Bank Lawyer's Blog

Criminalizing Corporate Governance

Emily Flitter at BankThink concisely summarizes a recent useless contretemps among conservative and liberal bloggers and newspaper columnists over a proposal by leftard Paul Collier of Pravda The Guardian to make bad business decisions by bank managers that lead to the failure of a bank a criminal offense ("bankslaughter"). Collier's idea was promoted by the often-but-apparently-not-always-sensible Felix Salmon, who stoked the ire of Clusterstock's John Carney, who, in turn, drove first-year Yale law student James Kwak to lecture all of us, based upon his vast reservoir of knowledge about the US legal system. Links to all the bloviators are contained in Emily's post.

It makes for "interesting reading," but it's a non-issue. Anyone who knows anything about the current state of the law and regulation that governs the US commercial banking system knows that the banking regulators have all the firepower they need to punish reckless bank management and directors until they cry like little girls, including stripping them naked, tying them to an anthill, cutting off their eyelids, and pouring honey on their private parts. Then, they can get really nasty.

Regulators can issue cease and desist orders, impose civil money penalties of up to $27,500 per day, institute removal and prohibition proceedings against "institution affiliated parties" (including officers and directors), sue directors and officers personally for "gross negligence," and seize assets in prejudgment seizure actions. If an institution fails because of the type of "reckless" conduct that so irks the proponents of criminal penalties, you can bet your bottom dollar that the FDIC and the US Justice Department will be all over the management and directors with as many civil and criminal sanctions as they can concoct. Ask Don Dixon and Woody Lemons.

Any bank officer, director, or professional who survived the last banking crisis knows full well that the government has all the arrows in its enforcement quiver that it needs to theoretically deter and punish every "reckless" officer and director it can lay its hands upon. Adding additional criminal penaltiies at this point makes as much sense as all the current discussions about reducing the US and Russian nuclear weapons stockpiles. What's the difference in deterrence incentive between being able to blow up the world 10 times over versus 15 times over?

Ms. Flitter closes in on the most important aspect of the discussion, however, when she wonders whether additional criminal penalties would actually deter anyone when current penalties do not. The obvious answer is "No." The kind of people who take reckless, bank-destroying risks in one of the most heavily-regulated businesses in the world aren't the type of people who worry about the downside. Again, if you'd actually had experience in this business, and had encountered people like this previously, you'd understand all of this. If you're devoid of such actual experience, however, you can always blog or write a newspaper column about the subject, and readers who are equally ignorant might find your opinions useful.

More Evidence That Failed Bank Directors Are In FDIC's Crosshairs

If you're not reading FinCri Advisor, you should be. It's putting out some of the most useful commentary on the financial crisis to be found on the internet.

No, I have no connection with Fin Cri Advisor and this is an unpaid endorsement. I simply like their reporting. For those who loathe this blog, I may be damning them with my praise. Of course, if you loathe this blog, I doubt you're reading this recommendation.

One of the most recent posts discussed a topic that we've been pursuing, that being the not-so-subtle indications that the FDIC is gearing up to sue directors and officers of failed FDIC-insured financial institutions. According to FinCri Advisor's sources, the FDIC has been sending claims letters to former officers and directors of failed banks in order to preserve recourse against "claims made" D&O insurance policies. The fact that these letters are going out impacts not just the obvious persons involved, but every bank that has a D&O insurance policy; in other words, practically every commercial bank and thrift institution.

Such actions "impact everyone - not just failed banks, but all banks - in terms of D&O costs and provisions of the policies," says attorney Walt Moeling, co-manager of the Financial Institutions Group at Bryan Cave in Atlanta.

As the author of the article correctly observes, more claims activity means higher premiums for banks.

The ripples extend beyond existing FDIC-insured institutions, however.

That, in turn, leads to other issues, a 16-year investment banking veteran who blogs at www.capitalbeacon.com writes to FinCri Advisor. "I am aware of several people that have altered plans to raise private equity funds because D&O insurance was either too expensive or unavailable," he offers, adding that it affects mortgage companies, hedge funds and private equity firms, also.

Bryan Cave attorney Walt Moeling points out that while he's not aware of any suits having been filed to date, that doesn't mean that they won't be filed, and if they are, the effects won't be pleasant.

The statue of limitations to file typically is 1 to 2 years, depending on the D&O policy, but the actual litigation can last 6 to 12 years, "and it is very painful for an individual to defend it," Moeling says.

There's other useful information for directors and officers who are concerned about their coverage, including:

• A lawsuit is more likely if there is D&O coverage.
• Directors and officers sleep better at night knowing that they're covered and are more willing to settle if the settlement money is coming out of the insurance carrier's pocket.
• The "regulatory exclusion" (discussed here last week) can ruin the day of both the FDIC and the insureds, so read your policy carefully before you purchase it.
• Also, read the policy carefully for what acts and omissions are and are not covered.
• Renewal of coverage can be a painful process and is likely to become increasingly painful as the FDIC increases its claims activity.

One of the interesting (to me) sidelights of the story is the fact that Bryan Cave acts as independent counsel to the FDIC in suits against officers of failed banks and at the same time has clients that have received claims letters from the FDIC. I assume they'll have to pick either the FDIC or the recipients of the letters as clients if the claims letters ripen into litigation. I haven't looked into the conflict-of-interest policies of the FDIC recently, but when I acted as independent counsel to the RTC in the early 1990s, it used the FDIC's conflict-of-interest policy, which prevented law firms from representing parties whose interests were adverse to those of the FDIC "anywhere in the system" if they also represented the FDIC "anywhere in the system." For example, if you were acting as outside counsel to the FDIC in evaluating potential claims against directors and officers of one failed institution you couldn't represent the director of another failed institution in an action brought by the FDIC. I assume these policies remain essentially unchanged. For those who are interested, here's a link to the FDIC's Statement of Policies Concerning Outside Counsel Conflicts of Interest.

Don't even think about trying a "Chinese Wall" argument with the FDIC. It's not biting into that apple.

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

Regulatory Exclusion

Recently, in response to a post I did about the FDIC allegedly preparing to sue directors and senior executives of failed banks in Georgia, a regular reader e-mailed me to ask whether the threat was a credible threat in light of the "regulatory exclusion" found in director and officer errors and omissions policies. There's some question as to the prevalence of such exclusions in policies today. According to a blurb on the current web site of the American Bankers Association, between 50% and 75% of policies contain such an exclusion. On the other hand, a recent issue of Bank Director magazine asserted that the regulatory exclusion "faded away" after the end of the S&L bailouts and that as of the first quarter of 2009, it had not been "brought back" by insurers. In a recent telephone conversation with a bank director defense attorney in another state, he stated that he'd seen the regulatory exclusion in a policy written in the last few years for more than one of his clients, all from the same Kansas-based insurance company. I'll assume for that it might very well be included in some D&O policies today.

As well-known blogger Kevin LaCroix explained in a post from last July following the meltdown of IndyMac, the regulatory exclusion came into prominence during the last mass failure of thrifts and commercial banks in certain areas of the country during the late 1980s and early 1990s.

The regulatory exclusion typically precludes coverage for claims brought by any governmental, quasi-governmental, or self-regulatory agency. In the competitive underwriting environment that has prevailed in recent years, the regulatory exclusions has become an infrequent part of financial institutions’ D&O insurance policies, a development that has seemed unremarkable as the prior failed bank era has receded into the past. However, with the dramatic news of IndyMac’s regulatory seizure, and the consequent concern that further financial institutions failures may lie ahead...the issues surrounding the regulatory exclusion could once again become relevant.

Kevin linked to an excellent memorandum prepared by Latham & Watkins that discusses the regulatory exclusion. For those who are interested, I recommend it for a little history on the exclusion.

To show how far things have fallen in less than a year, Kevin made some qualifications last summer that he would have not made had he written his blog post today.

It remains to be seen whether or not there will in fact be further financial institution failures, and if there are, whether the regulators will pursue claims against the failed institutions’ former management. Even if the government does pursue these kinds of claims, it is relatively unlikely that many of the institutions current policies contain a regulatory exclusion that would preclude coverage for these claims.

We all know that banks have been dropping like flies since Kevin wrote that post. Moreover, as discussed above, I'm not certain that it is "realtively unlikely" that many current policies contain such an exclusion. If I were a board member, I'd want to make certain.

My correspondent is right to bring up the issue. If the D&O policy will not cover the directors of the failed bank in connection with a law suit brought by the FDIC as receiver for a failed bank, then the FDIC will factor that into its judgment of whether or not a successful lawsuit might result in a pyrrhic victory. In cases where there is a D&O policy but it contains a regulatory exclusion, I think that much will depend on the strength of the evidence that supports the FDIC's claims under applicable law and that might support any defenses to those claims. In other words, what are the chances the FDIC can win if the directors, their backs to the wall, decide they have nothing to lose by slugging it out?  In such cases, I think that also important will be whether the defendants have unencumbered assets that the FDIC can seize and liquidate to satisfy any judgment it might obtain or extract through settlement. In addition, there may be cases where the conduct of officers and/or directors was so objectionable that the FDIC decides to pursue claims in order to send a message, however rare such cases might be. Therefore, the existence of a regulatory exclusion in a D&O policy will certainly be a critical factor, but not the only factor, that influences a decision by the FDIC to sue or not to sue the directors and management of a failed bank.

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.

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?

FDIC Torpedoes A Bank's Reacpitalization?

There's a community bank in Greeley, Colorado that appears to be on its last legs.

Bank traffic was heavy Friday afternoon amid continued rumors that regulators had planned a takeover. No such takeover occurred, although some customers remained worried.

“They’re busy,” said Eleanore Wiggett of Greeley, there Friday to close an account she held with her daughter, Sara Wiggett. “We’ve been in there before and there’s usually one or two people but they’re extremely busy today. I think the rumor’s gotten out. They said the checks would all be honored and everything and everybody would have received a (bank statement) next week giving them time to transfer their accounts.”

A car filled with onlookers sat in a parking lot across the street on Friday until 6:30 p.m., when the bank’s drive-through closed.

“They definitely told me in there that it’s just a matter of days,” Eleanore Wiggett said.

It's not as if the bank couldn't have secured the private capital sufficient, perhaps, to stave off failure or, at the least, absorb losses before the FDIC absorbed them. The bank's holding company had struck a deal for additional capital with a couple of rich Colorado businessmen who were attempting to give back to the local community by saving a large (for that particular community) local financial institution from going the way of the Dodo bird. The holding company had also applied to the US Treasury Department for a TARP CPP investment. The management and directors of the bank (and, apparently, private investors) thought that the combined additional capital infusions would allow the bank to absorb the losses in its loan portfolio and hang on until the economy in general, and the bank in particular, righted itself.

Within the last week or so, the private investor group pulled out and the government denied the application for the TARP CPP investment. The bank's president, Larry Seastrom, said that the reason the private investors withdrew is because, at the same time they were doing their due diligence on the bank, the FDIC put the bank out for bid, and potential bidders were also doing due diligence on the bank. Learning that the bank you thought you're buying control of is being marketed by the FDIC is the ultimate "WTF?" moment.

Seastrom said the deal was doomed because the FDIC offered a sweeter deal for other banks to bid on New Frontier — the icing on the cake being that the FDIC would take the bank’s troubled loans out of the deal. He said that jeopardized the private deal still on the table.

“When the FDIC has you out on the bid process, why would anyone buy you?” Seastrom said. “If and when we fail, it will be as devastating to this community as Citibank was to New York.”

Seastrom had equally strong words about the TARP application process.

He also expressed frustration with the federal Troubled Asset Relieve Program process, $53 million of which New Frontier Bank would have qualified for based on its size. He said the bank was denied. He said that would have been small potatoes compared to how much it will cost to close the bank. He called the process politically corrupt.

“It will cost the FDIC, if we get closed down, $500-$750 million,” Seastrom said. “If they give us $53 million we could save it.”

I guess the bank's holding company should have called Maxine Waters to open up the CPP floodgates, or perhaps Barney Frank would have been a good choice. "Politically corrupt process." Ya think?

Mr. Seastrom is viewed by the FDIC as part of the bank's problems. The article states that the FDIC has demanded his removal, although it extended the deadline for his departure. Therefore, Mr. Seastrom is not an objective observer. On the other hand, he's also in the position of not having much skin left in the game to protect, which tends to make a man less politically correct and more apt to tell you what he really thinks.

It may very well be that the FDIC decided early on that this bank was a "loser." Since the FDIC is picking winners and losers these days, and favors the Citibanks of the world with colossally screwed-up balance sheets, over community banks with screwed-up balance sheets of lesser size, the FDIC could have predetermined that no amount of capital raising by the bank would be successful. Letting bidders for an FDIC-assisted transaction into the bank to perform due diligence while a private investor group is simultaneously doing due diligence for an unassisted deal is a great way to make sure that the private deal never happens.

Rather than be open and transparent (as the regulators insist the banks they regulate must be) and just telling the bank these facts of life, the FDIC just let the bank futz along with the TARP application, the private equity deal, and, obviously, all kinds of regulatory "make work" necessary to respond to enforcement action, formulate mandated capital plans, etc. That useless rearranging of deck chairs on The Titantic simply adds to the ultimate expense to the FDIC, and it also prolongs and increases the pain and suffering of all involved, including bank employees and outside investors.

As we observed when we discussed the alleged de facto moratorium on new bank charters, there seems to be no concern on the part of some within the bank regulatory agencies that real human beings are involved with these transactions, and that real emotional and financial resources are being wasted chasing outcomes that the regulators have predetermined will never happen. Obviously, those individuals simply don't give a damn.

Good luck to the FDIC if it plans to pursue any claims against officers or directors for negligence. I can think of a number of interesting defenses.

TARP Free And Proud Of It

Four banks, led by Iberiabank Corp,  were first out of the gate today to announce that they'd paid back their TARP CPP investments. The four repaid the US Treasury over $338 million to redeem referred stock and warrants, and also repaid accrued dividends. Two of the banks, Iberia and Signature Bank, said that the repayment was directly tied to the Treasury Department's after-the-fact imposition of executive compensation restrictions in February.

A February revision to the bailout as part of a federal stimulus package “adversely affected our business model and it became apparent that we should return these funds to the Treasury,” Signature Chief Executive Officer Joseph DePaolo said today in a statement. 

That's a nice way of saying, "Hey Timmy: Take this TARP and shove it!"

According to today's edition of The American Banker, the Gang of Four is only the first group of banks to repay, and (as we predicted) there will be more on the way.

Other banking companies have announced that they will return the capital they received as soon as possible, including the $16.3 billion-asset TCF Financial Corp. in Wayzata, Minn., and the $82 billion-asset Northern Trust Corp. in Chicago.

[...]

Many healthy Tarp recipients have become disenchanted with the program, saying that the political climate shifted from one where they were encouraged to take the money to help stimulate the economy to one where they are being treated punitively.

The cynics in D.C. have queered this program for many banks who otherwise would have participated. Instead of actually leading the public, politicians have bowed before (or worse, actively incited and manipulated) the Howling Herd that can't separate Wall Street "banks" from community "banks." Much of the public apparently believes that the CPP was designed solely to line the pockets of top executives at the corner bank. Instead of emphasizing that the US Government sought out and encouraged banks to take the CPP money in order to leverage it into new lending, or to cushion the banks against losses on toxic loans and, it was hoped, "unclog" a frozen interbank lending market, the pols in  Washington have willfully failed to exercise leadership by clearly explaining these facts or, worse, have engaged in dishonest demagoguery in order to exploit the public's misunderstanding of the program so that blame for the mess we're in could be deflected onto a convenient scapegoat. In that effort, the politicians have been aided by some equally cynical bankers, who've used TARP as a marketing bat with which to beat their brothers over the head.

Daryl G. Byrd, Iberiabank's president and chief executive officer, has complained that the public feels Tarp recipients are troubled and deserve to have new requirements imposed on how they do business.

"When we decided to accept funds under this program, we believed we were the type of healthy bank that could employ the funds in the manner consistent with the goals initially set out by Congress and the Treasury in supporting the expansion of credit to the markets we serve," Byrd said in a press release when Iberia announced its plan to exit Tarp.

"We believe recent actions, interpretations, and commentary regarding various aspects of the program places our company at an unacceptable competitive disadvantage. Our board of directors has determined that continued participation in this program is no longer in the best interest of our company and its shareholders."

What does T-A-R-P spell? "FAIL."

More Of The Same Old Sleaze

We once thought that Clinton appointee Franklin Raines had a sweet deal at Fannie Mae (even though he had to--kind of--sort of--pay back a wad of his "compensation"). On a per-hour basis, Franklin had nothing on current White House Chief of Staff Rahm Emanuel. Emanuel, appointed to Freddie Mac's Board of Directors by Clinton, stayed a smidge over a year at Freddie Mac, didn't serve on any of the committees where the actual work of the Board was performed, and still pocketed a cool $320,000. Even if he forced himself to attend seven board meetings (the board met only every other month) and actually stayed awake during them, what's that work out to, $46,000 an hour? Wow, even Eliot Spizer wouldn't pay that much for an hour of straight sex.

 And, boy did Freddie get its money's worth of strict oversight out of Rahm ("Eagle-Eye") Emanuel!

On Emanuel's watch, the board was told by executives of a plan to use accounting tricks to mislead shareholders about outsize profits the government-chartered firm was then reaping from risky investments. The goal was to push earnings onto the books in future years, ensuring that Freddie Mac would appear profitable on paper for years to come and helping maximize annual bonuses for company brass.

The accounting scandal wasn't the only one that brewed during Emanuel's tenure.

During his brief time on the board, the company hatched a plan to enhance its political muscle. That scheme, also reviewed by the board, led to a record $3.8 million fine from the Federal Election Commission for illegally using corporate resources to host fundraisers for politicians. Emanuel was the beneficiary of one of those parties after he left the board and ran in 2002 for a seat in Congress from the North Side of Chicago.

The board was throttled for its acquiescence to the accounting manipulation in a 2003 report by Armando Falcon Jr., head of a federaloversight agency for Freddie Mac. The scandal forced Freddie Mac to restate $5 billion in earnings and pay $585 million in fines and legal settlements. It also foreshadowed even harder times at the firm.

Many of those same risky investment practices tied to the accounting scandal eventually brought the firm to the brink of insolvency and led to its seizure last year by the Bush administration, which pledged to inject up to $100 billion in new capital to keep the firm afloat. The Obama administration has doubled that commitment.

Freddie Mac reported recently that it lost $50 billion in 2008. It so far has tapped $14 billion of the government's guarantee and said it soon will need an additional $30 billion to keep operating.

The Change We Have Been Waiting For. Not.

Where There's A Will, There's A Way

An article by Cheyenne Hopkins in today's American Banker (paid subscription required) nicely outlines the immediate reactions of many banking lawyers and consultants to the toxic asset and loan purchase plans announced yesterday by the Treasury Department.

"My concern is that the willing buyer and the willing seller may still be too far apart to create a trade," said Douglas Elliott, a fellow at the Brookings Institution.

FDIC Chairman Sheila Bair conceded that possibility, acknowledging nothing could guarantee the process would produce a good deal for the investor, the bank and the government.

"There is always that risk," she said in a conference call with reporters. "Markets will do what markets will do, but I think this structure has a better chance than any that I've seen to provide that magic price where buyer and seller are willing to meet. But we won't find out until we get it running and see what happens."

The first reaction many of us had to the plan was: "what's the incentive for the bank holding the 'toxic assets' to unload them at prices at which private investors would want to purchase them?" That's been the problem from Day One, when Paulson announced this program last fall. If a bank's written them down to a level that nears a current "fair market value" price, so that no further "haircut" (and no further hit to capital) is taken, then why sell them to a third party who'll benefit from all of the upside as prices recover? Why not hold onto them and let the other chumps establish a market price, get the business moving again, and reap all of the eventual upside for itself?

If the bank hasn't written the assets down, or has, but not enough to make them attractive to buyers, then why would the bank sell them now and take the hit to capital? Let the other chumps sell, reinvigorate the market, and wait until the haircut is much less.

Sheila Bair and others give us a clue as to what might "induce" an unwilling bank to sell.

When asked if regulators might push bankers to accept a price offered through the auction process, Bair responded that it would be a "consultative process with supervisors."

Industry observers argued that the banking agencies would penalize banks that did not take the opportunity to shed their most troublesome assets.

"If the banks refuse to sell, I think you'll see an increased pressure on the part of the regulators and an increased Camels rating going on to the watch list," said Thoma Barrack Jr., the founder, chairman and chief executive of Colony Capital LLC. "The regulators will have no other alternative to start shutting down more banks."

Mark Zandi, chief economist and co-founder of Moody's Economy.com, Inc., said pressure from the Treasury Department and the results of "stress tests" on the banks could force many to participate.

"The stress tests might push the banks to lower their price, and given the very lucrative financing for investors, that will get them to raise their price, and we'll find a nice middle ground here," he said. "So I'm hopeful that the Treasury is pushing both the buyer and the seller to some middle ground, and that will get the auction to work reasonably well."

My guess is that if the regulators start pressuring banks to sell even though they take a hit to capital that impairs their ability to survive, then the quid-pro-quo will need to be additional capital, open bank assistance, or forbearance from the regulators. No bank board will willingly permit a sale at a price that impairs the bank's ability to survive. They'd just as soon let the regulators take punitive action against the institution, even if that results in failure, because they'll at least have a better defense to any action shareholders or the regulators might take against them later that their negligence or malfeasance caused the bank to fail. They can say that the regulators punished them for not doing an unsafe and unsound thing: selling at a price that would have caused the bank to fail.

I can also foresee that if some banks start participating in the program, then the sales prices for assets will be used by the regulators to benchmark values for assets held by recalcitrant banks. If those asset prices would cause a hit to capital, the regulators might "suggest" to the bank that it might as well sell and take the hit, because the next examination team in the bank is going to write down the value of those securities to at least that "market" value and, who knows, maybe even lower. Again, unless the regulators want more banks to fail, I assume they've got a plan in place to replace that capital. Either that, or the FDIC better start taking steroids.

I've seen a lot of complaints on blogs and elsewhere that this is a giant conspiracy to set the price of assets too high and to screw the taxpayer. Banks should be so lucky. The private investors we and others have talked to are salivating at the prospect of offering a nickel on the dollar and making oodles and oodles of serious money by buying assets on the cheap. Those profits will be shared with the US government. Folks like Wilbur Ross, who announced that he's onboard with the program, aren't going to give away profit for the public good. The financing may be so cheap, and the leverage so good, that above-distressed market prices will be offered, but I simply don't think that it's the taxpayers and private investors who will take it on the chin by "overpaying."

No, I think Ms. Bair's comments are very instructive. "Consultations" will be held. Arms will be twisted. Fingers will be broken.

Or, perhaps, the entire cumbersome structure will grind to a halt and collapse under its gross bureaucratic weight.

Wait a minute, I forgot: failure is not an option! As Tim Geithner said in today's House hearing, when asked if he had a backup plan in case this one failed, competence is not a consideration in the success or failure of this program.

Geithner: "This plan will work...it just requires will, not ability."

How very Neitzchean of Secretary Geithner. "Competence? We don't need no stinkin' competence! We have the Force, and the Force is with us!"

Man, this year is going to be a barrel of fun.