When reflecting on what caused the banking crisis, there are two key elements that stood out to Albert J. Tumpson: A lack of regulatory oversight, and good old fashioned greed.
Tumpson, a private practice lawyer specializing in banking law, has a solid history and deep understanding of banking regulation. He served as Western Regional Council for the Federal Deposit Insurance Corporation (FDIC) between 1984 and 1987. He spoke to Bankless Times about his views on the cause of the crisis, how we got to where we are today, and his views on bankless financing.
“My view of what happened is that there was a climate during the last administration of laissez-faire regulatory matters, there were not as many enforcement actions, not as much overseeing of what banks were doing,” Tumpson said during a phone interview. “Banks are businesses, and they like to make money, so they will do things that under normal regulatory circumstances the examiners would not allow.”
Tumpson acknowledges that there is a belief held by many that regulation is bad for business, but he believes that it’s necessary in the financial services industry to protect everyone involved. The subprime mortgage meltdown, for example, offered a very stark reminder of this need for oversight. Before the meltdown, brokers were selling loan pools to investors, representing that proper due diligence and loan making techniques had been applied, Tumpson explains, though as we all quickly learned, this was not the case.
“We had a bunch of banks making subprime loans based only on the high value of properties and with no connection to reality in terms of the borrower's ability to repay the loan.”
The mortgage industry, Tumson explains, along with the finance industry as a whole, is a profit-centred business, and since at the time there weren’t enough borrowers taking out mortgages, there were rumors that some institutions were encouraging mortgage brokers to be “inventive.”
Tumpson himself personally handled litigation that suggested brokers were acting to increase profits in whatever ways they could. For example, mortgage brokers would fake bank statements on behalf of borrowers, showing income and employment that didn’t exist.
He cites a specific case in which a woman bought two houses in one month. To do so, she provided one lender with a bank statement that showed she had $178,000 in her bank account, then showed another lender a bank statement that showed that she had $50,000 in the same account, during the same month. Once subpoenaed, it was revealed that she had only $58.
When it comes to peer-to-peer (P2P) lending, Tumpson sees the potential for similar issues. He believes that on the whole, the idea is a good, but worries that there are not enough protections for the "little guy" who is putting in his money, and who may lose it with little to no recourse.
Tumpson sees P2P companies as acting as loan brokers, and if a site arranges a bogus loan that goes bust, the “broker” can move on with no responsibility.
“When banks make loans, they are required to do due diligence, and in most situations they feel motivated to do due diligence as it’s their money being risked,” explains Tumpson. “They are also motivated to conduct this because regulation will come down on them and pacify their loans if they aren’t doing these investigations.”
However, Tumpson says, with P2P loans, there isn’t that same push towards oversight.
“[With] P2P loans you have a middle man who is not risking anything, and not being regulated. They give you information with no insight into where or how they got it,” he says. “They're not risking their own money, so how do you make sure the people who are investing in this are not investing in loans that are too risky?”
Online lenders are left to rely on these middle men, says Tumpson, who aren’t providing enough information about whether loans are safe, or how safe they are.
“Making loans is something that has to be done carefully, with due diligence, but when you go online, someone else has done your due diligence [for you].”
While acknowledging the low rate of default in this industry to date, Tumpson questions whether there’s a long enough history to know if this is to be a long-term trend, noting that the banking industry, which has been around for hundreds of years, has different banks with different rates of default on their loans.
Tumpson suggests that would-be lenders read the fine print on agreements on P2P sites, noting that the language typically relinquishes liability if the loan should go bad. He also recommends asking questions about what kind of investigation is done, and determine if they are comfortable with this due diligence model.
“People have to understand that they are relying on someone to advise them on something where they’re going to spend their money, and they have no recourse if that advice is faulty,” he says, pointing out that the P2P companies aren’t taking a lot of risk. “They don’t have, as they say in the south, a dog in the fight, they are not risking any money, they’re asking you to risk money.”
He believes that P2P companies should be regulated in order to ensure a certain level of standards and measurements by which companies can be evaluated.
“Regulation is a necessary part of these quasi-public businesses, otherwise profit motive takes over,” says Tumpson, speaking broadly about the banking industry. “This same profit motive exists at P2Ps, who only make a profit if they sell loans.”
Tumpson believe that the bankless financing concept is a good idea, but that it needs to be an idea that someone watches over.
“A great idea, but there has to have some level of regulatory oversight for me to believe it is not too risky for the normal person,” says Tumpson, stating that he feels there is a big potential to harm the public in a very direct way. “This is your money directly being lent to someone who could default on you. You lose it.”