Bank Lawyer's Blog

Enhanced Recordkeeping Proposal: Kill It Before It Multiplies

One of BLB's favorite gadflies, Bert Ely, was at it again last week (paid subscription required). This time, his incredulity was focused on an FDIC proposal to require the country's largest banks (those with over two million deposit accounts) to implement more "robust" (and expensive) systems for determining more quickly, upon failure of the bank, whether a deposit is inured, uninsured, or partially insured. While Bert concedes that the proposed rule initially burdens only 36 banks, "one could imagine a scenario when this regulation could easily be extended to all banks." "One" could. It's called "trickle down" regulation. The CFPB's "race to the overbearing bottom" is a classic example. Therefore, argues Bert, "all banks" should oppose it.

While Bert criticizes the difficulty and expense (FDIC estimates the 36 banks will have to spend $328 million in system upgrades) of the proposal, his real criticism is that, based on recent history, the "proposed rule bears no relationship to reality."

Inasmuch as the FDIC has had the power (since the enactment of FIDICA in 1991) to protect the uninsured deposits of a failed bank if that was a less costly alternative to letting the uninsured depositors "eat cake," and since the panicked lines of depositors at IndyMac in 2008 encouraged The Care Bair and her successor to favor to overwhelmingly favor protecting all depositors in subsequent failures (in 482 of 512 post-IndyMac failures, Ely asserts), there is little likelihood that the FDIC would not protect all depositors from a public relations standpoint. Moreover, Ely argues, because protecting all depositors usually protects the "franchise value" of the failed bank, acquiring institutions are usually motivated to pay enough for the deposits and non-mortally wounded assets of the failed bank that liquidation and "stiffing" the uninsured depositors is not likely to ever be the least costly alternative.

Bert also argues that liquidation "can be very disruptive to the failed bank's lending and other nondeposit relationships. He cites the 2009 liquidation of New Frontier in Greeley, Colorado, as one instance in which local businesses were negatively impacted. Being familiar with that specific example, I can vouch for the veracity of Ely's opinion. Finally, Bert argues that the FDIC's recent concern with the continuing liquidity of banks (especially large banks) in crisis situations would be hampered by liquidations in which uninsured depositors were not paid, and might induce uninsured (and even insured) depositors in other banks to stage runs (ala IndyMac).

All-in-all, says Bert, this proposal is a bad idea and "the FDIC should kill it."

Amen.

The Blame Game Is Still Being Played

In the spring of 2008, months before Lehman Brothers became the largest bankruptcy in US history and the world as we knew it went to hell in a hand basket, I wrote a post about a Wall Street Journal editorial by the former CEO of Nomura Capital, Ethan Penner, in which he decried the bailout culture and the lack of personal responsibility it both reflected and fostered in America.

And so we have the insidious modern trend to shirk responsibility and blame others for our missteps. This trend, this "victim mentality," is a path toward personal disaster.

Perhaps if the Fed had raised short-term rates more aggressively, the excesses of the bubble could have been avoided. Maybe regulators could have noticed that the criteria for achieving an AAA rating had weakened markedly and inserted themselves early on. Yes, we can hope that the government takes the appropriate steps to ensure that the regulatory system improves as a result of this crisis. However, we citizens also need to accept our share of the responsibility.

Homeowners must learn that there are risks to using a home as an ATM. Investors who borrowed to flip condos must learn the downside of such risk. Individuals who steered money from insured bank deposits into uninsured money market accounts to pick up 1% more yield – like the institutional investors who purchased complex securities with little due diligence – need to know that in an efficient market, extra yield means extra risk. Those who played the derivatives market, focusing more on computer-driven pricing models and less on managing counterparty risk, must pay for that oversight. And, much as it is impolitic to say, people who took money from lenders and signed without considering how they'd repay those loans must also be held accountable.

In one of this year's primary debates, Ron Paul said it is not the president's job to run the economy. I'd add that it is not the government's job either. It is each and every citizen's job to manage our own affairs, make our own decisions, bear the fruits or painful consequences and learn our lessons.

The free market is the essence of our society's strength and is rooted in the Lincolnian precepts of accountability and responsibility. When decisions are made and actions taken (or not taken), there are consequences. These consequences are models for us to learn from and serve to stimulate social growth and advancement.

Less than six months later, the collapse occurred, the big bailouts ensued, and as we all know, the lessons taught by the adverse consequences of poor decision making were not learned. At least the world economy didn't tip over into total depression, but eight years later, we still haven't fully recovered from the meltdown.

Last December, Michael Burry, a main character in the book and movie, "The Big Short," gave an interview to Jessica Pressler which was published in New York Magazine, in which he, too, bemoned the unlearned lessons of the events leading up to that collapse. When asked if the crash resulted in any "positive changes," he responded negatively.

Unfortunately, not many that I can see. The biggest hope I had was that we would enter a new era of personal responsibility. Instead, we doubled down on blaming others, and this is long-term tragic. Too, the crisis, incredibly, made the biggest banks bigger. And it made the Federal Reserve, an unelected body, even more powerful and therefore more relevant. The major reform legislation, Dodd-Frank, was named after two guys bought and sold by special interests, and one of them should be shouldering a good amount of blame for the crisis. Banks were forced, by the government, to save some of the worst lenders in the housing bubble, then the government turned around and pilloried the banks for the crimes of the companies they were forced to acquire. The zero interest-rate policy broke the social contract for generations of hardworking Americans who saved for retirement, only to find their savings are not nearly enough. And the interest the Federal Reserve pays on the excess reserves of lending institutions broke the money multiplier and handcuffed lending to small and midsized enterprises, where the majority of job creation and upward mobility in wages occurs. Government policies and regulations in the postcrisis era have aided the hollowing-out of middle America far more than anything the private sector has done. These changes even expanded the wealth gap by making asset owners richer at the expense of renters. Maybe there are some positive changes in there, but it seems I fail to see beyond the absurdity.

[...]

The postcrisis perception, at least in the media, appears to be one of Americans being held down by Wall Street, by big companies in the private sector, and by the wealthy. Capitalism is on trial. I see it a little differently. If a lender offers me free money, I do not have to take it. And if I take it, I better understand all the terms, because there is no such thing as free money. That is just basic personal responsibility and common sense. The enablers for this crisis were varied, and it starts not with the bank but with decisions by individuals to borrow to finance a better life, and that is one very loaded decision. This crisis was such a bona fide 100-year flood that the entire world is still trying to dig out of the mud seven years later. Yet so few took responsibility for having any part in it, and the reason is simple: All these people found others to blame, and to that extent, an unhelpful narrative was created. Whether it’s the one percent or hedge funds or Wall Street, I do not think society is well served by failing to encourage every last American to look within. This crisis truly took a village, and most of the villagers themselves are not without some personal responsibility for the circumstances in which they found themselves. We should be teaching our kids to be better citizens through personal responsibility, not by the example of blame.

Burry's another smart guy who condemns the consequences of a culture in which "personal responsibility" is a foreign concept. If the vitriol of this election season has emphasized anything to me, it's certain that most of us are no closer to looking in a mirror when it comes to assigning blame for the bad things that happen to us today than we were in late 2008. In fact, after eight years of non-governance, with Nanny State organs like the CFPB "all fired up and ready to go" with the task of finding others to blame for every single instance of inequality of condition, and with an apparent choice between (as Peggy Noonan put it) a criminal and a crazy man for the title of "Leader of the Free World," we appear to be farther down the road to perdition than we were in 2008, and with a heavy jackboot pressing the accelerator pedal all the way to the floor.

Not that I expect anyone to really give a rat's tukus about the foregoing, this being an election year in which every person seems to be polarized by the zeigeist. However, maybe we ought to be concerned by the prospect of "deja vu all over again." Ben Lane at Housing Wire pointed out this past week that during the first quarter of this year, Mr. Burry's hedge fund liquidated its portfolio of a number of big bank stocks. Lane states that "[t]ime will tell if Burry’s bet is proven right again." Although that's true, based on his track record, this should not allow anyone to sleep well at night. Unless, of course, you, too, are "going short."

[Edited to clean up typos and the brutal overuse of the verb "decry."]

De Novos: A Recipe For Success or Heartburn?

Long time community bank attorney (and former FDIC Regional Counsel) Jeff Gerrish created his recipe for cooking up a new bank charter.

The number one ingredient is cash, and plenty of it. Because FDIC policy is that de novos need meet an 8% leverage ratio by the end of the third year, "if your new bank is going to be $250 million in total assets at the end of its third year, you will need to raise about $20 million in order to obtain the charter. And that is the minimum. If FDIC determines there is some unique risk in your proposed charter, then the requirement could be higher."

My somewhat jaundiced take is that the FDIC will frequently find additional risk, so for planning purposes, count on 10%.

Jeff's second main ingredient is seasoned senior management and an impressive board of directors.

[Y]ou need to find a seasoned CEO of an existing community bank or previously healthy community bank that sold. You also need to find a couple of other seasoned senior officers, as well as a board of directors that, while not maintaining quite as much “seasoning,” still has some folks on it who have possibly been directors of community banks previously, or know something about the industry. The era of establishing a board of directors of a new bank, anywhere from 8 to 15 people typically, made up of individuals who are simply pillars of the community with no banking experience is over.

Jeff also observes that getting FDIC, as well as other regulatory, approvals is "daunting and time-consuming" (He thinks 12 to 18 months from the first meeting of the organizing group to discuss the concept among the members is "good; I'd call it "optimistic."). I think that he and I would agree that in addition to raising money for capital contributions, the organizers need to raise a decent chunk of cash to fund organization expenses, including expertise needed to prepare and shepherd the necessary applications through the FDIC and the state or federal chartering authority. Depending upon how the organizers intend to raise capital, additional expertise will be needed (and expense incurred) in those efforts.

I would throw a couple of additional ingredients into Jeff's recipe. One is a convincing argument that there is a need for a new bank in the community that it is intended to serve. The few de novo applications that have survived the "gauntlet" in the past half-dozen years have been intended to create a bank in a well-defined and targeted community that the organizers have argued convincingly is not being served by existing financial institutions. I'm not saying that that everyone has to have a "bird in hand" like serving the Amish community, but the applicants ought to have at least two-in-the-bush that can serve the same purpose. Unless you can show a need other than you'd just like to be in the community banking biz, I don't think that the regulators will see much upside in granting you a new charter.

A related ingredient is a combination of a well-thought-out and well-prepared business plan that is as close to conventional as it can be, and a feasibility study that demonstrates that, "By Gum, we can make money running this thing!" In other words, assume that you're a guard taking the rock to the iron for a thunder-dunk and the FDIC is Hakeem Olajuwon towering in the post screaming "Don't be bringing that internet-only, CRE-centric, lowering-our-payday-lending-conglomerate's-cost-of-funding-through-the-use-of-insured deposits garbage into my house!" right before he pile-drives you into the floor with a flagrant 2 foul. Moreover, spend some time and money securing help from folks who have actually carried water to the bench in this arena, so you have at least a fighting chance of surviving the initial hurdle in any such endeavor: the laugh test.

I remain skeptical about a "thaw" in this freeze. Others are more buoyant. I think a threshold question you have to ask yourself is how early in the "thaw" do you want to put out into open water. Is it better to let others blaze the trail and learn from their success (and/or failure), or is time "a wastin"? If you think you've got the necessary ingredients, including plenty of cash, patience, and persistence, then maybe the time is finally right to cast off. I would recommend that you initially paddle slowly and carefully, though.

Fourth Corner: Staying Power or Sampling The Product?

When last we checked in January on the trials and tribulations of Fourth Corner Credit Union, a state-chartered Colorado credit union formed to provide financial services to the marijuana industry, the credit union had been denied an injunction by a federal district court in Colorado to force the Federal Reserve Bank of Kansas City to grant the credit union a "master account." It needs that master account to gain access to the banking system. The district court judge ruled that the court was not going to compel the Fed to grant access to a credit union that would facilitate illegal money laundering under federal criminal laws (albeit an activity that is fine and dandy under Colorado law). The court also "hinted" that if it ever got to the merits of the issue of whether Colorado marijuana laws trumped federal marijuana laws, the Supremacy Clause of the US Constitution would lead the court to favor federal law.

On April 29th, the credit union appealed the district court's decision to the 10th US Circuit Court of Appeals in Denver. I have not reviewed the appellant's brief, so all I have to go on regarding the arguments to support the appeal thus far are the public statements of the credit union's spokesperson as reported in The Denver Post. Those statements don't fill me with an excess of hope that the credit union's appeal will be successful. The arguments seem to be:

• The Justice Department and FinCEN are "hypocritical" for issuing guidance that would lead banks to believe that they can successfully avoid prosecution under federal law if they follow the guidance without actually allowing them to do so.
• The government bureaucracy moves slowly, so drug money can't be laundered through the banking system and is, thus, "unsecured," and that "scares" the spokesperson.
• A decision was rendered by a Colorado district court judge that marijuana buds were covered under a general liability insurance policy, a decision that the court made clear involved solely state, not federal, law.
• The US Supreme Court declined to hear a lawsuit filed by the states of Nebraska and Oklahoma against the state of Colorado, a decision that was based solely on jurisdictional grounds, in that the alleged harm is being caused by individuals, not by a state, and, therefore, the SCOTUS does not have jurisdiction to hear the case. The attorneys general of Nebraska and Oklahoma can refile the case in federal district court.

There may be fine legal arguments made by the credit union that support its contention that the Fed must issue it a master account. If so, they are not making it into the main stream media. If all it's got is what I read in the newspaper, I'd recommend that the CU roll 'em if its got 'em, don't Bogart the joints, slap a few Cheech & Chong cd's in the boom box, and "get mellow," because the future is looking somewhat gloomy in the real world.

Then again, come November, we have absolutely no idea what kind of wild card the electorate might draw for the Oval Office. We might actually get a president and Congress that will take the Thai Stick by the lit end and burn down the barriers to a full monty of a Mary Jane-friendly society. Or, those of us who haven't rolled a joint in nearly a half century might be compelled to nestle down in the high country with a M249 SAW, a bale of concertina wire, a half-dozen claymores, plenty of bottled water and Tostitos, and several pounds of Ghost Train Haze and Blue Dream. And yes, unlike our former president and future first man, in such circumstances, we would plan to inhale.

Will PHH Clip The CFPB's Wings?

In a recent hearing before a federal appeals court, some of the justices appeared to be sympathetic to arguments by mortgage giant PHH Mortgage that the CFPB is unconstitutional. In Forbes, Susan Dudley, Director of the GW Regulatory Studies Center and a former White House official in the "W" administration, explores the arguments in favor of knocking the CFPB off its high horse and finds that they might have traction. She cites the following critical passage from PHH's brief:

The Director is not answerable to the President, as he is removable only for cause. Nor is Congress able to rein in the Director using its power over the purse, as he has the sole power to fund his agency from the Federal Reserve System’s operating expenses, and Congress is prohibited from reviewing the Director’s budget determinations. The Director is not checked by the deliberative decision-making process of a multi-member commission structure, nor is he checked by a short tenure, as he serves a fixed five-year term. And far from a limited scope of power, the Director wields vast authority under eighteen statutes previously enforced by seven different agencies. Never before has so much power been accumulated in the hands of one individual so thoroughly shielded from democratic accountability. The combination of these unprecedented structural features violates the separation of powers.

As Dudley correctly observes, the CFPB is unique. Other federal regulatory bodies are either executive branch agencies or independent commissions. In either case, they are subject to executive and/or legislative control directly or through an oversight body composed of members selected by the president and confirmed by Congress. Most are also subject to control through the appropriations process, giving another body control of the purse strings.

The CFPB is controlled not by a commission, but by a single director (currently, King Richard Cordray, Champion of Jeopardy) who is subject to removal by the president only "for cause." Other agency heads can be removed for wearing a tie with an offensive motif. calling the First Lady "Babe," or for an infinite variety of spurious reasons. Moreover, the CFPB's budget cannot be controlled by Congress. The FRB, is required to fund it by law, and Congress has no oversight.

This lack of checks and balances has concerned us since the CFPB sprang from the nether regions of Lizzie Warren, who deliberately concocted the Adjustment Bureau to be completely outside the control of anyone other than the reichsführer who runs it on any given day, which Warren originally intended be herself. The Director would be guided only by his or her knowledge of what was best for all consumers, applying truth, justice, and anti-abusiveness as Gaia gave him or her to see the light.

About six months ago, I attended a conference at which one of the panelists was a millennial former member of the CFPB's enforcement "arm" who recently rushed out the revolving D.C. door into a high-paying job with a banking law firm where he, naturally, advised those being persecuted prosecuted by the CFPB. In addition to possessing his generation's endearing narcissism and lack of respect for his elders, he scoffed, with a self-satisfied smirk, at concerns about the lack of controls over the CFPB because the Adjustment Bureau had been around for several years "and nothing horrible had occurred." One of the older panelists interjected one word: "Yet." I might have added: "Ask PHH."

As Dudley points out, even if the appeals court rules in favor of the petitioner, there are half-steps between nothing and abolishing the CFPB in its entirety as being an unconstitutionally created monster of Franken-Dodd. It could strike down the sole director structure; it could strike down the provision of Franken-Dodd that permits the president to fire the director only for cause; it could strike down the funding structure; it could do none of the above or all of the above. Whatever it decides, the decision is almost certainly to be appealed. By the time it reaches the SCOTUS, who knows what the composition of that august body might be, given the insanity that is the current season of "Election 2016"?

Nevertheless, Dudley asserts that "the future of something President Obama considers one of his main accomplishments is hanging in the balance."Here's hoping that the U.S. Court of Appeals for the District of Columbia Circuit gives the CFPB a little nudge in the "right" direction.