By now we’re all aware that the economy grew by a healthy 4.2 percent in the second quarter (April-June) topping early predictions and strongly suggesting growth is picking up speed.
More good news comes from the University of Michigan’s announcement that its index of consumer sentiment rose to 82.5 in August from 81.8 in July. The increase was attributable to greater optimism about jobs, rising incomes and increasing wealth. Also notable is that almost 60 percent of surveyed households in the top third of income earners — a prime target market for buying boats — reported that they are financially better off this month.
On the flip side, however, much of the feeling of increased wealth comes from recovering real estate values, something that’s also good for future boat sales. But that quickly brings to mind the recent prediction that we could soon see another mortgage-related banking crisis.
So says Charles W. Calomiris of the Columbia Business School and Stephen H. Haber of the School of Humanities and Sciences at Stanford University. They contend that the claim by central bankers and officials that banking crises are unpredictable isn’t necessarily true. They are not random. Simply, when banks take on large amounts of risk in loans and investments and when regulators allow those loans to be backed with low levels of capital, the result is a financial crisis. Sound familiar?
Moreover, they contend that such a toxic combination is usually the result of some political deal. The subprime mortgage crisis that pushed us into the Great Recession boiled down to large banks wanting support for merger plans, while activist groups pushed for subsidized mortgage credit for their constituents and Fannie Mae and Freddie Mac sought regulations that allowed for repurchase and securitizing loans backed by borrowed money. The deadly combination resulted in politicians supporting loose underwriting standards and thin capital requirements.
So why the prediction of another crisis? Basically, since the debacle of 2008, reforms that could prevent a repeat haven’t actually been made. Once again, political deal-making has won the day. Calomiris and Haber cite, for example, the Consumer Financial Protection Bureau’s recently issued rules on "Qualifying Mortgages" and how they’ve been watered down. The original proposal required a 20 percent down payment and a housing-cost-to-income ratio of 28 percent. It’s been replaced with a total-debt-to-income ratio of 43 percent.
They also point out that the Volker Rule, which prohibited banks from using depositors' money to invest in securities, was aborted. Amazingly, the final rule now exempts real estate-related securities, ignoring the cause of the subprime crisis that sank us six years ago.
Bottom line: While most of us probably assume that the financial reforms passed by Congress mean we won’t live through another disastrous banking crisis, actual real reform has not taken place in the mortgage loan industry and there isn’t any change on the radar. Sadly, then, we remain vulnerable to banking crises and that certainly tempers the good economic news.