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Warren/CFPB Fight About Bank Exposure?

The surge of pressure on the Obama Administration to name Elizabeth Warren as the first head of the Consumer Financial Protection Bureau has led Administration officials to dole out helpings of praise but not yet any indication that she could get the position.

I haven’t heard many good reasons to object to Warren. The most plausible is the idea that she’s an untested manager to bring about a brand-new federal agency. But the universe of people who have commanded new agencies is pretty small, and anyway her pick wouldn’t preclude a chief operating officer to handle the details while she struck fear in the hearts of predatory businesspeople. It’s not really the role of the chairperson of an agency of this type to manage the bureaucracy.

John Talbott has a theory why the White House would be wary to select Warren for the job that makes some sense, however:

I believe Geithner sees the appointment of Elizabeth Warren as a threat to the very scheme he has utilized to date to hide bank losses, thus keeping the banks solvent and out of bankruptcy court and their existing management teams employed and well-paid […]

So where are the trillions of dollars of bad loans that the banks had on their books? They are still there. The Federal Reserve took possession temporarily of some of them as collateral for lending to the banks in an attempt to clean up the banks for their supposed” stress tests”. But as of now, the trillions of dollars of underwater mortgages, CDO’s and worthless credit default swaps are still on the banks books. Geithner is going to the familiar “bank in crisis” playbook and hoping that the banks can earn their way out of their solvency problems over time so the banks are continuing to slowly write off their problem loans but at a rate that will take years, if not decades, to clean up the problem.

And this is where defeat of the nomination of Elizabeth Warren becomes critical for Geithner. For Geithner’s strategy to work, the banks have to find increasing sources of profitability in their business segments to balance out their annual loan loss recognition from their existing bad loans in an environment in which they continue to recognize new losses in prime residential mortgages, commercial real estate lending, sovereign debt investments, bridge loans to private equity groups, leverage buyout lending and credit card defaults.

The banks have made no secret as to where they will find this increase in cash flow. They intend to soak their small retail customers, their consumer and small business borrowers, their credit card holders and their small depositors with increased costs and fees and are continuing many of the bad mortgage practices that led to the crisis (ARM’s, option pay deals, zero down payments, second mortgages, teaser rates, etc). American and Banking Market News reports this week that the rule changes in the financial reform bill may lead banks to start implementing fees that had essentially disappeared from the industry early in the new millennium, such as fees for not meeting minimum balance requirements on a checking account, or reinstituting fees for certain online banking transactions that are currently free or charging to receive a paper statement or to talk to a live teller as Bank of America’s CEO has recently proposed.

I don’t think that increasing fees and ripping off customers are the only sources of big bank revenue – they have the carry trade, making billions off the difference in interest between what they can get from the discount window and what they can loan out. And they are still engaging in plenty of risky activities like high-frequency and derivative trading. But certainly, fees and bad loan contracts still exist. And it would be the CFPB’s mandate to stamp them out. And so Talbot is correct that Warren’s appointment would threaten this profit center for the banks, which they’ve been using to hide their shaky solvency status. Those inside the Administration who don’t want to see the banks exposed are probably making this argument right now.

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David Dayen

David Dayen