Bank Lawyer's Blog

ILCs: Plenty Of Fight In The Dog

It's not the size of the dog in the fight, it's the size of the fight in the dog.
---Mark Twain

While the OTS has been getting much of the attention of the trade press for being singled out by "The One" and his minions for liquidation, the industrial loan corporation charter and similar forms of "non-bank banks" are also on the administration's chopping block. The Democrats in the House have been pushing for the end of the ILC for the last few years, especially during the eighteen month period that ended in early 2008 when the FDIC put a moratorium on insurance applications for new ILC charters and for non-financial firms acquiring existing ILCs. "Rampaging Robert" Bennett, the Republican Senator from Utah who sits on the Senate Banking Committee, effectively killed attempts to pass such legislation in the Senate (although it passed in the House in 2007). He shows no signs of relenting.

During testimony last week before the Senate Banking Committee (paid subscription required), Treasury's "Tim Terrific" Geithner was pummeled by Bennett over the issue.

"There is not a single ILC that contributed to the crisis, not a single ILC that went down," Bennett said. "Destruction of an industry is not a modest change. … You are taking an area that worked and going to abolish it. You are engaged in overkill, in my view."

He left unspoken a threat to take Geithner snipe hunting with Dick Cheney if the Obama administration pursues the ILC charter's immolation. Since Utah is home to most of the remaining 45 to 50 remaining industrial banks, thrift and loans, industrial loan companies, and similar "loophole" financial institutions, Bennett definitely has "skin in the game." Plus, he's got a track record of winning when nit comes to protecting his home state's turf.

Also with skin in the game is Senate Majority Leader "Dirty Harry" Reid of Nevada, which is home to some of those institutions, as well, and which is a state whose economy doesn't need to lose anymore economic firepower of any sort. As he did with previous fights over this issue, Harry's not wild about face time and has left the public fighting to Bennett. As I speculated before, however, I don't think Senator Reid will stay out of the game if the Democrats push the issue.

It should be noted that while the Obama proposal is not to outlaw the charter itself (as it has proposed to do with federal savings banks and savings associations). Instead, the administration wants to require ILCs to be defined as "banks" under the Bank Holding Company Act, which would eliminate the ability of "non-financial" holding companies like Target, Harley-Davidson, Pitney Bowes, BMW and others to continue to own them and to also carry on their "commercial" activities. They would also have to meet the FRB's capital levels and would be examined and more closely regulated just like other "bank holding companies." As noted by David Enrich and Robin Sidel in a recent Wall Street Journal piece (paid subscription required), the practical effect of this change would be to cause the holding companies to close the ILCs down.That, in turn, may very well have the effect of choking off credit to businesses and consumers at a time when the economy needs these financing sources.

Though relatively small players in the financial system, ILCs provide a wide variety of products and services to businesses and consumers. The offerings range from financing purchases of Harley motorcycles to loans that cover corporate medical payments to insurers. Eliminating or sharply curtailing those operations could make it harder or costlier for customers to get credit.

While most ILCs and their holding companies are publicly taking a wait-and-see attitude, and Utah bankers profess optimism, the proposal has got to be severely annoying to the industry. A well-placed source told me that a couple of months ago, a delegation of executives of Utah ILCs and other interested parties from Utah made a trek back to D.C. to visit with FDIC Chairman Bair as to when the FDIC might, in actuality, remove the moratorium on ILC acquisitions and new charters in light of the fact that the moratorium had expired over a year ago and yet the FDIC had not approved any pending applications since that time. "Chair Bair" told them that these were tough times for new charters but that if some holding company came up with big bucks to help take a load off the FDIC's back in the form of a rescue of an FDIC-insured ILC that needed the assistance, that might play favorably with the FDIC. No mention was made of the idea that the federal government was getting ready to unload a world of hurt on the business model itself, so that the whole discussion was likely moot. That may mean that Ms. Bair (reportedly not a favorite of Tim Geithner's) was out of the loop on this issue, or it may mean that she was simply not forthcoming. Regardless, they could have saved themselves the trip had they known what was coming down the pike.

 It's very early in this game, but if I were forced to bet now on the eventual winner, I wouldn't back the anti-ILC crowd. ILCs and their supporters have large investments to protect, businesses that make good sense for them and their customers, and, perhaps most important, plenty of fight in them if the going gets nasty.

A Plethora Of Political Incorrectness

Some days, when I'm especially pressed for time, I seriously consider bagging putting up a post. Then, out of the blue, my readers will supply me with material too good to pass on. Two recent examples beg for a post.

The first is a fairly common form of e-mail I receive from public relations flaks, who apparently supply reporters with pithy quotes from attorneys who seek to make their mark as "experts" of one sort or another. I hadn't considered hiring a public relations firm to push quotes on reporters, but then, I've earned my clients the old fashioned way: barratry and champerty. Even more disconcerting was the notion that any person possessed of even the most modest powers of perception would consider this blog a place where the authors might be interested in someone else's opinion. "Unfair and Unblanced" is our motto.

Nevertheless, I received such an e-mail today and decided to post the guts of it, rather than just dribble out individual quotes within the context of a substantive post. Hey, you want free publicity, here it is, unvarnished and without comment. Individual readers can peruse the following and decide for themselves as to its value.

BANK LAW EXPERT: THOUGHTS ON NEW REGULATIONS

Financial institutions law expert James Wheeler, a partner at the international law firm, says the Obama Administration is not shy about wanting to change the financial regulatory landscape, but says all the talk about regulating the banking industry is nothing new.

“This is very similar to what we heard in the mid-1970s and again in the early 1990s,” Wheeler says. “Then, too, there were threats and talk from the federal government on how to regulate things better.”

What’s different this time, Wheeler says, is the severity and global nature of the current recession, as well as the wide-ranging impact it’s had all around the world.

“I hope any change made by the Obama administration is for the purpose of more-efficient regulation, rather than just more regulation for regulation’s sake,” Wheeler says.

The rumored nature of the new regulations is to have key federal agencies work together to avoid another perfect-storm collapse of the national financial system.  But Wheeler says a paralysis among the financial regulators, and a history of non-collaboration, are hurdles the administration must overcome.

“A lot of regulators are unsure what to do,” Wheeler says, “they don't know where they’ll be next week, next month or next year, and that keeps them from moving forward.  Traditionally, federal banking regulators have not always played nicely together, which sometimes creates turf wars.”

Wheeler’s is concerned about the impact rule changes could have on federal thrifts (or savings associations), and other smaller banks and financial institutions.  A frequent rumor has the Office of Thrift Supervision (OTS), now overseen by the Treasury Department, being folded into the FDIC, the Federal Reserve or another national regulatory agency.

“Many people in the industry think moving the OTS would be a mistake,” Wheeler says. “Small savings banks, and savings and loans, need baby steps toward change.  They don't need oversight by an organization that doesn’t always understand their needs.”

There you have it, folks. Straight-up, in-depth insight unlike the kind of snarky fluff you usually find on rags like Bank Lawyer's Blog. I hope you enjoyed it. If so, Mr. Wheeler's publicist says that he is available for interviews.

In another interesting e-mail, a reader from The Left Coast accused me of pushing a hidden homophobic agenda in my most recent mockery of Barney Frank. I tried and failed to get my head around the paradox of having concocted a rational plan (agenda) to push an irrational anxiety disorder (homophobia), but, then, I never claimed to be G.K. Chesterton. Still, I wish to clarify that I do, indeed, hate homosexuals, not because of their sexual orientation, but because I am a misanthrope. Homosexuals are members of either "mankind" or "womynkind" and, therefore, merely a subclass of a despised species, all of whose subclasses are mock-worthy, especially the subclass that consists of Blue State dwellers who awaken each morning convinced that the sun rose in the East for the sole purpose of shining through their bedroom windows and into their soft-lidded eyes just to piss them off, all at the instigation of Sarah Palin and her fellow creationist whack-jobs. To members of this subclass: I must exhort you to fine tune the rabbit ears on your tin foil hats and find another blog to offend you. You needn't search far. Hot house flowers will find almost any climate inhospitable to their delicate, politically correct, sensibilities.

The subclass of professional politicians, to which Barney Frank belongs, is also high on my list of the mock-worthy. It's not as target-rich a subclass as lawyers, but it's pretty darned close. Any aspect of Frank's sordid past is open season. Any aspect, from his notorious association with Stephen L. Gobie, who Frank paid for sex and who ran a prostitution ring out of Frank's apartment, to his recent branding of Justice Scalia as a "homophobe" (sound familiar?). This despicable human being is the head of the House committee on banking legislation. If the consequences of the gaping holes in the characters of men and women in his position and other leadership positions in Washington, D.C. weren't so serious for the country, he'd be a laughingstock. Instead, the fact that he's in a position of such power is potentially tragic. If you don't like my mocking clowns like Frank, again, I urge you: read elsewhere. The Internet is a place filled with an infinite amount of white noise and you'll surely be able to find an echo chamber to your liking, a place where bloggers aren't so "mean."

Now that I've driven away more of the bootless and unhorsed, it's time to tell my more robust readers what really chaps my hide: short people. I also suffer from mycrophobia.

Have a nice day.

Jeb Hensarling: Modern Day Don Quixote

I didn't agree with Texas Congressman Jeb Hensarling, the only sitting member of Congress who serves on the TARP Congressional Oversight Panel, when he initially opposed the Bush administration's original TARP proposal last year. I can't say that I agree with every position he takes on political and economic issues. On the other hand, he's nothing if not consistent in his suspicion of the role of big government (especially, big federal government) in intervening in the economy, and for that I respect him. We need thoughtful opposition to the march of the current administration and Congress, aided and abetted by the federal banking agencies and some of the more notorious opportunists who head a few of them, to impose their version of a "command economy" on this country under the guise of dealing with an "economic crisis."

Last week, Hensarling proposed a bill that would end TARP on December 31, 2009. It would also make it easy for any TARP recipients to repay TARP CPP capital and would end the current administration's attempt to make TARP a roach motel for certain large banks (e.g., Bank of America, Citigroup) that are branded "too big to fail," which is turning into "too big not to be micromanaged by Democratic politicians for the benefit of their core constituencies and largest political contributors." Hensarling's legislation would also force the Treasury Department to liquidate warrants as TARP preferred stock is repaid, thereby removing a hammer hanging over the head of those banks that have otherwise repaid what they "borrowed." Finally, it would reduce the TARP funds available for use by the Treasury Department dollar-for-dollar with the amounts repaid, thereby reducing the Treasury Department's ability to spend those dollars again and meddle elsewhere in the economy with them.

Hensarling appeared last week on CNCB's program "Squawk Box" (see clip below) to discuss the proposed legislation. It became apparent that TARP's merely one of the aspects of the federal government's intervention in the economy that's bugging him. He admitted that his "tipping point" was the "lawlessness" (my term, ot his) of the Obama administration's behavior in perverting the bankruptcy laws so that the United Auto Workers union received far more than they would have had Obama and his minions not used TARP as an arm-twister to get creditors who received TARP and other federal assistance to approve a plan that screwed bond holders who otherwise would have been entitled to more preference than they were given in the final plan. He's worried that this is only the first of many instances of creeping "command economy" maneuvers by the current administration and the majority party in Congress. I suppose he calculates that he might as well start "squawking" about it on television and through whatever other venue he can.

I agree with his attitude toward the prospects of the legislation being enacted: "high hoes, low expectations." I'd add something about a snowball in Hell, but I think he covered the prospects properly. Nevertheless, as time marches on and the agenda of the powers-that-be continues to play out, he'll likely have an increasingly sympathetic audience among many bankers, including all those community bankers who are too small to save, and who've either been left on the sidelines or beaten like drums by the same regulators who handle the big boys with kid gloves.

Barney Frank: Corporate Governance Expert

House Financial Services Committee Chairman Barney ("Boy George") Frank flew off the deep end this morning when CNCB's Mark Haines challenged the basis for Frank's argument that shareholders of banks and other businesses must have a right, mandated by federal law, to set executive compensation, a matter that is currently left to boards of directors. Rather than let Haines finish his question, Frank interrupted him and, when Haines tried to finish the question over Frank's interruption, Frank accused Haines of interrupting him, erupted, and abruptly ended the interview. Rather than apologize, Haines dismissed him with a gesture that amounted to "goodbye and good riddance."

You can view the video of the brief exchange yourself and decide whether Barney's hissy fit was justified or not.

As The Deal.com's Maria Woehr observed, the interesting question is why Frank bothered to answer the other questions posed by Haines and two other reporters, but threw a tantrum over the final question. My guess, which is only a guess, is that Frank was irritated and under the gun because he was late to a filming session of a music video of his latest hit record (currently number 6 "with a bullet" on Billboard's "Adult Contemporary" chart), "Banking Queen." It's obvious that the video was put together in a hurry. Nevertheless, whatever defects might mar the images, there is no denying the power of Frank's wispy, lispy song stylings, nor the raw power of the lyrics.

Oooooooo

Oooooooooo

You can build.

You can buy.

Any house your heart desires.

Oo zero down.

Financing.

I am the banking queen.

Friday night and your cash is low.

I know a place that you can go.

Oh, get your house and use it.

Go ahead abuse it.

You can do anything.

Go out and have a fling.

I am the banking queen.

Old and sweet didn’t do a thing.

Banking queen.

Don’t complain or you’ll hear me scream oh yeah.

You can build.

You can buy.

Any house your heart desires.

Oo zero down.

Financing.

I am the banking queen.

Told the bankers hey you guys.

Make the loans or it’s your behind.

My friends at Fannie sure need it.

Do it my way or beat it.

Why are the stocks crashing?

That doesn’t mean a thing.

I’m still the banking queen.

Never spanked for a single thing.

Banking queen.

Don’t complain or you’ll hear me scream oh yeah.

You can build.

You can buy.

Any house your heart desires.

Oo, zero down

Financing

I am the banking queen.

Oooooooo I am the banking queen.

Oooooooo

Ohio: Land of the Lost

While most of the sneering generated by Ohio municipalities who blame mortgage lenders and securitiziers for the pitiful state of their fiscal and physical condition has been directed against Cleveland, we should not forget another veritable Eden-on-Earth, Cincinnati, the city where one of the hardest playing, hardest headed, and most ethically challenged baseball players of all time, Pete Rose, spent the lion's share of his career. Gamblin' Pedro never would have whined like the leaders of this fair city have, suing lenders right and left in a desperate bid to overtake Cleveland in "the-fact-we-suck-is-not-our-fault" sweepstakes.

Proving that when you're actually solvent you get to hire lawyers who not only have a sense of ingenuity, but a sense of irony, as well, one of the sued banks went on the offensive and sued the city. According to a recent article in The Cincinnati Enquirer, the worm turned and bit the City square on the tukus.

The city of Cincinnati violated the civil rights of a West Virginia bank holding company by holding it responsible for apartment buildings it foreclosed on, the bank claimed in a lawsuit Monday.

Wesbanco Bank Inc. alleged in Hamilton County Common Pleas Court that the city and two of its building inspectors engaged in a pattern of malicious prosecution against the bank.

[...]

The lawsuit invokes a section of federal law - popularly known as the Ku Klux Klan Act - most often used today in cases involving police brutality, false arrest or other police misconduct. It claims building inspectors Albert Taylor and Edward Cunningham violated the bank's constitutional rights by attempting to force it to clean up a North Fairmount apartment building the bank says it doesn't own.

The City filed criminal charges against the bank even though the bank didn't accept title to the property. The borrower tried to skate liability for the condition of the property by unilaterally recording deeds to the bank without the bank's prior knowledge and walking away. If I were running the bank, once I found out about the deeds, I would have quitclaimed the derelict rat-traps to the mayor and demanded that he be given the death penalty.

As it was, the bank claimed (quite correctly) that it couldn't be forced to accept title to collateral, was not the owner, and didn't need to show up in court to face criminal charges. A judge tossed out the criminal charges. The city is now asking the Ohio Supreme Court to rule that cities can press criminal charges against banks arising out of the condition of real property even if the bank doesn't own the property, apparently under some legal theory concocted during an all-nighter spent consuming mushroom caps and licking toads.

The ultimate disconnect between fantasy and reality, however, appears to reside in the mind of the city's lawyer.

Cincinnati Solicitor John P. Curp said Monday that he's met with executives from several major banks in an effort to work out solutions to the foreclosure crisis, but Wesbanco doesn't want to come to the table. Filing criminal actions was a "last resort," he said.

"I'm disappointed that they've chosen to escalate this with a new lawsuit," he said. "We have a lot of current issues in front of us, and I think everyone's energies would be better served by them cleaning up the parcels they currently own."

Well, I'm sure the bank was also disappointed when questionable criminal charges were brought against it and it had to shell out cash to hire legal gunslingers to ride into town and make you cry like a little girl, John. That's what happens when you try to bully people from West Virginia. They breed tough hombres  there who are incapable of knuckling under to effete Buckeyes who falsely brand them criminals. Moreover, you weren't demanding that the bank clean up property it owns. You filed criminal charges against it to clean up property that it didn't own.

A source close to the litigation, who requested anonymity, filled me in on several facts not mentioned in the article (not that the local press might be anti-bank, mind you). First, the city had previously dismissed two other criminal actions when the bank threatened the same type of lawsuit. Those other properties involved the same borrower using the same tactic of unilaterally deeding real estate to the bank. The city handled the dismissals quietly because they were strong-arming other lenders with the same bully-boy tactics and didn't want to jeopardize the opportunity to extort money from shake down reach settlements with the other lenders, who might not have had as much testosterone flowing through their corporate veins as Wesbanco Bank. I'm not certain, but agreeing to pay money to the city under such a bogus threat smacks of a bank with much less than the right stuff, a bank based in a more gentile clime, say San Francisco, or France, perhaps.

Also not discussed in the story is that the bank shot back at the city not with a single bullet (the Section 1983 claim), but with double-O buckshot: additional claims of malicious prosecution and that the city was attempting to improperly regulate the business of lending (similar to the claim that smacked down Cleveland). Furthermore, although the article states that the bank's counsel was not authorized to comment, it failed to use any portion of a press release issued by the bank, which stated the bank's official position quite clearly. Far from an "objective analysis", eh?

Don't expect the city to win in court. It's reasoning defies logic. On the other hand, the spin is all cynical pols care about, especially when the press fails or refuses to understand and/or report the issues thoroughly. It's merely a matter of shining bright objects in the eyes of the voters and hoping they'll continue to be distracted from the real causes of the deterioration of their cities.

As we and others have said, this pattern of dysfunctional behavior by local politicians is likely to continue, no matter how pathetic the prospects might be for ultimately prevailing in court.

The Inmates Run The Asylum

When you think of experienced banking gurus with genius-level IQs, commercial banking expertise, and decades of hands-on experience solving real-world commercial banking problems, the kind of gurus most qualified to select senior-level executives for one of the world's largest financial institutions, I'm sure the same name pops into your mind as pops into mine, doesn't it? You thought of Sheila Bair, correct? No, me neither.

That hasn't stopped "Ooo-My-Little-Sheila" from asserting that Mother Bair knows best who should be running Citigroup. According to The New York Times, the "who" doesn't include current CEO Vikram Pandit. It appears that Ms. Bair is baring her claws at more than just Mr. Pandit, however. She's engaged in a jihad with other federal banking regulators that involves a theme as old as the first ape-man who took the jawbone of an ass and slayed the pretender for leader of the clan: power over other human beings and their goods.

Sheila C. Bair, appointed by President George W. Bush, has been butting heads with Citigroup executives as well as with her counterparts at almost every other federal bank regulatory agency.

When the Federal Reserve and Treasury hammered out a plan last fall to shore up Citigroup with another big round of federal money and guarantees, the F.D.I.C. reluctantly went along. But Ms. Bair has argued that the F.D.I.C. should take over many of the big troubled banks rather than rescue them, just as it is doing with a growing number of smaller, regional banks.

Now, as the Obama administration maps out a plan to overhaul and expand Washington’s fragmented system of financial regulation, Ms. Bair is immersed in a broad power struggle.

Great: The economy burns and Sheila's worried most of all about satisfying her craving for more power. Of course, in D.C., power is all that counts. Obviously, you sure can't measure success inside the beltway by the standards applied to private enterprise.

As an aside, it appears that W was as good at picking conservative appointees for federal agencies as his Poppy was in picking conservatives for the US Supreme Court. Poppy picks David Souter for SCOTUS, who turns into the second coming of William O. Douglas (only without the sexy young law students he kept marrying and that we loved to look at) and Junior picks rock-solid Republican Bair, who turns into the second coming of Ralph Nader, only without Nader's wicked slapstick sense of humor that makes him such a hit on the stand-up comedy circuit.

There may be more to Bair's Sam Peckinpah-like screaming at her subordinates to "Bring Me The Head Of Vikram Pandit." In fact, it might be personal.

The NYT only hints at this aspect.

At Citigroup, executives worked this week to defuse the tensions between Mr. Pandit and Ms. Bair, which have simmered since the F.D.I.C. thwarted Citigroup’s plans to acquire another big bank last fall.

As recently as Tuesday, Richard D. Parsons, Citigroup’s chairman, asked Ms. Bair if the board needed to replace senior management to satisfy the F.D.I.C., according to people with knowledge of the situation. Ms. Bair said she was not demanding immediate changes, although she did not discourage them.

Well, that little bit of no clarification by Sheila was certainly telling. That's one of those phone calls where Parsons and his lieutenants spend the aftermath doing fifteen minutes of "WTF was she saying?", followed by fifteen minutes of creative use of Anglo-Saxon expletives and crude discussions of the FDIC Chairman's various body parts and what forms of flora and fauna the executives would prefer they be fed to.

The Wall Street Journal had more dirt on this little sordid story arising out of Bair's selling Citigroup down the river last fall and how Sheila might have had her feelings hurt when Citigroup executives called her on her double-dealing ways.

The discord between Citigroup and the FDIC dates to last fall. In September, Citigroup agreed to buy faltering Wachovia Corp. in a government-arranged marriage. Days later, however, Wells Fargo & Co. swept in with a higher offer for Wachovia. Citigroup officials felt blindsided and faulted Ms. Bair for endorsing the Wells Fargo bid over their own.

On a 2 a.m. conference call at that time, the usually mild-mannered Mr. Pandit launched into an obscenity-laced tirade about the FDIC chairman, according to people familiar with the call.

Citigroup soon filed lawsuits against Wells Fargo and Wachovia, accusing them of improperly breaking up the Citigroup deal. Citigroup executives came to blame the deal's demise as the catalyst for a plunge in Citigroup's stock price, one cause of the federal bailouts.

After months of not talking to the agency, Citigroup executives in the past couple of months have tried to repair relations with the FDIC.

Board members including Mr. Parsons, the new chairman, have reached out to FDIC officials, according to people familiar with the matter. Their message: "We're here to help," one person said. "Please use us as your avenue. We want to facilitate your review of Citi."

Hasn't everyone launched at least one obscenity-laced tirade on a 2 a.m. conference call at one point or another in their professional or personal lives, usually after consuming a half-dozen jello shots and a quart of Jagermeister? No? Oh, never mind, then.

Oh, my: intemperate language directed at the FDIC generally and Ms. Bair specifically, followed by lawsuits, then the silent treatment, then a reach out to make it all better again. That sounds like the various steps of the grieving process gone terribly, terribly wrong. No wonder Ms. Bair and her coven are looking to stir up a witches brew of payback and whoop-ass on Pandit and his crew. They were mean to Sheila and then, after a lot of time went by, they begged for forgiveness and asked Sheila to take them back. Anyone who's ever witnessed puppy love gone sour knows that the girl will NEVER take the boy back until she makes him suffer like the gnarly, cruel, hateful, and really, like, SPASTIC bully he is. Or until he apologizes sweetly, buys her a Kobe Bryant-like 6-carat rock for her ring finger, and, like, promises never to do it again, cross his heart and hope to die.

What we have here is not simply a failure to communicate. What we have here is the federal government run by a bunch of high school kids.

Stressed Out

A couple of weeks ago, FinCri Advisors warned that as a result of the stress tests administered to the nation's top 19 banks, community banks should batten down the hatches, stock plenty of ammo, concertina wire, bottled water, and condoms canned food, and otherwise prepare themselves for a "perfect storm of harsher exams, deposit flight, dry capital markets and share price declines." According to my observations and those of other bank attorneys with whom I speak and correspond, the "harsher exams" front has already moved in and appears parked directly over the community bank biz.

The reason for the harshness, according to former OCC Chief Counsel Brian Smith, is due to the fact that bank regulators are using the same methodology on small banks as they used on the "Gang of 19," including "examiner scrutiny of tangible common equity (TCE) and highly customized, portfolio specific analysis of an institution's ability to withstand economic stress."

This already has manifested itself in the field with examiner application of optional guidelines as required rules. "Banks are being more rigorously pressured to comply with various guidelines as if they were regulations," Smith says. He cites heavy examiner scrutiny of commercial real estate and directives to comply with previously optional lending guidelines on it.

"The institution says, ‘This is a business we really know, the guideline is not a fixed regulation and we are not too far off the norm,'" Smith relates. "The regulator says, ‘We issued the guideline, so you will comply.' If they don't, it manifests itself [negatively] in bank exam results, board meetings and supervisory reviews. They are taking more of a rulebook approach, even though the rules are not issued as rules. They are supervisory guidelines, suggestions for examiners, instructive/educational guidelines and not a final regulation."

I once heard a presentation by a "consultant" to banks that concerned the Interagency Information Security Guidelines that were adopted by the federal banking agencies to comply with the Gramm-Leach-Bliley Act. One critical aspect of the guidelines was dismissed by the lecturer as "merely guidance, not enforceable regulation." A compliance officer of a large regional bank shot up out of her chair like she'd just been "tased" and chirped that failure to follow the Information Security Guidelines violated the FDIC regulation to operate in a safe and sound manner. The "consultant" waived her off, but that bank treated the Guidelines as having the force of law for all practical purposes. To me, that was a safe, conservative approach.

It's simply not surprising to me that the examiners are treating guidelines as fixed-in-stone requirements. Flexibility might be a good thing for Shawn Johnson trying to pull off the splits on the balance beam. For a bureaucrat who wants to retain his or her present position and keep movin' on up in the agency, it's not so attractive a character trait. This should be expected by anyone who's been in the business of commercial banking for more than ten minutes. Banks may think that this is all unfair, but expect the regulators to remain dry-eyed while you complain about the cruel nature of it all.

One bank executive quoted in the FinCri Advisors article complains that applying the same stress test to smaller, "non-core" banks will give an unfair advantage to the top-level "core banks." This executive asserts that the core banks were able to negotiate the test criteria on a case-by-case basis, and, therefore, received a "tailor made" test that they were better able to pass. Small banks won't have that negotiating power. The executive claims that this will result in inaccurate test results that will be harder on the little guys. He also claims that by making the stress tests of the Big 19 transparent to the public, the big boys have a perceived imprimatur from the federal government that smaller banks will not have when their less-transparent tests are performed. Community bankers are worried about the potential flight of deposits from smaller banks to core banks. I think he has a point, but it's still too early to tell.

What sorts of other problems might arise from "harsher exams"? One I'm seeing is the push by regulators to have many smaller banks reduce concentration of assets (especially in commercial real estate loans), increase reserves, and/or increase capital levels. In a number of cases, this has put pressure on community banks not to renew existing lines of credit to many performing business borrowers and to divest assets (especially commercial real estate loans) that consist of performing loans. For all the talk of "dent and scratch" funds having been established to buy distressed assets, banks appear to be unloading the easier to sell, performing loans first, because they're quicker to sell and the bank doesn't have to absorb the haircut that would be necessary to sell the "dicey" loans.

Another problem that results from "harsher exams" is an increased amount of enforcement action (formal and informal) by bank regulators against community banks. Some of us who went through this drill in the 1980s believe that the enforcement actions are much more widespread and tougher today than they were the last time we went through this wave of "harshness." This time around, the federal bank regulators have a wider array of enforcement weaponry to unleash against their hapless victims regulated entities. Banks should be on top of the examination process long before the exam report is issued, and should be prepared to address the examiners' concerns on a point-by-point basis before an exam report is sent to Washington, D.C., because once it enters the beltway it ossifies to a hardness akin to titanium.

In the unfortunate event that enforcement action is initiated by the regulator, there is a dance that begins. As expected, the "Dancing Bear" will lead and you'll follow. However, the bank is not completely helpless (although it certainly will feel that way most of the time). For an excellent discussion of how to respond to proposed enforcement actions by federal banking regulators, I recommend a publication posted on the web site of national law firm ReedSmith, entitled (amazingly) "Responding to Proposed Enforcement Actions by the Federal Banking Agencies." (One of the authors, Joe Lynyak, is now at Venable LLP.) It contains an excellent discussion of what enforcement actions entail and appropriate considerations in responding to them. Unfortunately for many banks, it's a subject that more and more of them are finding to be of interest.

As for the stress tests on community banks, let's hope that Geithner is as calm when he announces the results as he was when he announced the results for the big boys.

The Glass Is Half Empty

FinCri Advisor advises us that the recent federal district judge's dismissal of a lawsuit brought by the city of Cleveland against banks and investment banks (which we discussed last week) is no cause for celebration by the defendants. In the first place, as we noted last week, Cleveland is appealing the dismissal and vows to fight until the last breath of the last municipal taxpayer left standing, and also has a related lawsuit pending in state court (although Buffalo's suit suffered a setback a few months ago). Moreover, Baltimore, Birmingham and Buffalo still have ongoing litigation against banks and Shelby County, Mississippi and Atlanta are reportedly gearing up to jump on the dog pile. Some litigators who've been defending banks in these lawsuits believe that more are on the way, and whether or not the claims will be ultimately successful, the cost to banks will be substantial.

"Think of the potential number of jurisdictions that can bring these claims," notes attorney Richard E. Gottlieb, head of the Financial Institutions and Insurance group for Dykema in Chicago, who represented IndyMac in the Cleveland case and NationsBank in Buffalo.

Even if the claims have no merit, Gottlieb says banks still can end up spending a lot of money defending them. "I will expect a lot more of these lawsuits," he says. "My guess is that the public nuisance claim is the most logical for cities to file under. It is the one that has the greatest potential appeal for holding lenders liable."

It's also one that might resonate with voters in the municipalities that have brought claims thus far. Most of those cities have been in decline for some time prior to the subprime mortgage mess, but the recent meltdown has exacerbated the misery of those municipalities and, at the same time, offered the failed leadership a convenient scapegoat.

Another litigator disagrees with Mr. Gottlieb.

But Skadden partner Joseph Barloon in Washington, D.C. isn't so sure. "I think this will make municipalities think twice before filing copycat lawsuits," he says. "That's a good thing for the banks."

Mr. Barloon assumes that local politicians can think once, much less multiple times. I'm not certain that assumption is correct. Mr. Barloon's firm, the well-known Skadden Arps, has analyzed the issues and suggested several possible approaches that municipalities might use to survive a motion to dismiss.

In a May 15 memorandum, Skadden attorneys suggest that "the decision may lead municipalities and other entities pursuing similar claims to allege that the defendants violated one or more laws or regulations, in order to distinguish their case from City of Cleveland and survive a motion to dismiss." The memo also notes that the decision "will give financial institutions facing ‘subprime meltdown' litigation significant support in setting forth preemption and causation defenses."

Gottlieb advises banks not "to be overly optimistic as a result of Judge Lioi's opinion." Still, he says, "judges tend to operate in packs." So "if you get a second or a third decision favorable to the industry, you might see the end of these cases."

Mr. Gottlieb and one of his partners, Andrew McGuinness, wrote more extensively last summer in the American Bar Association's Business Law Today on the different legal theories being pursued by the municipalities. Inasmuch as these gentlemen represent banks involved in this litigation, you might suppose that they're skeptical about the advisability of municipalities pursuing these types of suits. Your supposition would be correct. With that natural bias in mind, however, they touch on what they call "a paradox wrapped in a paradox" that rests at the heart of these lawsuits, regardless of the legal theory being employed to sue banks.

One of the central contradictions of these cases is that banks are essentially being sued for making credit available to high-risk inner-city borrowers, thereby allowing numerous otherwise underserved consumers to achieve or maintain the American dream of home ownership. Another, related, paradox is that essential market-based features of these riskier loans that allowed them to materialize—higher fees and interest rates to compensate for the increased risk of default—themselves increased their cost by making the loans less "affordable" and thereby more likely to result in such default.

The city lawsuits focus more on the effects, that is, foreclosures and abandoned homes. They point to these foreclosures and ask the court (or jury) to conclude—based largely on the fact of the foreclosures themselves—that the banks acted improperly, even "unscrupulously" and "irresponsibly." The irony is that no bank wants a foreclosure. A foreclosure represents a failed loan and, typically, huge bank losses. This is even more manifestly the case when the foreclosed property remains vacant (the alleged public nuisance). Every vacant home resulting from a foreclosure that a city claims is blighting its neighborhoods represents not just a bad loan but an unsuccessful foreclosure as well. Are the cities pointing at these manifestations of failed loans and demanding one more ounce of flesh from a reeling industry? Or are these vacant homes the most conspicuous examples of irresponsible lending? 

As is usually the case whenever litigation is used to pursue purely political goals, logic and sound business rationales are irrelevant. All that matters is the political spin. The cities are suing banks for the same reason that Willie Sutton said he robbed them: "Because that's where the money is."

For legal geeks interested in parsing the nuances of these legal claims, the article is a good summary. To me, Messrs. Gottlieb and McGuinness seem even more insightful in their analysis of the expected results of all this litigation. In their view, even if the cities win (which, I assume, they don't believe is the most likely outcome), they'll lose.

[I]f successful, these lawsuits may ultimately do more long-term harm than good. The cities hope to reap hundreds of millions of dollars from the banks to reimburse them for a diminished real estate tax base resulting from foreclosures. But lenders should logically be entitled to an offset for the higher tax revenues collected by cities for years that, according to the logic implicit in their complaints, were associated with the now-challenged lending practices. And if banks stop making loans in urban areas to avoid exposure, the property tax base in these inner cities will be devastated. And how will poorer city residents buy houses then?

Let me think...hmmm...I got it. The cities will offer tax and other incentives, as well as as much public jawboning and whining as possible, to induce/force lenders to make mortgage loans to those who can't afford to repay them.

So You Thought Being A Bank Director Was An Honor?

For the past year or so, Georgia has been a hot bed of failed banks. According to an "unnamed source" within the FDIC, it's about to become the bulls-eye of FDIC target practice that seeks to score big returns to the Federal Deposit Insurance Fund from the D&O insurance carriers who issued policies covering failed banks' boards of directors and officers.

The Federal Deposit Insurance Corporation is expected within weeks to start suing directors and officers of failed Atlanta banks, according to people familiar with looming litigation.

[...]

A source familiar with the FDIC’s local operations said suits will be filed within weeks against board members and executive teams for some of the 11 Atlanta banks that have failed, primarily looking for claims under directors and officers insurance.

[...]

“They’re pulling a page from the S&L playbook and going after the D&O insurance,” the source said, who declined to name any of the banks that will be sued.

Yeah, just let 'em all sweat, eh "unnamed source"?

A FDIC "named source" refused to divulge any specific plans to sue or not to sue. On the other hand, his beating about the bush certainly would lead you to assume that lawsuits are on the way.

FDIC spokesman David Barr said the regulator does not comment on possible future actions.

In the past, however, Barr said, the FDIC has filed suit against directors, officers, appraisers, law firms, accountants, or other groups it believed were grossly negligent and contributed to the failure of the bank.

“We sued quite a few different entities during that time,” he said.

Yes, they did, and I was in the thick of it. It appeared to many of us on the other side of the table from the FDIC (generally working through its sock puppet, the RTC) that the primary criteria used by the FDIC for deciding whether or not to file a lawsuit against directors, officers, accountants, appraisers, attorneys, janitors, pest exterminators, plant care technicians, and parking lot attendants who might, at one time or another after the end of the Civil War but prior to the arrival of Bill Clinton in the White House, been associated in some fashion with a failed savings and loan or bank were (A) is there an insurance policy we can go after and, if so, (B) whether the complaint or petition could survive a motion for sanctions under Rule 11. Often, settlements were hammered out or claims defeated by a clever tactic used by defense counsel: retaining the services of consulting and testifying experts who had actually worked or performed services for a bank or savings and loan and who analyzed the fact pattern against the way the banking business works in the real world, not in the mind of a bureaucrat or (shudder) a trial lawyer who, due to the broad conflict of interest rules of the FDIC, likely never had any practical experience with the banking transactions that were involved in the "gross negligence" claim.

Then again, some bankers, directors, and advisors actually committed misfeasance or, in some cases, malfeasance, and deserved to be sued. The problem is, the last time around, a lot of dolphin were swept up in the tuna nets along with the fish. I hope this time around, the FDIC isn't as trigger-happy. Bryan Cave partner Walt Moeling and Jones Day partner Chip MacDonald think that it won't be and that even if it is, it'll have a tougher time collecting on D&O policies.

Moeling said the FDIC pursues a case only if it believes it has a likelihood of success, and the legal costs would be less than any recovery.

But Moeling said he thinks the FDIC may have a tougher time recouping on D&O insurance claims in this economy.

“It’s hard to get around the fact we’re in an unprecedented economic downturn,” he said. “The regulators, including the FDIC, were telling everyone to prepare for a 100-year flood, and the 500-year flood is the one we got.”

And the burden of proving gross negligence, attorneys said, is a high bar.

“Just because a bank fails doesn’t mean the executives or directors haven’t performed their duty,” said Chip MacDonald, a Jones Day banking attorney. “Directors and executives are not supposed to be Superman.”

MacDonald said the most common claims under gross negligence for a failed bank include loans beyond the legal lending limit, insider transactions that are not done as arms-length deals, and criminal violations such as kickbacks or bribes for business.

Then we have Sheila Bair on May 18, 2009's Today show on NBC, who was interviewed by host Matt Lauer. When he asked her whether she ever thought that the economy would be this bad, she answered: ""No. Even I didn't think things would ever be this bad." If a prophet of Bair's stature couldn't foresee the damage (and she was being interviewed because she was a recipient of a "Profiles in Courage Award" due to her prescient warnings of subprime mortgage problems), how can mere mortals like bank directors be expected to foresee the future?

I'll also be curious as to what kind of intelligence comes creeping out of the regulatory woodwork once the FDIC starts going after directors and others associated with failed banks, and once old hands from the wars of the 1980s and 1990s, many of them still alive and kicking, step up to lead the defense. Were FDIC officials warned earlier in this decade by internal analyses of the danger lurking on the horizon? Were the bearers of this bad news and the news itself suppressed? Did anyone lose his or her job at any bank regulatory agency for being a Cassandra? I don't know for certain, but I have my suspicions. If the regulatory agencies, which have access to industry-wide information not available to the institutions they regulate, had advanced knowledge of a potential catastrophe and didn't raise the alarm because they didn't want to derail the mortgage lending and securitization engine that was running the country's economy at high speed off the rails, what effect might that evidence have on allegations by the FDIC that it was the "gross negligence" of bank directors and officers that was the primary cause of an institution's failure?

I'm merely asking the question. No need to get riled.

Obviously, we're in for some interesting discovery in the course of the upcoming litigation, aren't we?

Geithner's Growing Nose and Flammable Pants

 It's telling that so many observers are reacting with increasingly unbridled cynicism to every word that comes out of the mouth of Pinochio Tim Geithner.  Last week's guffaw-inducer was the statement that the CPP investments that are paid back by big banks will be used to help smaller community banks. The little guys were shut out of the initial rounds of TARP CPP investments, and those smaller banks that took it aren't doing backflips over the changes Congress and the U.S. Treasury Department made to the program after the fact. Now, few of the banks that qualify for CPP want to touch it with a ten-foot pole.

As The American Banker discussed late last week (paid subscription required) discussed late last week, the community banks that really need the additional capital aren't strong enough to qualify for it under standards set by Treasury and the federal banking regulators. If you're a very large train wreck, you get the U.S. government falling all over itself to force-feed you additional capital, but if you're a community bank train wreck that might be important to your local community but not within the daisy chain of anointed big boys, you're out of luck. The e-mail I receive from community bankers and their attorneys lately is spewing a new level of venom toward the regulators, none of which I intend to share with anyone, other than to speculate that what they've requested Sheila Bair do to herself is, I believe, physically impossible, even for a contortionist.

Bankers and their counsel cite instances of the FDIC pressuring community banks to withdraw their TARP applications, demanding increased levels of loan loss reserves, forcing the mark-down of carrying values of mortgage-backed securities and loans (especially commercial real estate loans), and otherwise paralyzing already gun-shy local banks and rendering them unwilling or unable to extend credit to businesses, much less to consumers. FinCriAdvoisor recently profiled the additional problem of federal banking regulators imposing higher levels of capital on otherwise well-capitalized banks through the issuance of Individual Minimum Capital Letters. One senior federal bank regulator's attorney even slipped up and came clean about the reason for the use of this latest "tool" in the "whack-a-community-bank" game.

OTS attorney Deborah Dakin, senior deputy chief counsel for Regulations and Legislation, in a talk at Pepperdine University School of Law, said that regulators are "feeling a lot of pressure" from Congress to increase enforcement orders against banks. Dakin declined comment to FinCri Advisor, but OTS spokesman William Ruberry confirmed that she made the "off the cuff" remarks, which were first reported by the American Banker.

That's right, it's not because the regulators would independently come to the conclusion that a well-capitalized community bank would have to raise capital levels to unprecedentedly high levels, but because they need to play the game of appearance-over-reality to placate federal legislators whose combined intellectual firepower makes a gerbil on a wheel look like Albert Einstein in comparison. Playing to the lowest common denominator; that's called "leadership" these days.

Simultaneously, the regulators and Geithner are squawking publicly about how they're going to help the little brothers of the BofAs and Citigroups by making all this cheap capital available to them so the small banks, in turn, can make more loans and dig us out of this economic hole that seems to grow deeper despite all the "dirt" being slung into it from D.C. You'd be stunned by the depths of the hypocrisy if you weren't already inured to it.

Not that community bankers would be standing in line to snatch up the new capital, even if Treasury actually intended to offer it.

"The biggest problem I have is the fact they have changed the rules so many times that as a chief executive officer of a company I have a very difficult time having a business partner in the form of the United States Treasury," [Heritage Oaks Bank CEO Lawrence] Ward said.

[,,,]

"I was shocked by it," said [Greater Southwest Bancshares Inc. CEO and past ICBA chairman Cindy Blankenship, who attended Geithner's speech. "Are there banks out there that still want the money?"

She reiterated ICBA's call for Treasury to bring in community banking advisors. "They don't understand community banking. They are from Wall Street. That's not a slam, but a fact. So when you have people inventing these programs, it would make a lot more sense if they asked for input," Blankenship said. "If they want to be helpful, they should ask what would help."

"This is not a slam, but a fact." It's a fact that is, in and of itself, a slam. Your federal government: once again, damned by the facts.

Of course, they don't "want to be helpful." They want to give speeches and issue press releases that give the appearance that they want to be helpful. After all, the average voter isn't reading the trade press. All that counts for the cynics in charge is to be able to fool most of the people, most of the time. At that task, they excel.