The Big Banks Shouldn't Inherit Our Housing Finance System

Eight years after high-risk, deceptive lending practices precipitated a near-meltdown of the global economy, we learned that at least 5,300 Wells Fargo employees created 2 million sham accounts that its customers apparently did not want, need or understand. Those unwitting Wells customers paid at least $1.5 million in fees.

But if only the bad-news stories about big banks ended there, and if only policymakers weren't threatening to help big banks boost their profits even more. Observers should take note of recent proposals to revamp the housing finance system into a more bank-centric model, which could benefit the largest institutions to the detriment of other mortgage market participants.

At Wells, employees were incentivized by sales goals to open as many accounts as possible. The executive who oversaw this operation, Carrie Tolstedt, has recently retired with a reported $124.6 million package. But what about the thousands of customers her team defrauded?

And yet, the Wells episode is just one example of the biggest banks' inability to stay out of the news. The scandal came on the heels of Bank of America's agreement in June to pay $430 million for misusing customers' cash. About a week after the Wells story broke, it was also reported that the Department of Justice was seeking $14 billion from Deutsche Bank to settle claims about the bank's sale of mortgage-backed security. In the meantime, Deutsche Bank is also mired in a scandal involving $10 billion of suspicious trades out of its Russian unit that resemble money-laundering.

How can this still be happening? In the eight years since the financial crisis, there have been dozens of congressional hearings, thousands of news stories, a host of best-selling books and a blue-ribbon commission promised to help us understand what went wrong and how to prevent a recurrence. The Dodd-Frank Act was heralded as a means of "constrain[ing] the growth of the largest financial firms" and ensuring that the "irresponsible lending" that led to the financial crisis "never happens again." But since then, the nation’s "too big to fail" banks have only gotten bigger, and, as this newest Wells Fargo episode demonstrates, old habits die hard.

Rather than preventing "too big to fail," we've doubled down. In fact, since President Obama signed the deeply flawed Dodd-Frank in 2010, the banks regarded as too big have grown by 30%. The six largest banks now control assets of approximately $10 trillion, equal to almost 60% of our country's GDP (compared with 17% in 1995). In contrast, small community-focused lenders are being squeezed out of existence. There are at least 1,500 fewer banks with assets under $1 billion than prior to the financial crisis.

Now, against this backdrop of stratospheric growth, the big banks could be closer to having more control over America's colossal mortgage markets and their traditional stewards: Fannie Mae and Freddie Mac. Like every major American financial firm, private mortgage companies Fannie and Freddie faced acute financial distress during the crisis of 2007-8. Although the two companies were never deemed insolvent, Congress injected billions into the two private companies and placed them into a conservatorship under the supervision of the Federal Housing Finance Agency.

The Wells scandal should be a wakeup call to policymakers working on housing finance reform.

Already the largest nonagency player in mortgage origination, Wells Fargo spent more than $20 million lobbying Congress on housing finance issues since 2013. Wells Fargo was a proponent of failed legislation written by Sens. Tim Johnson and Mike Crapo, who followed a model favored by Sens. Bob Corker and Mark Warner, which would have replaced mortgage giants Fannie and Freddie with a more bank-centric model. And more recently, Wells has been advocating for the FHFA's implementation of the Common Securitization Platform, which would allow big banks to sell "agency" mortgage-backed securities.

Some applaud such a move because they view Fannie and Freddie as emblematic of big government cronyism. Others say the two mortgage giants have been historically successful in assisting millions of people in securing homes over three generations, and they should be reformed and recapitalized rather than eliminated. Regardless, no one has come up with an acceptable alternative to Fannie and Freddie for keeping the nation’s mortgage market liquid and stable enough so that qualified buyers can obtain loans to buy homes.

To date, Fannie and Freddie have repaid the full $187 billion advanced to them by the Treasury Department plus another $60 billion in dividend payments. Compare that with the over $200 billion the big banks have paid to the Treasury as penalties and fines for their misconduct. Despite these facts, Wells Fargo and peer banks are pushing for the government to line their pockets with the mortgage companies’ revenue streams — rather than permit Fannie and Freddie to retain earnings and rebuild their capital base in order protect taxpayers against future bailouts.

Wells Fargo and other big banks are now lobbying Washington to hand over Fannie and Freddie's business to them. If recent history is any indication, that would be a disastrous mistake.

Logan Beirne is an Information Society Project fellow and lecturer at Yale Law School. He is also the chief executive of Matterhorn Transactions Inc., a legal information services company.