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Fed Held Back as Evidence Mounted on Subprime Loan Abuses

The Fed may lose its consumer protection duties to a proposed new agency.
The Fed may lose its consumer protection duties to a proposed new agency. (By Brendan Smialowski -- Bloomberg News)
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"The significant amount of subprime lending among holding company subsidiaries, combined with recent large settlements in cases involving allegations against such subsidiaries, suggests a need for additional scrutiny and monitoring of these entities," the GAO said.

This time, the GAO suggested that Congress clarify the question of legal authority to address the Fed's concerns.

A response letter signed by Gramlich, who died in 2007, said the Fed had all the authority it needed if it wanted to act. "The existing structure has not been a barrier to Federal Reserve oversight," he wrote.

Five months later, the Fed took its first public enforcement action against an affiliate, fining Citigroup $70 million. In settling the FTC's earlier charges, Citigroup had agreed to a number of reforms. The Fed found that some practices had continued in violation of that commitment, and that employees had misled regulators.

Fed officials cite the fine as evidence that the agency was able to protect consumers without conducting regular examinations. Consumer advocates took the opposite lesson: Despite finding that a major affiliate was violating consumer protection laws, the Fed still was refusing to create a reliable system for identifying other abuses.

The Citigroup case remains the Fed's only public enforcement action against a lending affiliate.

Retreat From Oversight

The Fed's reluctance was part of a broad governmental retreat from oversight of the financial industry. Greenspan and many politicians in both parties saw regulation as a blunt instrument that often deprived more people than it protected.

"There was a long period when things were going very well and regulation was viewed as something that got in the way," said Alice Rivlin, the Fed's vice chairman from 1996 to 1999 and now a fellow at the Brookings Institution.

The Fed also minimized repeated warnings about mortgage lending abuses in part because it was an institution dominated by big-picture economists focused on the health of the broader economy rather than the problems faced by individual borrowers.

Greenspan said in an interview that he did not think the Fed was suited to policing lending abuses because of its focus on broader issues, but he added, "I'm not sure anyone could have done it better." He said the administration's plan to create a consumer protection agency was "probably the right decision."

Throughout the lending boom, consumer advocates trooped regularly to the Fed's monumental marble headquarters on Constitution Avenue to offer specific accounts of abuses in financial transactions. But what seemed powerful to advocates often was dismissed as anecdotal by regulators.

"The response we were getting from most of the governors and the staff was, 'All you're able to do is point to the stories of individual consumers, you're not able to show the macroeconomic effect,' " said Patricia McCoy, a law professor at the University of Connecticut who served on the Fed's consumer advisory council from 2002 to 2004. "That is a classic Fed mindset. If you cannot prove that it is a broad-based problem that threatens systemic consequences, then you will be dismissed."

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