Is Your Refinance "Too Big to Fail"?

[Oct 2, 2009.]

 

Yes, I've used the "too big to fail" headline before (twice in one day).

But that's no excuse to not examine how the new too big to fail legislation being discussed by Congress could help or hurt the millions of Americans who either want to refinance now or will want to refinance soon.

Too big to fail, of course, refers to the notion that the collapse of certain financial institutions would endanger the entire financial system, therefore those financial institutions are protected by the government, if not explicitly (Fannie Mae and Freddie Mac) then implicitly (Bank of America, Citigroup).

The refinancing angle of the too big to fail debate is an interesting one if only because the major banks have been snapping up plain vanilla refinances with such reckless abandon over the past months.

It would be strange if big banks didn't go for the low-hanging refinance fruit. Especially in the case of a standard conforming loan (under $417,000 loan amount), the opportunity to make good fees and interest income with the full backing of the U.S. government is nice work if you can get it.

No wonder banks are back to making money (not that there's anything wrong with that).

Nevertheless, as this too big to fail article points out, at some point the banks that are too big to fail have to undergo some sort of restructuring process. The most cogent argument in this direction calls for big banks to separate their investment activities from their lending and deposit activities.

In essence, the new regulations would mirror the old regulations of the Glass-Steagall Act, which prohibited banks from owning other financial institutions that take more risk (such as, say, bond trading houses). A return to that simpler era, in today's age of Goldman Sachs being widely regarded as a "giant vampire squid," would necessitate many Solomonic decisions about which half of the baby belongs to whom.

If in fact banking in the traditional sense (lending, deposits) were to be separated by law from risk-laden activities like trading, what effect that might have on refinance rates?

Would the too big to fail banks take on more mortgages or fewer? Would the system work better, or would refinance hopefuls pine for the days when trading profits fueled low cost home loans?

As usual, questions are more plentiful than answers as the mortgage market tries to figure itself out...with a little help from its friends on Capitol Hill.

 

About Author:

Andrew Freiburghouse is a writer and businessman. He has worked as a magazine reporter, tax preparer, screenwriter, copywriter, and loan officer. He graduated from Santa Clara University in 1999 with a B.A. in English. Andrew was born and raised in the City of Los Angeles.