Fed Under the Microscope and New Mortgage Fees

In the aftermath of the failure of Silicon Valley Bank (SVB), the Federal Reserve said that it would undertake an investigation as to what went wrong. The 118 page result of that investigation (Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank) was released last week and it provided a rare look into the opaque and often-shrouded processes that occurs at the central bank and at its 12 regional banks.

Yes, there was bad management at SVB, but more instructive was the acknowledgment that the Fed itself flubbed in its role as supervisor and regulator of the banking system. According to Michael Barr, the vice chair of supervision at the Federal Reserve, Fed officials “did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity”; when they spotted problems “they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough”; and when banks lobbied to change banking rules in 2018, the result was a reduction in supervisory standards, more complexity, and most alarmingly, “a less assertive supervisory approach.”  

The report calls into question Mr. Barr’s predecessor, Randal Quarles’ full-throated defense of “tailoring” banking rules for mid-sized institutions. (The shift in regulation came after the 2018 passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), which amended the post-financial crisis Dodd-Frank Wall Street Reform and Consumer Protection Act in order to loosen regulations for small and mid-sized banks.) The changes to the Fed’s approach to supervision were supposed allow it to “ensure the safety and soundness of the institutions they supervise,” but at the time, then Fed-governor Lael Brainard raised the fear that the shift would “weaken core safeguards against the vulnerabilities that caused so much damage in the crisis.”

The review is the starting point for a re-evaluation of banking supervision in the post-SVB era. There will likely be rule changes and equally important will be a refocused effort from top Fed officials to individual examiners and supervisors on the ground, who need “to form judgments that challenge bankers with a precautionary perspective.”

MEANWHILE, IN THE FED’S OTHER ROLE...

The Fed’s SVB report came out days before its upcoming two-day monetary policy meeting, where the central bank is expected to increase short term rates by a quarter of a percentage point to a target range of 5.00-5.25 percent. The rationale is expected to go something like this: Yes, we know that the economy is softening (Q1 GDP showed a 1.1 percent annualized pace, a significant downshift from the Q4 reading of 2.6 percent) and consumers are slowing down their spending, BUT inflation remains higher than we would like and as a result, we are tapping the brakes one more time, and hoping that the new level is sufficient  enough to push down inflation in the second half of the year.

That said, the big risk continues to be that the cumulative effect of 15 months of the Fed’s foot on the brakes amounts to the economic car swerving into a recessionary ditch. So far, there is no evidence of a recession and although job growth has tapered off in the past few months, the March employment report is expected to show another 175,000-200,000 jobs added and the unemployment rate holding steady at 3.6 percent.

FINALLY, ABOUT THOSE NEW MORTGAGE FEES...

You may have heard about new fees that government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac are imposing for new loans starting on May 1st. Headlines are screaming something like this: “RESPONSIBLE AMERICANS, WHO PAY THEIR BILLS ON TIME AND HAVE EARNED HIGH CREDIT SCORES ARE UNDERWRITING LOSERS WITH LOW CREDIT SCORES.”

There is a lot of heat around this issue, so let’s peel back some of the layers. In case you missed it (I certainly did), there was a fee increase LAST YEAR for some borrowers. Beginning April 1, 2022, the Federal Housing Finance Agency (FHFA) raised upfront fees “for certain high balance loans and second home loans.” The fees increased by 0.25-0.75 percent for high balance and “super conforming” loans, tiered by loan-to-value ratio; and for second home loans, fees increased by 1.125 - 3.875 percent. The rationale for the change, according to Jim Parrott, a nonresident fellow at the Urban Institute, is that “there is less justification for deep government support—loans for vacation homes, investor properties, million-dollar homes, and cash-out refinancing.” The increased fee revenue is being used for “borrowers with limited wealth or income.”

Separate from last year’s actions, new FHFA fees start on May 1, which will raise pricing on many loans that borrowers with high credit scores assume. Parrot notes that the May 1st fees are primarily intended “to cover the higher capital requirements that went into effect last year,” not to generate a subsidy for those with lower credit scores.

In some of the alarmist headlines, there is also a suggestion that those who put down less than the 20 percent standard down payment are getting a better deal than those who put down more, due to the new rules. But in a subsequent post, Parrot and co-author Janneke Ratcliffe note that these homeowners are forced to also pay for private mortgage insurance (PMI), moving “some of the risk from Fannie Mae and Freddie Mac to a private mortgage insurer,” which in turn allows the GSEs to charge a lower amount. The homeowner is of course paying slightly less to the GSEs but is still paying for the extra PMI.

In the end, there will be those who do end up paying more for their loans due to the new fees, but as always, there is a lot more nuance to the story than the outrageous click-bait headlines.