguing for disclosure are the ones who then light the fuse to have these boycotts and other things go on. Ultimately, it’s the board of directors that oversees these sorts of contributions in the end who have a fiduciary duty to the shareholders to decide what is or is not in their best interest and how they should build shareholder value.”

Atkins pointed out that disclosure requirements are already in place for contributions to candidates, and that Congress always has the option of requiring similar disclosure for super PACs.

“But it should not be where the shareholders themselves disarm unilaterally and say, ‘OK, we will disclose and open ourselves up to criticism and what not,’” he said. “So what we are trying to do is encourage boards and others basically to stand their ground if they choose to do so. Some companies disclose and others don’t. But it is a very slippery slope if you start going down that road.”