As Congress Holds Hearing on High-Risk Leveraged Lending Trend That Threatens Another Financial Crisis, OCC Head Joseph Otting Hasn’t Lifted a Finger To Contain It

June 4, 2019

WASHINGTON, D.C. — Ahead of today’s Congressional hearing on the economic risks of the leveraged lending market, consumer watchdog group Allied Progress called on Comptroller of the Currency and former banker Joseph Otting to start taking the threat seriously at the OCC and the FSOC by taking action to stem the tide of these risky loans.

Leveraged lending has been called the “New Subprime Boom” and has grown substantially worse on President Trump’s watch. More and more big banks have been allowed to make substantial loans to heavily indebted companies and then quickly repackage and sell off the debt to other investors like hedge funds or insurance companies. This market – now exceeding $1.2 trillion – is inherently risky as many of the troubled companies that took out loans have no means of repaying themif there’s an economic downturn or jump in interest rates. While OCC head Joseph Otting has recognized that leveraged lending could have a “contagious impact” from Wall Street to Main Street, he has refused to uphold previous OCC guidance that successfully reined in this kind of risky behavior, telling the banking industry: “You Have The Right To Do What You Want.”

In fact, Otting has done worse than nothing. As a member of Trump’s Financial Stability Oversight Council (FSOC), Otting voted to gut oversight of major investment firms that offer leveraged loans despite warnings from leading financial experts, including Former Federal Reserve Chair Janet Yellen, that this practice could ignite the next financial crisis.

“Just like the subprime mortgage crisis, the big banks are playing a dangerous shell game with over a trillion dollars’ worth of troubled assets, and sooner or later, someone will get burned. A safe bet is it will be the same kind of people who lost their jobs and retirement savings in the last financial crisis while the bankers get another bail out,” said Jeremy Funk, spokesman for Allied Progress. “As a longtime banking insider, Joseph Otting knows the leverage lending trend contains all the ingredients for another Wall Street meltdown. He knows he has tools at his disposal to address it, but refuses. Could it be because he’s more concerned about how much money his old banking friends can make before Wall Street’s latest casino game goes bust?” 

Before becoming Comptroller, Joseph Otting worked in the banking industry for over three decades – and acts as if he still does. In 2018, Otting told a roomful of his former banking colleagues that the OCC – which is tasked with ensuring over 1000 lenders big and small are operating safely and soundly — is working to improve its ‘responsiveness to our customers, which are the banks.’ And clearly Otting believes that the customer is always right. Otting has assured the industry that he wants to “scale back” and “round the edges” of reforms put in place under Dodd-Frank that are working to prevent another financial crisis. Otting is continuing his lifework doing the bidding of the big banks, only this time from the inside looking out.

WHAT YOU NEED TO KNOW:

The $1.2 Trillion Leveraged Loan Market Is Built On High-Risk Lending To Heavily Indebted Companies.

Risky Leveraged Loans Are Repackaged Into Highly-Demanded Securities Known As Collateralized Debt Obligations (CLOs).“The boom bears striking similarities to the mortgage frenzy that preceded it. Instead of holding the debt, lenders sell it to be repackaged into so-called collateralized loan obligations, which — by allocating income into tranches with different levels of risk and return — transform a large chunk into triple-A-rated securities. Investor demand for these securities is so strong that it has pushed lenders to lower standards.” [Editorial Board, “What to Do About the New Subprime Boom [Editorial],” Bloomberg, 02/20/19]

• A CLO Is “A Package Of Risky Corporate Loans Made To Companies With Less Than Stellar Credit.” “C.L.O.s are nothing more than a package of risky corporate loans made to companies with less than stellar credit. The big Wall Street banks make these loans to their corporate clients and then seek to move them off their balance sheets as quickly as possible, in the same way that a decade ago they packaged up and offloaded risky mortgage securities.” [William D. Cohan, “Wall Street’s Latest Love Affair With Risky Repackaged Debt,” The New York Times, 03/18/19]

Leveraged Lending “Bears Striking Similarities” To The Subprime Mortgage Practices That Caused The Financial Crisis In 2008.

Bloomberg’s Editorial Board Has Called The Leveraged Loan Market “The New Subprime Boom,” Arguing That It “Bears Striking Similarities To The Mortgage Frenzy” That Caused The 2008 Crisis.  In a February 2019 editorial, Bloombergargued that leveraged lending is “The New Subprime Boom,” adding that, “[t]he U.S. is back in risk-taking mode. This time around, the problem is corporate debt, not mortgages — specifically, so-called leveraged loans. These are loans extended to firms that already have a lot of debt or a poor credit rating. It’s another kind of subprime financing, often used in corporate buyouts.” [Editorial Board, “What to Do About the New Subprime Boom [Editorial],” Bloomberg, 02/20/19]

There Are Approximately $1.2 Trillion In Loans To Companies That May “Not Be Able To Handle The High Level Of Debt They Have Taken On” In The Event Of An Economic Downturn. “This is not a tiny slice of the market. Of the trillions of dollars of corporate loans outstanding in the United States, roughly $1.2 trillion of them are considered ‘leveraged loans,’ or loans to companies considered bigger credit risks. Some of those companies will not be able to handle the high level of debt they have taken on, and when they reach the breaking point, corporate bankruptcies will again begin to rise.” [William D. Cohan, “Wall Street’s Latest Love Affair With Risky Repackaged Debt,” The New York Times, 03/18/19]

The Federal Reserve Reported A “Sharp Increase” In Leveraged Lending Alongside “Less Stringent” Underwriting Standards — With The Leveraged Lending Market Growing 20% Last Year Alone.

In May 2019, The Federal Reserve Found That The Leveraged Loan Market Increased “By 20 Percent In 2018.” “Companies with large amounts of debt are borrowing more money at a breakneck pace, prompting the Federal Reserve to flag the trend as one potential risk in the financial system. Loans to companies with large amounts of outstanding debt — known as leveraged lending — grew by 20 percent in 2018 to $1.1 trillion, according to the Fed’s twice-annual Financial Stability Report. The share of new, large loans going to the comparatively risky borrowers now exceeds peak levels reached previously in 2007 and 2014.” [Jeanna Smialek, “Federal Reserve Warns as Risky Corporate Debt Exceeds Peak Crisis Level,” The New York Times, 05/06/19]

• The Fed’s Report Showed A “Sharp Increase In Leveraged Lending” And “Less Stringent” Underwriting Standards. “[Senator Sherrod Brown] told the regulators that his concern about leveraged lending was reinforced by a report [in May 2019], issued by the Fed, which showed a sharp increase in leveraged lending and said underwriting and credit standards have become less stringent over the last six months.” [Neil Haggerty, “Brown to regulators: Be ready to discuss leveraged loans at hearing,” American Banker, 05/13/19]
• In The First Quarter Of 2019, “A Record 40 Per Cent Of Loans” Went To The Most Indebted Companies. “The report published on Monday found that in the first three months of 2019, a record 40 per cent of loans to highly indebted companies went to the most indebted of all.” [Kiran Stacey, “Fed warns leveraged lending could exacerbate a downturn,” Financial Times, 05/06/19]

Joseph Otting Has Led The Office Of The Comptroller Of The Currency (OCC) Since November 2017.

Joseph Otting Has Been Comptroller Of The Currency Since November 2017. [“Joseph M. Otting,” Office of the Comptroller Of The Currency, accessed 05/31/19]

Joseph Otting Acknowledged Before Congress That Leveraged Lending Poses An Increased Risk To The Economy.

Joseph Otting Testified Before The Senate Banking Committee That “There Is Much Less Transparency” In How Nonbank Institutions Handle Leveraged Loans And Recognized That They Are More Vulnerable To Risks Because They Are Less Regulated. “Although supervised banks originate a significant portion of leveraged loans, nonbank entities have substantially increased their purchases of leveraged loans. Most of the problem loan leveraged loan exposure is held outside of the regulated banking system where there is much less transparency. While purchases of leveraged loan participations by nonbank entities allows the risks to be shared more broadly, the nonbank entities may not be required to hold the levels of capital and liquidity that supervised financial institutions must hold to protect them in an economic downturn or during a period of market disruption.” [Testimony of Joseph M. Otting, Hearing of the Senate Committee on Banking, Housing, and Urban Affairs, 05/15/19]

Despite Admitting That Problems With Leveraged Loans Could Have A “‘Contagious Impact’” On Banks And The Wider Economy — Joseph Otting Doesn’t Believe Leveraged Lending Presents A “Systemic” Risk.

Joseph Otting Said That Banks “Could Be Indirectly Putting Themselves At Risk” By Lending To Investment Firms That Are Engaged With The Leveraged Loan Market — But Asserted That Leveraged Lending “Doesn’t Currently Present A ‘Systemic’ Risk.” “Comptroller of the Currency Joseph Otting separately said that while he had not seen ‘significant default’ in leveraged loans, banks could be indirectly putting themselves at risk by lending to private equity or debt funds that are exposed to the loans. ‘We feel comfortable in their underwriting,’ Mr. Otting said in a phone call with reporters. Mr. Otting was speaking about his office’s twice-annual report on risks facing the banking sector, which was released on Monday. That report included a new section on leveraged lending, warning about weakening underwriting standards and a potential reversal in market conditions that could make it harder for borrowers to stay afloat. While leveraged lending doesn’t currently present a ‘systemic’ risk, banks should be wary of a ‘contagious impact’ on companies they are lending to, said Mr. Otting.” [Ryan Tracy and Lalita Clozel, “Regulators Look More Closely at CLO Boom,” The Wall Street Journal, 12/03/18]

• Otting Said That Banks Should Be Wary Of A “‘Contagious Impact’” Of Leveraged Loans. “While leveraged lending doesn’t currently present a ‘systemic’ risk, banks should be wary of a ‘contagious impact’ on companies they are lending to, said Mr. Otting.” [Ryan Tracy and Lalita Clozel, “Regulators Look More Closely at CLO Boom,” The Wall Street Journal, 12/03/18]

The Trump Administration Stopped Enforcing OCC Guidance That Successfully Discouraged Banks From Issuing Risky Leveraged Loans — And Joseph Otting Joined Regulators In Declaring That Such Guidance Would Not Be Enforced.

In 2013, The OCC And Other Banking Regulators Issued A Formal Guidance To Discourage Banks From Issuing Risky Leveraged Loans. In 2013, “the OCC joined with the Federal Reserve and Federal Deposit Insurance Corp., the main banking regulators, to issue formal ‘guidance’ meant to steer banks away from the riskiest of these loans, cementing Long’s warning into a firmer policy.” [Damian Paletta, “How regulators, Republicans and big banks fought for a big increase in lucrative but risky corporate loans,” The Washington Post, 04/06/19]

• The Guidance Successfully Lowered Leveraged Lending From $607 Billion In 2013 To Just $423 Billion Two Years Later. “This new regulatory push sent shudders through the banking industry. Financial companies dialed back their leveraged lending, according to industry data. Issuance of these loans fell from $607 billion in 2013 to $423 billion in 2015, according to S&P Global Market Intelligence. Private equity firms complained that it was harder to obtain loans for leveraged buyouts.” [Damian Paletta, “How regulators, Republicans and big banks fought for a big increase in lucrative but risky corporate loans,” The Washington Post, 04/06/19]

Joseph Otting’s Predecessor And Trump’s First Comptroller Of The Currency Keith Noreika Stopped Enforcing The Guidance In Late 2017. In November 2017, “Rep. Blaine Luetkemeyer (R-Mo.), then-chairman of the House subcommittee on financial institutions and consumer credit, sent a letter to the regulators asking for assurances that they would not be enforcing the leveraged-lending guidance. A few days later, Noreika told the Wall Street Journal that the leveraged-lending guidelines ‘shouldn’t be binding on anyone.’” [Damian Paletta, “How regulators, Republicans and big banks fought for a big increase in lucrative but risky corporate loans,” The Washington Post, 04/06/19]

Joseph Otting Said That The OCC’s Leveraged Lending Guidelines Allowed “Flexibility” For Banks, Saying, “‘I Think It Was Always Intended To Be Guidance.’” “Comptroller of the Currency Joseph Otting said […] that he does not expect to make changes to the federal leveraged lending guidance as he does not see revisions necessary since the guidelines currently allow for flexibility for banks. The comments came on a conference call with reporters. In February [2018], while speaking at the ABS Vegas conference, he put forward the idea that banks could step outside the guidelines if they have the capital to support that without threatening their financial well-being. Otting said […] he understands leveraged lending guidance to, in fact, be just that, and as such banks may occasionally operate outside those parameters. ‘I think it was always intended to be guidance,’ Otting said.” [Jonathan Schwarzberg, “OCC head says leveraged lending guidance needs no revisions,” Reuters, 05/24/18]

Joseph Otting Joined Trump Administration Financial Regulators In Declaring That Supervisory Guidance Does Not Have The Force Of Law And Would Not Lead To Enforcement Actions.

Last Year, The Office Of The Comptroller Of The Currency Joined The Trump Administration’s Other Financial Regulators In Declaring That “Supervisory Guidance Does Not Have The Force And Effect Of Law, And The Agencies Do Not Take Enforcement Actions Based On Supervisory Guidance.” “A law or regulation has the force and effect of law. Unlike a law or regulation, supervisory guidance does not have the force and effect of law, and the agencies do not take enforcement actions based on supervisory guidance.” [“Interagency Statement Clarifying the Role of Supervisory Guidance,” Board of Governors of the Federal Reserve System, 09/11/18]

• The Statement Was Issued By The Federal Reserve Board, FDIC, NCUA, And The OCC. “The Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, and Office of the Comptroller of the Currency (together, the “prudential agencies”) […] are issuing this statement to explain the role of supervisory guidance and to describe the agencies’ approach to supervisory guidance.” [“Interagency Statement Clarifying the Role of Supervisory Guidance,” Board of Governors of the Federal Reserve System, 09/11/18]
• Otting Has Been Comptroller Of The Currency Since November 2017.[“Joseph M. Otting,” Office of the Comptroller Of The Currency, accessed 05/31/19]

Joseph Otting Told An Industry Conference That Banks Broadly “‘Have The Right To Do What [They] Want’” And That Regulators Would Not “‘Challenge That.’”

In 2018, Joseph Otting Said Of Risky Corporate Loans, Banks “‘Have The Right To Do What [They] Want As Long As It Does Not Impair Safety And Soundness. It’s Not Our Position To Challenge That.’” “Noreika’s replacement at the OCC was Joseph Otting, a financial executive and former colleague of Mnuchin. In early 2018, Otting told an investor conference in Las Vegas that banks, in terms of leveraged loans, ‘have the right to do what you want as long as it does not impair safety and soundness. It’s not our position to challenge that.’” [Damian Paletta, “How regulators, Republicans and big banks fought for a big increase in lucrative but risky corporate loans,” The Washington Post, 04/06/19]

As A Member Of Trump’s Financial Stability Oversight Council (FSOC), Joseph Otting Voted To Strip Heightened Oversight Of Systemically Important Financial Institutions Like Blackrock, “The Biggest Investment Group On The Planet.”

Joseph Otting Is A Voting Member Of The Financial Stability Oversight Council, Which In March Decided To Move Forward In Stripping “Systemically Important” Designations From Nonbank Institutions Like Blackrock.  “Otting, who worked closely with Mnuchin at his former employer, OneWest Bank, is a voting member of the Financial Stability Oversight Council that proposed to exempt the big firms from the stiffest regulation.” [Bradley Keoun, “Junk Loans, Now at $1.2 Trillion, Could Haunt U.S. Banks, Top Regulator Warns,”The Street, 05/16/19]

• In March 2019, The Financial Stability Oversight Council Unanimously Voted To Reconsider Its Oversight Of Systemically Important Nonbank Financial Institutions. “The Financial Stability Oversight Council (Council) today voted unanimously to issue for public comment proposed interpretive guidance regarding nonbank financial company designations.” [Press Release, U.S. Department of the Treasury, 03/06/19]
• The Trump Administration Moved To Strip The Systemically Important Designation From Nonbank Firms Like Blackrock. “Trump administration officials led by Treasury Secretary Steven Mnuchin proposed in March to exempt nonbank companies such as Blackstone and Apollo from the ‘systemically important financial institution’ label, which would subject designated firms to strict regulation by the Federal Reserve.” [Bradley Keoun, “Junk Loans, Now at $1.2 Trillion, Could Haunt U.S. Banks, Top Regulator Warns,”The Street, 05/16/19]

o  BlackRock Is “The Biggest Investment Group On The Planet.” “BlackRock, the company he founded in 1988, was comfortably the biggest investment group on the planet, with more than $6tn of assets under management. During a record-shattering 2017, the group managed to pull in more than $1bn a day from investors.” [Robin Wigglesworth, “BlackRock: a vast money machine splutters,” Financial Times, 10/19/18]

The Move Was Condemned By Former Treasury Secretaries And Federal Reserve Chairs Who Argued That It Would “Make It Impossible To Prevent The Build-Up Of Risk” That Sparked The Last Financial Crisis.

The Move To Reconsider FSOC Designations Of Nonbank Institutions Was Opposed By Former Treasury Secretaries Tim Geithner And Jacob Lew, And Former Federal Reserve Chairs Janet Yellen And Ben Bernanke, Who Argued That The Move Would Limit FSOC’s Ability To Address Risks Associated With Leveraged Lending. “Yet the proposal has brought stiff pushback from former Treasury secretaries Tim Geithner and Jacob Lew as well as former Federal Reserve chairs Ben Bernanke and Janet Yellen. In a joint letter submitted to the council […], they wrote that the ‘activity-based approaches cannot address risks that are tied to the funding, leverage and combination of activities within a corporation.’” [Bradley Keoun, “Junk Loans, Now at $1.2 Trillion, Could Haunt U.S. Banks, Top Regulator Warns,”The Street, 05/16/19]

Former Treasury Secretaries And Federal Reserve Chairs Have Argued That The Trump Administration’s Proposal Would “Neuter” FSOC’s Ability To Designate Systemically Important Institutions And “Make It Impossible To Prevent The Build-Up Of Risk In Financial Institutions Whose Failure Would Threaten The Stability Of The System As A Whole.” “We believe that these steps – in design and in practice – would neuter the designation authority. Though framed as procedural changes, these amendments amount to a substantial weakening of the post-crisis reforms. These changes would make it impossible to prevent the build-up of risk in financial institutions whose failure would threaten the stability of the system as a whole.” [Letter from Timothy F. Geithner et al. to Steven T. Mnuchin and Jerome H. Powell, 05/13/19]

The Former Financial Officials Argued That The Last Crisis Was Caused By A “Cascading Cycle” In Which Highly Leveraged Companies Failed, Disrupted The Market, And Caused Further Company Failures. “The failure of nonbank financial companies was central to the propagation of risk from the financial system to the U.S. economy, international financial markets, and the global economy as a whole during the crisis. The story of the crisis is a cascading cycle of market losses causing the failure of highly leveraged financial companies, which in turn caused further market disruptions, and additional failures.” [Letter from Timothy F. Geithner et al. to Steven T. Mnuchin and Jerome H. Powell, 05/13/19]

Former Federal Reserve Chair Janet Yellen Has Voiced Concern About Corporate Debt And Argued That Leveraged Lending Could Worsen The Next Economic Downturn.

Former Federal Reserve Chair Janet Yellen Has “Singled Out” Leveraged Lending As Her Main Economic Concern, Arguing That The Next Financial Crisis Could Be Worsened Because “‘Non-Financial Corporations Have Run Up, Really, Quite A Lot Of Debt.’” “Former Federal Reserve (Fed) Chair Janet Yellen warned […] that America’s corporate debt binge could end up sparking a deeper recession when the next downturn hits. […] When asked about asset bubbles and potential fallout when the current US economic expansion cools down, Yellen singled out high corporate debt levels as a worry […] ‘I have expressed concerns about leveraged lending,’ Yellen said during a keynote discussion that was closed to the press. ‘I do think non-financial corporations have run up, really, quite a lot of debt.’” [Joy Wiltermuth, Kristen Haunss, “Yellen warns of corporate distress, economic fallout,” Reuters, 02/27/19]

• Yellen Said That A Recession Sparked By Risky Corporate Loans “‘Could Be More Serious And Longer-Lasting And More Difficult To Deal With.’” “‘This means that the next downturn that we have could be more serious and longer-lasting and more difficult to deal with than it would have been if we had constrained these practices,’ former Federal Reserve chair Janet L. Yellen said in an interview.” [Damian Paletta, “How regulators, Republicans and big banks fought for a big increase in lucrative but risky corporate loans,” The Washington Post, 04/06/19]

The Biggest Bank CEOs Have Told Congress They Believe Leveraged Loans Are One Of The “Chief Risks To The Economy.”

In April 2019, Leaders From The Biggest Banks Told Congress That “They Believed Leveraged Loans To Be Among The Chief Risks To The Economy.” “At a congressional hearing [in April 2019], several chief executives of major US banks said they believed leveraged loans to be among the chief risks to the economy.” [Kiran Stacey, “Fed warns leveraged lending could exacerbate a downturn,” Financial Times, 05/06/19]

Financial Experts Who Foresaw Aspects Of The Last Financial Crisis Now Identify “Low-Quality Corporate Debt” As A Threat To The Economy.

The Former International Monetary Fund (IMF) Chief Economist Who Foresaw Aspects Of The 2007-08 Financial Crisis Now “Sees Potential Problems In U.S. Corporate Debt.” “Rajan also sees potential problems in U.S. corporate debt, particularly as rates rise […]” [Howard Gold, “Opinion: These 4 called the last financial crisis. Here’s what they see causing the next one,”MarketWatch, 09/14/18]

• “Raghuram Rajan, then chief economist of the International Monetary Fund, said [before the 2007-08 crisis] the amount of risk and leverage in the system was much higher than most people thought.” [Howard Gold, “Opinion: These 4 called the last financial crisis. Here’s what they see causing the next one,”MarketWatch, 09/14/18]

A Financial Analyst Who Foresaw Aspects Of The 2007-08 Financial Crisis And The 1987 Stock Market Crash Has Argued That “The Biggest Danger […] Is From Low-Quality Corporate Debt.” Jim Stack, President Of A $1.3 Billion Management Firm, Told MarketWatch“the biggest danger […] is from low-quality corporate debt. Issuance of corporate bonds has ‘gone from around $700 billion in 2008 to about two and a half times that [today].’ And, he added, more and more of that debt is subprime. Uh-oh. In 2005, he pointed out, companies issued five times as much high-quality as subprime debt, but last year ‘we had as much subprime debt, poor quality-debt issued, as quality debt on the corporate level,’ he said, warning ‘this is the kind of debt that does get defaulted on dramatically in an economic downturn.’” [Howard Gold, “Opinion: These 4 called the last financial crisis. Here’s what they see causing the next one,”MarketWatch, 09/14/18]

• “Stack is president of Stack Financial Management, which manages $1.3 Billion, and InvesTech Research […] As a young analyst, he called the 1987 stock market crash.”[Howard Gold, “Opinion: These 4 called the last financial crisis. Here’s what they see causing the next one,”MarketWatch, 09/14/18]

In 2009, Joseph Otting Argued That A Recession “Usually Frees Up A Lot Of Great Entrepreneurial People To Work In Their Garages.”

Joseph Otting Said During The Financial Crisis That A Recession “Usually Frees Up A Lot Of Great Entrepreneurial People To Work In Their Garages […] I Think We’re About To Launch Another Innovation Phase In America.” Joseph Otting said in June 2009, “[i]f anything positive comes out of a recession, it usually frees up a lot of great entrepreneurial people to work in their garages and come up with the next great technology idea or medical products breakthrough. I think we’re about to launch another innovation phase in America, because as people perhaps lose their jobs at these large industrial companies, an opportunity they may not take if they were in the normal course gets thrust upon them to go out and live their entrepreneurial dreams. Some of the greatest successes of our era have come through that environment.” [“UNIBusiness: The Alumni Magazine of the College of Business Administration University of Northern Iowa, 2009-2010,” University of Northern Iowa, 2009-2010]

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