Bank Lawyer's Blog

Community Banks to Congress: You're Crushing Us

According to community bank chairman William Grant, the burden of compliance with many tons of new regulations is crushing community banks. As a result, he claims, everyone should prepare for the phenomenon of the incredible shrinking bank biz. According to a recent Bank Safety & Soundness Advisor article (paid subscription required), Mr. Grant's recent testimony before Congress on behalf of the American Bankers Association was the polar opposite of "sunny."

“Without quick and bold action to relieve regulatory burdens we will witness an appalling contraction of the banking industry, at a pace much faster than we’ve witnessed over the last decade,” Grant said. “It is not unusual to hear bankers—from strong, healthy banks—say they are ready to sell to larger banks because the regulatory burden has become too much to manage. These are good banks that for decades have been contributing to the economic growth and vitality of their towns, cities, and counties but whose ability to serve their communities is being undermined by excessive regulation and government micro-management. Each bank that disappears from the community makes that community poorer.”

Perhaps anticipating the argumenht of the disintellctually dishonest pundits from the left of the political spectrum that bankers of all stripes want absolutely no regulations of their business, Mr. Grant claims that a basic problem with the deluge of regulations promulgated (and to be promulgated) in the wake of the abuses of the last decade is that their cost to banks outweighs their benefit to anyone.

“Banks appreciate the importance of regulation that protects the safety and soundness of the bank and protects the interests of our customers,” he said. “We know that there will always be regulations that control our business – but the reaction to the financial crisis has layered on regulation after regulation that does nothing to improve safety or soundness and only raises the cost of providing credit to our customers.”

[...]

“During the last decade the regulatory burden for community banks has multiplied tenfold, with more than 50 new rules in the two years before Dodd-Frank. Over the last decade 1,500 community banks have disappeared from communities. Each new law or regulation in isolation might be manageable, but wave after wave, one on top of another, will certainly over-run many more community banks.”

Grant also warns of something that other community bankers lay awake at night sweating: Dodd-Frank trickle down. Grant alleges that such fears are justified, and gives a specific example.

“We thought that the Volcker rule was something that only our colleagues in the largest banks had to attend to,” Grant said. “Instead, the regulators have proposed to implement the Volcker rule in a way that requires even a bank of our size to carefully examine any security we buy to manage our mix of assets and liabilities so that we do not accidentally do something that the implementing rule may not permit. We will also have to review every community investment we make for the same reason.”

The bank not only has to keep a close eye on securities and investments, but it also has to pay more attention to bank policies, he argues.

“Both asset and liability management and community reinvestment are basic banking activities that our regulators expect us to do day-to-day,” he says. “Now we have to develop policies and procedures to make sure we are evaluating those activities regularly in light of some 300 pages of technical regulatory guidance that is intended to address activities it wouldn’t even occur to us to conduct. These and other changes will have a pernicious impact on banks and their communities. They raise credit costs and litigation costs (for even minor compliance issues), lead to less hiring or even a reduction in staff, make hedging risks more difficult and costly, and restrict new business outreach. In fact, banks’ biggest risk has become regulatory risk.”

Personally, I expect regulators and some in Congress (primarily, those with strong ties to constituents in the community banking business) to pay some lip service to the need for a two-tired system of regulations to address this concern and to attempt to alleviate the "trickle down effect." I also expect that nothing substantial will be done to actually ensure that the crushing regulatory burden is alleviated. Talk is cheap and plentiful in the nation's capital. Effective action is a scarce commodity in a town where the acquisition and retention of power trumps all other considerations, especially a notion as outdated as "principle."

There's the additional problem that there is a strong desire by many in the federal regulatory agencies, in the political arena, and in some corners of the banking industry itself, to see a drastic reduction in the number of banks in this country. Proponents of a smaller industry include not only those afflicted with the nervous condition commonly referred to as "Socialistic Hysteria," but by banks who already have achieved a certain hefty size and think all this competition is bad for squeezing the most blood out the veins of consumers and business customers alike. If only we had fewer banks, the remaining banks would be more profitable. We've heard this argument for, literally, decades. I won't name names, but the singers of this ditty include some very, very high-priced lawyers who are currently being paid by the same community banks they think ought to be "down-sized."

Perhaps this view is overly cynical. However, if community banks (and I'm including credit unions in this category, because they have a stake in this regulatory burden crunch, and bigger banks have as little use for them as any other smaller competitors) want to derail this train, they'd better give it the cooperative, focused attention it deserves. They need to tell their legislative representatives that they're as mad as hell and they're not going to take it any more.

Or, they can decide that they've had enough, no longer want the cheese, and merely want out of the trap. Surrender is always an option.

Let Me Just Clarify That Point

My post of the day before yesterday, concerning a "warranty" offered by Greenway Solutions that would cover a portion of losses suffered by a bank's business customer by reason of an online account takeover (provided the customer uses an approved online security product from a third-party vendor), caused Jon Meyer of Greenway Solutions to reach out to me. Jon wanted to discuss some points I raised in my story and to provide some clarification. After a very pleasant telephone conversation, I offered to supplement my previous post with additional information and clarification.

As to my question about the fees paid by the customer and the bank to Greenway Solutions, Chartis, and the security software providers, Jon informed me that Greenway Solutions will launch this solution with $24.95 per-month "all-in" pricing. In other words, the cost of the service is a total of $24.95 a month. The customer would pay that cost to Greenway Solutions, and that would be the only cost paid. Of course, the customer's bank could decide to pay that cost, if it wished to do so, for competitive reasons.

Jon also wanted to emphasize that business customers do not have the equivalent protection afforded to consumers by Regulation E (no liability for unauthorized funds transfers provided the customer reports the unauthorized nature of the transfer within time limits established by Regulation E). He also made the point that Article 4A, Section 202, of the Uniform Commercial Code provides little practical protection for unauthorized "payment orders," because in the vast majority of cases of account takeover, (1) the customer has expressly agreed in writing with the bank to be bound by any payment order, whether or not authorized, issued in its name and accepted by the bank in compliance with a security procedure chosen by the customer, which, under the Code, makes the security procedure "commercially reasonable"; and (2) the unauthorized payment order is usually made in compliance with such security procedure because the crooks have penetrated the customer's computer system and gained access to the information needed to compromise those security procedures. You'll continue to have lawsuits brought by victimized customers that allege that the security procedures of the bank were not "commercially reasonable," notwithstanding the terms of the applicable account agreement (perhaps because the security procedures do not comply with the mutli-factor authentication guidance of the FFIEC), but  that fight is in most cases an uphill battle for the customer. Counting on banks to settle in order to avoid reputational risk is cold comfort. Therefore, I agree that there is value in "incentivizing" business customers to add additional software security solutions and to cover at least some of the financial risk with "insurance." Although I'm not endorsing Greenway Solutions' specific product, I'm in favor of exploring creative answers to a problem is that is not going to be resolved anytime soon.

As to my wisecrack about vendor's collecting fees and denying liability, Jon wanted me to point out that this stance is not unusual in the software security vendor "space" given the "price point" ($24.95 a month). I agree that it's not unusual. Technology service providers, especially those that collect relatively low monthly fees for providing a standardized product, will generally provide indemnification against intellectual property infringement claims that arise out of the use of their technology within the limitations on use contained in their license agreement, but generally aren't going to take on additional liability for indemnifcation that could result in the vendor incurring "bet-the-company" damages. Whether or not this is a reasonable position to take, my intent was to point out to banks that because of it, they need to make certain they aren't going to be on the hook for liability caused by the acts or omissions of the vendor or its product.

Plus, I was going for the cheap laugh. It's what I do.

I hope I've now clarified the pertinent points and can return tomorrow to my customary menu of ill-considered snark and off-the-cuff, half-baked opinions of inconsequentiality that my readers have come to expect from this blog.

Barney And The Spitz Make My Day

As I watched ABC's "This Week With George Stephanopoulos" yesterday morning, I assumed that most of the press attention would be given to Barney Frank's meltdown against Tennessee Republican Marsha Blackburn, and I think that expectation was verified by today's frequent postings online of the video of that session. I loved the way Barney accused Blackburn of filibustering him when it was obvious that he did 90% of the filibustering and didn't shut up until they literally cut him off and went to a commercial. Man, that guy makes for some great theater! If you've got the stomach for it, here's the link: http://abcnews.go.com/watch/this-week/SH559082/VD55202126/this-week-0513-rep-barney-frank-and-rep-marsha-blackburn.

For me, however, the biggest treat was the way that The Comeback Kid, Eliot Mess, handled himself during the round table session, alternating between some reasonable observations and absolute moonbattery. Of the latter, my favorites include this exchange with Republican Hit-Woman Mary Matalin about Mitt Romney's economic policy:

SPITZER: They want to go back to medieval medicine, the blood-letting, leeches. They want to go back to the very crazy economics that brought us over --

MATALIN: What are you talking about, Eliot?

SPITZER: -- the cliff and created a cataclysm.

I'm sure The Spitz wanted to add "and they want to go back to using the Mann Act to persecute boys who just wanna' have fun." Matalin looked at him like he'd just consumed one of her children. I assume that when married women sit next to Spitzer and the word "leech" comes to mind, the image that accompanies it is not going to be Mitt's but Eliot's.

The always trenchant George Will was a off the panel for the day, and Ralph Reed of the Faith and Freedom Coalition was filling in, which was a strange insert from the bench, but it's major network television news, so someone must have thought the two were interchangeable parts. Reed tried to make a point about the current state of unemployment, but Eliot Mess cut him short with more of the same "cataclysmic" hyperbole.

REED: -- 15 percent of college graduates can't find a job.

SPITZER: Ralph, Ralph, you simply ignore the reality that the economic model that Romney wants to bring back gave us the cataclysm of a -- wait, it's deregulation. It's lower taxes for the wealthy, higher deficits, cutting infrastructure investment, making us less competitive, giving up our competitiveness to foreign nations, unilateral trade failure that does not serve the American public well.

You can see that when he used the tern "cataclysm," Matalin and Reed reacted poorly. Spitz also alleged that Keynesian economics has been working well for 70 years and "it will work in the next 100 years." No, I'm not making that up.

Concerning Chase's $2 billion "hedging" faux pas, Spitzer claimed that the Volcker Rule, even if finalized, would not have prevented this loss because Chase desires to commit suicide so that the federal government can rescue it again. I suppose Spitzer is accusing Jamie Dimon of being possessed by an adolescent "rescue fantasy."

SPITZER: Of course, the regulations as put in place after JPMorgan lobbied to eviscerate would not have precluded this because JPMorgan wants to be able to lose all the money it can so we can bail them out again. That's the problem. The incentive structure here is perverse. They can gamble with a federal backstop.

Matalin, obviously suffering from too many years in proximity to James Carville, made some interesting rejoinders, despite her insistence on giving Barney first billing over Chris.

MATALIN: This also reraised how ineffective Frank-Dodd (sic) is. As Barney said, the Volcker rule, which is still being formulated, they want to enforce something that hasn't been formulated and they don't even know when it would come into effect, as is the case with all of Frank-Dodd.

What's absent from Frank-Dodd (sic) is the -- what financial institutions need and they want. And they can't function without it. It is clarity, uniformity, cohesion, coherence, enforceability that's predictable. And none of that has happened.

"Clarity, uniformity, cohesion, coherence, enforceability that's predictable." Yes, that would be acceptable if we can't have the alternative: setting fire to the whole thing and burning it down to the ground.

Hilary Rosen, the political operative who claimed that Ann Romeny never worked a day in her life and was disowned by The White House, then claimed Matalin didn't want any regulation of the banks, and Spitzer revisited how great Glass-Steagall was, how he's a "true capitalist" (ignoring the cognitive dissonance of his love for Keynesian economics), his repeated beatings on federal preemption by the OCC, and just about everything other than the fact that Joel Steinberg put tacks in his seat in his third grade classroom and was never properly punished for that crime.

It's not that the Sunday morning network news shows are totally useless. It's just that they seem to devolve into sound-bite shouting matches, where distortions, glaring omissions, and outright lies are often countered with the same, where the parties engage in loud "crosstalk" that cancels one another out, and where the host eventually drills down on a critical issue by prefacing it with "We've got only 10 seconds left."

If we want to have a decent, serious discussion of critical issues, we need something akin to the format of the late Bill Buckley's "Firing Line," where, for example, Buckley and Keynesian economist John Kenneth Galbraith, a close personal friend of Buckley's whose political and economic views were the polar opposite of Buckley's, would sit side-by-side in swivel chairs and discuss and debate an issue for a solid hour, with no commercial interruptions. They also attempted to treat each other with courtesy and respect because they realized that a difference in ideas does not necessarily equate to a difference in character. As far as I know, neither of them knew a woman named Ashley Dupre.

Given the average viewer's typically short attention span, I assume such a show would garner a rating that might not be measurable. Nevertheless, it would come as a pleasant change of pace from what passes for serious discussion on network television (or cable television, for that matter) in the current age.

Filling A Gap With "Insurance"

It's tough enough, on a daily basis, to make sense of what a portion of the trade press has to say about banking legal issues, but it's doubly tough when they cite section numbers and laws that don't exist. A story last week in The American Banker (paid subscription required) made a very valid point, and one I've harped on previously: commercial bank customers don't have the same protections that are afforded consumers by Regulation E when it comes to unauthorized transfers from their accounts. The reporter for The American Banker asserts that commercial customers don't have protection in excess of the basic requirements of "the universal commercial code's section 404 2A, which specifies that banks must supply a basic level of security for their commercial clients." I think he intended to refer to Section 4A-202 of the Uniform Commercial Code, and I expect that a lawyer he interviewed mentioned the correct section but something was lost in translation between ear and written notes. It happens.

Nonetheless, the article offers insight about how some customers (on their own or through their banks) are trying to add a measure of protection for unauthorized hacking of their bank accounts through a "warranty" product called EFTGuard, offered by Greenway Solutions and backed by insurance company Chartis. The warranty will cover up to $100,000 in losses from an individual account (with an aggregate limit of $500,000) as long as the bank's customer adopts "at least one of a handful of preapproved third-party security products." The companies listed in the article are IronKey, SafeCentral, Trusteer and Webroot. The banks pay $15/month per customer for the product, presumably to Greeway Solutions or the service provider, although the article doesn't state who receives that fee. The article also does not enlighten the reader as to what, if anything, the customer pays Greenway Solutions and/or Chartis and/or the service provider.

Whatever fees are paid and to whomever they are paid, here's a tip for banks deploying these third-party security products: whatever service the service provider provides, (1) test it before you deploy it widely, and (2) make sure your account agreements with your customer protect you from any liability arising out of or related to the customer's installation and use of the vendor's product. In one case I read about, a security product (NOTE: not one offered by one of the four companies listed above) that was designed to set up a secure "tunnel" between customer and bank for each online banking session, reportedly interfaced poorly with commonly used off-the-shelf software found on some customers' systems, causing "crashes" and other problems for those customers. As to the second point, my personal experience is that most vendors in this space are not willing to indemnify the bank from claims by its customers that use of the product damaged them in some respect (see the immediately preceding sentence) or that it simply doesn't work as advertised. A recent negotiation with one such vendor (again, not one the four listed above) went something like this:

Bank:  "Please provide us with an obligation to hold harmless, defend, and indemnify the bank from such risks."

Vendor:  "Here's a bucket of sand. Here's a croquet mallet. Start pounding."

As is typical of technology service vendors, once the salespeople stop gushing about how their product will not only ensure world peace, but will actually raise the dead, the risk management people tell you that they'll consider taking on indemnification obligations that have actual substance exactly two hours after the commencement of The Second Coming. Therefore, make sure the bank's contract with those of its customers who employ this product relieve the bank of risk. If the customers squawk, you can remind them that if they'd actually read any of the "boilerplate" license agreements they'd "clicked through" and used on their computer systems, they'd understand that the technology service business model is like the insurance company business model: collect fees, deny liability.

Of course, savvy customers will point out that in many cases, that seems to be the business model of banking. At which point, we can all have a good laugh and get on with seeing how long it takes cybercrooks to bust these latest "solutions."

Bank Bashing: It's Not All Fun And Games

Long-time bank analyst Richard Bove has some harsh words for The New York Times and the anti-bank critics it's recently quoted. If Mr. Bove pulled any of his punches, it's not obvious to me. Basically, he calls many of the critics either ignoramuses or worse: ideologues. He thinks that the basic premise of these critics is that banks are "public utilities."

They should be price controlled and offer products for lower income households even if this results in losses. Moreover, there is a core belief that banks should not be allowed to make profits.

The obvious problem caused by all this bank bashing for Mr. Bove, an equity research specialist, is that investors are avoiding bank stocks like they carry the Ebola Virus.

[T]here is a definite sense that there is too much risk to get involved in an industry which the government is clearly attempting to nationalize on a de facto basis— i.e., the government is using regulations to control the industry’s activities. In essence, the government wants to run the industry without actually owning it. This is not appealing to investors.

I think he's right. I think he's also right that if the CFPB ("a new tool with which to bash banks") enacts de facto price controls on bank fees through regulation of "unfair" or "abusive" practices, many investors will treat bank stocks as toxic waste.

While I don't necessarily agree with Mr. Bove that all negative news is bad for banks, certainly the unthinking sort of spleen-venting isn't helping the health of banks of any size. Further, while I'm not as alarmed as he is by the "break-up-the-too-big-to-fail" threat, I can't argue with his allegation that many critics of the bank "bailouts" just don't get it.

There is no understanding that if the banks failed then millions of businesses across the country would have had their loans called causing them to fail driving unemployment higher.

No one even thinks about asking the question as to why every country in the world protects its banking system. The answer, of course, is because the banking system holds the key to the health of middle to small business and the people they employ. There is even less understanding that taxpayers made over $150 billion on the investment made in banks by the Treasury.

Just think how much taxpayers would have made if TARP hadn't been used to bail out automobile manufacturers and insurance companies.

There doesn't seem to be much doubt that too much of the "debate" in this country on most issues, including "banks," degenerates into pure polemics, often uttered (screamed, actually) inside of echo chambers, where like-minded true believers reinforce their prepackaged world views. It's as if a quarter of the country watches nothing but MSNBC, another quarter nothing but Fox News, and the other half is too busy hoping that what happens in Vegas, really does stay in Vegas, or whether you should have a medium or large fries with that Whopper, to give a rip.

A Tale Of Two (Spinning) Tops

A reader who toils in the credit union industry sent me an interesting juxtaposition in spin, one from the NCUA and one from a trade press publication. They both concern recent financial results announced by the NCUA for AEA Federal Credit Union, which was seized by the NCUA in December 2010 and placed into conservatorship. The NCUA injected a $20 million subordinated note that it allows AEA to count as capital. In a press release trumpeting how well AEA is turning things around, the NCUA sounds almost giddy.

AEA Federal Credit Union, which operates under the conservatorship of the National Credit Union Administration (NCUA), posted 2012 year-to-date net income of $839,096. Total assets at the end of the first quarter stood at $245.1 million, up from $230.6 million at year-end 2011. AEA Federal Credit Union’s net worth also improved by 18 basis points during the first three months of 2012, ending the first quarter at 2.85 percent.

[...]

Since Dec. 17, 2010, NCUA, the interim management team, and AEA Federal Credit Union’s employees have worked to dramatically improve the credit union’s financial condition and maintain services for the credit union’s 42,000 members. Deposits at AEA Federal Credit Union remain protected up to $250,000 through NCUA’s National Credit Union Share Insurance Fund.

Sounds like everything is just peachy at the formerly busted credit union, doesn't it?

Here's the take of the Credit Union Journal (paid subscription required) on the same financial results.

NCUA said this afternoon that AEA FCU, the one-time $410 million credit union which was victimized by a massive MBL fraud, continues to operate with zero capital, despite a $20 million emergency NCUA loan it is allowed to count as net worth.

AEA, whose former MBL director William Liddle is headed to jail as a result of the fraud, reported net income of $840,000 for the first quarter of 2012, but is still operating with negative $12 million of its own net worth. A new federal law allows such credit union and bank failures to count regulatory assistance, such as NCUA’s $20 million bailout loan, as regulatory net worth. As a result, NCUA says AEA actually has 2.85% net worth.

Are we talking about the same institution? Counting debt as net worth is a great trick. The FSLIC used it in connection with the Southwest Plan in the late 1980s, which allowed the FSLIC to hide the fact that it was technically insolvent, until Congress finally caught on and punished the FSLIC by merging it out of existence and transforming its operating head, the independent Federal Home Loan Bank Board, into the OTS (recently abolished by Dodd-Frank). Could the NCUA be following down FSLIC's weed-strewn road to perdition?

A couple of months ago, I sat through a presentation by a couple of "big guns" from our nation's capital, both lawyers who do a lot of credit union representation, and one who's a lobbyist for financial institutions. They told us that the NCUA was the reincarnation of the FSLIC and when the extent of its financial troubles came to light, the political fallout might be toxic. I have no idea whether or not this allegation is correct. However, using debt as equity and issuing a press release that trumpets an increase in "net worth" without noting that we're not talking about GAAP net worth, but the often-vilified "regulatory net worth," smacks of slathering not only lipstick, but eyeshadow and rouge, all over a rather corpulent porcine-like slab of flab.

Earlier this year, credit union industry pundits were raising questions about how big the losses might be at the NCUA and how the NCUA was publicly handling the disclosure of its potential problems. It looks like this is an issue that might gain some traction.

Ironically, although the NCUA is allowed to use debt instruments as equity infusions, a simple proposal to permit commercial banks to amortize commercial real estate loan losses over a ten-year period was killed by federal regulatory opposition because it would cause "regulatory accounting" to depart from GAAP and might permit banks to "mask" their "true" financial condition. The depth of cynicism in D.C. is beyond the comprehension of anyone other than professional politicians and members of organized criminal enterprises.

Off The Rails

Cadwalader recently published a client memorandum that discussed why Dodd-Frank's been a bust when it comes to setting the world on fire as a template for financial reform, despite being advertised as the Platonic ideal of financial institution reform legislation when it was crammed down our throats passed by the US Congress. Rather than  bering a model of how it's done right, Cadwalader claims that foreign financial institutions find the law as popular as the Pope is to Richard Dawkins.

The memo states three principal reasons the law's been greeted with disdain:

1.    Very little consideration was given by the authors to the effect on international and cross-border finance;

2.    It's impact on foreign financial institutions "is even worse" than it's effect on domestic institutions (which is bad); and

3.    The act "ignores the legitimate governmental authority of non-U.S. financial regulators domestic institutions."

Describing eleven examples of how foreign financial institutions are negatively affected by Dodd-Frank, Cadwalader states that these examples are only a "few" of those negative affects. It may be cold comfort to US financial institutions groaning under the weight of Dodd-Frank's heavy burdens, but your foreign cousins feel your pain.

For the sake of the world, not merely our slice of it (hefty as that slice might be), let's keep this in mind when we take to the voting booths in November. Dismantling this monstrosity, or at least its worst features, isn't going to stand a chance without a major power shift in D.C.

Speaking of busts (nice segue, huh), I guess The Mother Of All Monstrosities (i.e., Lizzie Warren) just can't help digging a hole for herself over her past claims of being "Native American." According to the Washington Post (a Warren-loving publication, by the way), Liz has been running off the rails on this issue.

Asked if she regretted self-identifying as Native American given all the grief she’s gotten over the past week, Warren gave a long, rambling response.

“I have lived in a family that has talked about Native America, talked about tribes, since I’ve been a little girl,” she said. “I still have a picture on my mantle at home, and it’s a picture of my mother’s dad, a picture of my grandfather, and my Aunt Bee has walked by that picture at least a 1000 times, remarked that her father, my Pappa, had high cheekbones, like all of the Indians do, because that’s how she saw it, and your mother got those same great cheekbones, and I didn’t. And she though this was the bad deal she had gotten in life. Being Native American has been a part of my story, I guess since the day I was born, I don’t know any other way to describe it.”

[...]

That kind of convoluted answer, filled with odd details, is exactly how not to respond to an attack. Instead of a short and to the point response about why she claimed Native American heritage on some law documents, Warren instead launched on a personal reflection that gives her political opponents plenty of fodder. (High cheekbones!)

The linked story includes an embedded video clip of Warren's ramble. It's worth a view.

Hey Liz: Ann Romney's got high cheekbones. I guess that makes her a Ute princess, eh?

There was an expected counterattack from Warren supporters, who rounded up spokespeople from every law school where Liz taught. They asserted that notwithstanding the fact that Liz claimed minority status, that wasn't the reason they hired her. I guess that defense consists of the argument that it's acceptable to lie as long as you can claim "no harm, no foul."

On an unrelated note, I was very sorry to see Australian Aborigine ballroom dancer Kym Johnson voted off Dancing With the Stars this week. There just aren't enough "Native Australian" dancers left on television. While her official biography does not mention her aboriginal ancestry, it's obvious from her high cheekbones. Noted Welsh actress and 1/32nd Bantu Catherine Zeta-Jones confirmed the inerrancy of this facial-feature-racial-marker in a recent private telephone conversation.

Loaning To The Little Guys: A Dastardly Turn Of Events

Five years ago, when The Care Bair womanned the helm at the FDIC and was prodding banks to make payday-like loans to poor consumers, but to cap those loans at a 36 percent APR, most banks who experimented with the products were scratching their heads, trying to figure out how to make money on small loans made at those rates when the borrowers posed such a high default risk. These days, when banks of all sizes are strapped for income-yielding products and are dipping appendages bigger than than their pinky fingers into the icy waters of small loans, left-leaning propaganda rags main stream newspapers like The New York Times are aghast at how "big banks" are "preying" on "the little people."

An increasing number of the nation’s large banks — U.S. Bank, Regions Financial and Wells Fargo among them — are aggressively courting low-income customers like Mr. Wegner with alternative products that can carry high fees. They are rapidly expanding these offerings partly because the products were largely untouched by recent financial regulations, and also to recoup the billions in lost income from recent limits on debit and credit card fees.

Predictably, consumer advocates, including the chart-topping consumer band "Recess Richie and The Jackboots," are threatening to inspect these products with a bias-detecting electron microscope of political correctness to ensure that banks don't actually provide a needed service to lower-income consumers at a price that permits the bank to make a profit.

The Consumer Financial Protection Bureau, a new federal agency, said it was examining whether banks ran afoul of consumer protection laws in the marketing of these products.

[...]

“We look at alternative financial products offered by both banks and nonbanks through the same lens — what is the risk posed to consumers?” said Richard Cordray, director of the bureau. “Practices that make it hard for consumers to anticipate and avoid costly fees would be cause for concern.”

Buried in the middle of the piece is this disconcerting news for Cordray and his fellow-travelers.

Still, in an April survey of prepaid cards, Consumers Union found that some banks’ prepaid cards come with lower fees than nonbank competitors.

Wait a minute! If banks are jumping into these products and offering them at rates that are lower than those offered by non-bank predatory payday lenders, wouldn't it be logical to expect that this might eventually force the non-bank small-loan lenders to lower their prices in order to compete? Given most banks' funding advantage over most of their non-bank competitors, isn't it likely that if the banks are able to find a pricing model that allows them to expand this business while lowering existing rates and fees, this would ultimately benefit low-income consumers? Therefore, shouldn't consumer advocates, including the "We're Just Here To Help You" crowd from the KGB CFPB, think that banks entering this business is a potentially good thing for consumers? Shouldn't they encourage, rather than discourage, this trend?

Personally, I think bankers are thinking about getting into this line of business need to have thick hides, because it's a business in which the more successful you are in offering the right type of products and services to your targeted customer base, the greater your chance of being determined to be a discriminatory thug, fit only for being stretched on the rack, then drawn anhd quartered.

Mr. Wegner, the U.S. Bank customer, said that once he mentioned that he needed a bank account, an employee started selling him prepaid cards, check cashing and short-term loan options. Mr. Wegner, who makes about $1,200 a month, said that he felt like a second-tier customer.

“It was clear that I was not getting the same pitches that wealthy clients would,” he said. Since that initial visit, Mr. Wegner said he avoided the branch so he was not approached with offers. “I go through the drive-through now,” he said.

Next year, Mr. Wegner will be complaining that the bank never offers him any credit options at any price. He'll moan about having become invisible.

Mr. Wegner, wealthy clients have high incomes and substantial assets to pledge as collateral and, therefore, pose much less repayment risk to the bank. Of course they're not going to be offered products and services they won't purchase, just as you won't be offered products and services for which you do not qualify under prudent underwriting standards, the kind mandated by safety and soundness standards that are imposed upon banks by law. This is called "living in the real world."

It's obvious that there's an element of the chattering classes that desires that banks be run as public utilities that parcel out credit as mandated by politicians and bureaucrats at rates and fees deemed "fair" by government committee. Until that system's in place, banks will be damned if they do and damned if they don't.

There Is No Due Process?

Last night's post on United Western Bank generated a lot of traffic. Apparently, people are attracted by a David-versus-Goliath scenario. However, there's more to it than that.

In response to an earlier post on the attempt to give bankers a right to an "effective" appeal of examination decisions, one of the principal owners of a financial institution that failed during this latest crisis sent me an email that seems appropriate to post at this time. Obviously, this is only this individual's point of view, and the other "players" in the drama would likely disagree. However, his viewpoint is so well expressed, that I've decided to present it. I've changed some information to protect this individual from identification and retaliation (not that a federal regulatory agency would even THINK of EVER doing such a thing, of course). Other community bank owners, directors, and senior officers can share his pain.

It is my understanding that the processes you describe as set out in the Financial Institutions Examination Fairness & Reform Act have been  available to banks (at least [Bank Regulator] banks) for some time.  However, the ombudsman was more like a retired diplomat (for Monaco not Russia), rather than an informed, empowered decision maker.   And the administrative law judge is difficult to access (& triggers a severe adversarial breach in the relationship with the regulator), & the point at which it can be considered is too late in the process.

All of this discussion about oversight & review of due process presumes that the regulators basically know what they are doing, & exercise their regulatory authority in an appropriate manner.  The Office of Inspector General’s material loss review of the [Bank Regulator]’s handling of [The Bank] looked at the process the regulators went through & reviewed their narratives & calculations, but they never evaluated the validity of their loan evaluations nor whether the assumptions underpinning the subsequent reserve calculations could be substantiated.

So what recourse is there in the event the regulators don’t know what they are doing, or that they exercise malfeasance in their examination process?  At [The Bank] we had a complicated operation with large mortgage banking cash flow swings, complex servicing valuation issues, & large commercial real estate credits.  The field regulators were much more accustomed & qualified to review simple consumer credits.   Perhaps there were people up the chain of command at [The Bank Regulator] that could have weighed in in a more informed way, but they were embroiled in a political life & death struggle for their own survival & couldn’t be bothered to waste their time overseeing the destruction of a community bank.

[The Bank] was well capitalized [(Actual Precentage Omitted)] prior to the [Bank Regultor's] final examination in [Date Omitted].  They forced us to make a massive unsubstantiated addition to the bank’s loan loss reserve that immediately put us into a severely undercapitalized position.  And as you know we were extinguished within [A Short Period Of Time].  Now [A Number Of] years later we can look back & start to assess whether we, or the [Bank Regulator], was “right” in calculating the appropriate reserves.  If the books could ever be opened up & revealed in the bright light of day, the world would see that the [Bank Regulator]’s calculations were in fact totally wrong.  [The Bank]’s original reserve calculations very closely mirrored how the bank’s loans have actually performed (or not performed & subsequently liquidated).  Certainly, in these unprecedented market conditions, we didn’t dispute the need for added capital.  The question is, was it best for the FDIC, the depositors & the bank’s customers for the bank to be shuttered, or for it to work through its problems.  An informed & empowered ombudsman might have looked at the bank’s overall loan quality (delinquency rates: commercial RE0; consumer loans < 1%, etc.); profitability of the bank (earnings before reserves were about $[Substantial Dollar Amount] in [The Year Before The Bank Failed]; & history of operating in our market niche ([Many, Many] years), & decide that there should be an impartial, 3^rd party validation of the field examiner’s loan loss calculations before they pronounce the death sentence.

Instead, the government stole our life’s work, & destroyed an important community bank for the state [Where The Bank Was Located].  [The Acquirer From The FDIC] was able to swoop in & flip the bank in a [Relatively Short Peroid Of] time & walk away with a gain in excess of $[A Boatload].  This outcome is market validation of the error the regulators made.

But there is no due process, & this case will never see the light of day.  However, I don’t think this circumstance is unique to [The Bank].  If you look at the profile of the banks that have been put into receivership by the regulators in this cycle there appears, to me, to be a clear bias against private, closely held community banks.  Do the regulatory bureaucrats, with their mid-tier government pay scales secretly begrudge the entrepreneurs that run many community banks?  It bears closer examination, because the results of their bias will clandestinely define the future of the financial services industry & how communities & consumers are served.

As I said, that's one person's point of view. Each reader can decide for himself or herself where they stand on the primary causes of the community bank failures that have occurred thus far in the current cycle. Nevertheless, the foregoing illustrates why so many community bankers are following the United Western Bank litigation with much more than tepid interest.

American Bar Association to CFPB: That's Not "Legally Sound"

In a recent article in The American Banker (paid subscription required), Kate Davidson discussed the opposition that's been building to the CFPB's proposed rule that we discussed last month. In line with the arguments made by Reed Smith's Travis Nelson that we highlighted in the previous post, the ABA thinks that the CFPB is engaged in a stretch beyond the breaking point.

"The ABA has serious concerns regarding the assertions in the proposed rule's commentary that the bureau can require or compel supervised entities to submit privileged information in connection with the bureau's supervisory and regulatory processes," the group wrote. "In addition, the ABA is concerned that, because the proposed rule is based in part on this unfounded assertion of the bureau's authority to compel production of privileged materials, the proposed rule may not protect the privileged status of that information, thereby placing supervised entities at risk of losing the privilege with respect to materials furnished to the bureau."

To refresh the reader's memory, the CFPB is proposing a rule that would ostensibly protect the privileged nature of communications that are turned over to the CFPB by regulated entities on the basis that such entities are "compelled by law" to turn over attorney-client-privileged material whenever the CFPB asks for it, just like, the CFPB claims, is the case with other federal banking agencies.

The bar association, however, said that claim is "not legally sound" and would erode fundamental attorney-client privilege protections.

"Although the ABA understands that banks often produce privileged materials to federal banking agencies when requested to do so during examinations, the ABA is not aware of any reported federal appellate court case holding that federal banking regulators — or any other federal agencies — can require production of privileged materials, nor do the federal banking statutes contain such authority," the group wrote. "Furthermore, the application of this alleged agency authority to compel production of privileged information with regard to non-banks is wholly unprecedented."

The ABA "dismissed" cases cited by the CFPB because none of them address the right of the agency involved in the case (and, by analogy, the CFPB) to "compel" the production of attorney-client-privileged material. All sides to the argument agree that it would be helpful to have Congress extend to the CFPB the express protection of privileged material that an entity voluntarily produces, and the House did just that late last month. However, banks and CFPB-regulated non-banks aren't crazy about the CFPB's attempt to enact a regulatory fix that is based upon an assumption that the CFPB can step all over attorney-client privilege whenever it gets the whim.

Davidson also points out that the Clearing House, American Bankers Association, Consumer Bankers Association and the American Financial Services Association submitted a joint letter last week that supported the continued protection of privileged material and expressed concern with the CFPB's approach. In other words, the financial institutions industry stands united in its opposition to the CFPB on this particular issue, and they're aligned with the lawyers on this one. I don't think the opposition is going to back down an inch on this issue, so stay tuned for more fireworks if the CFPB continues to press its case.