Why the 'Too Big to Fail' Doctrine Scares Me Today.(Mortgage Scene)

Byline: Paul Muolo

First, the good news: thanks to the mortgage/credit crisis and the ensuing financial panic, we have created a new cadre of "mega banks" that are large, well capitalized and have come to the rescue of their ailing brethren in the financial services industry. All has been saved because of "charitable" takeovers of such ailing has-beens as Countrywide, Merrill Lynch, Wachovia and Washington Mutual.

We can all sleep again, knowing that the big boys are stable, and together control 67% of the mortgage market in terms of receivables on first and second liens. Here's how the servicing numbers shake out in terms of market share: Bank of America (21.68%), Wells Fargo (17.65%), Chase Home Finance (15.09%), CitiMortgage (8.49%) and Residential Capital LLC (4.14%).

Now for the bad news: the top five control 67% of the servicing market, which means in my book most of these firms are "too big too fail" just like Fannie and Freddie were. Think about it for a second: what if something goes wrong with Bank of America which now services $2 trillion in home mortgages for American consumers? I'm not saying BoA is in danger financially but we've created a financial system - for better or worse - where too much risk is in the hands of too few. There's something wrong with that.

Let's take Fannie Mae and Freddie Mac, for example. They own or guarantee $5.2 trillion of the nation's $9.6 trillion in U.S. housing debt, or 54%. That type of market share concentration should never have been allowed to happen. It creates a situation where the government cannot - for fear of a huge market disruption - allow something so big to fail.

As this edition of Mortgage Servicing News went to press the government had just announced it would use $250 billion of the $700 billion bailout bill money to invest in dozens of banks, including Bank of America, Wells, Chase and Citigroup. None of these firms were in immediate danger of failing but at the very least it can be argued that they were all partly nationalized.

Some of you remember the giant hedge fund Long Term Capital Management, the brainchild of John Meriwether, a former star bond trader at Salomon Brothers. LTCM went down during the Russian debt crisis in 1998 when it bet the wrong way on that nation's prospects. The Federal Reserve stepped in. Do you know why? Answer: LTCM had ...