Bank Lawyer's Blog

Ignorance Is Not Bliss

Paul Jackson, editor-in-chief of Housingwire.com and HousingWire Magazine, expressed his frustration yesterday with federal policy makers' apparent lack of comprehension of how the country's mortgage financing markets work. To me, their ignorance is par for the course. I long ago lost my sense of incredulity at the abysmal lack of understanding of many policy makers in Washington, D.C., which is why I'm the bitter, cynical crank who spews acid all over the pages of this blog today. Paul, being somewhat younger than I (a classification that applies to the vast majority of the world's population), is still able to be amazed at the fact that when it comes to D.C, what you need to know is how to acquire and retain political power, and any other knowledge gained is purely by osmosis and mostly superfluous (at least it is as far as the policy makers are concerned).

What especially irks Paul is the notion that issuers of mortgage-backed securities didn't have enough "skin in the game," and that, according to this line of thought, policy makers are proposing to require issuers to retain at least 5% of the risk on any asset-backed security and to forbid the issuer from hedging any portion of that risk. Paul alleges that this approach is 189 degrees "bass ackwards."

The first thing that should be coming to any market participant’s head when they hear about this so-called ’skin-in-the-game’ rule is this: isn’t skin in the game what has literally crippled once-proud institutions like Citigroup Inc. (C: 3.122 -3.94%)? Isn’t skin in the game what put Lehman and Bear Stearns into history books as former Wall Street firms, too?

[...]

[T]he problems at Citibank and elsewhere aren’t because the banks had too little skin in the game. It’s because they had too much.

Paul's also exasperated by the allegation that asset securitization itself is to blame for the mortgage market meltdown. He's worried that many folks who should know better are getting ready to "throw the baby out with the bath water."

Remarks such as this, from a June 15 Washington Post op-ed penned by Timothy Geithner and Lawrence Summers, should scare anyone involved in the securitization industry:

In theory, securitization should serve to reduce credit risk by spreading it more widely. But by breaking the direct link between borrowers and lenders, securitization led to an erosion of lending standards, resulting in a market failure that fed the housing boom and deepened the housing bust.

The fact that this dreck is coming from the head of Treasury (and from Lawrence Summers, too) scares the living snot out of me, because it demonstrates a fundamental misunderstanding of securitization. A lack of some much-needed oversight into structured finance by federal officials is now being used as an excuse by those same officials to toss cold water on the entire concept?

While Paul concedes the necessity to have a "healthy debate" about asset securitization and related issues, it's extremely difficult to have a debate of any kind, much less a "meaningful" debate, when one side's the equivalent of William F. Buckley, Jr. and the other the equivalent of a potted plant. When it comes to knowledge and intelligence, the debaters ought to at least have the intelligence level of a dull-normal member of the same genus, and preferably the same species.

I'm not optimistic, but, then again, I seldom am.

Jeb Hensarling: Modern Day Don Quixote

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

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

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

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

More Stress In Store For Community Banks

FinCriAdvisor claims that's what's good for the Big 19 will be great for the rest of the pack, or at least that's what they claim the federal banking regulators think.

Banks nationwide should brace for a perfect storm of harsher exams, deposit flight, dry capital markets and share price declines due in large part to the results of the stress tests of 19 core banks.

Because the core banks - those with assets of $100 billion or more - fared reasonably well (see test results), they are expected to attract renewed interest from investors and customers away from regional and community banks, explains Joe Harenza, CEO of Griffin Financial Group in Reading, Pa.

At the same time, the methodology of the stress tests, such as examiner scrutiny of tangible common equity (TCE) and highly customized, portfolio specific analysis of an institution's ability to withstand economic stress, is likely to be expanded to all institutions, adds former OCC Chief Counsel Brian Smith, now a partner with Latham & Watkins in Washington, D.C.

Smith claims that community banks are already seeing this in the case of the commercial real estate "guidelines," which, Smith claims, are being enforced by field examiners as if they were fixed rules. Obviously, any one attorney in private practice gets to see only a slice of the entire banking community; however, my slice and Brian Smith's slice of the business look remarkably similar. The heat is on commercial real estate.

Smith and consultant Joe Harenza posit that the methodology developed by the regulators in connection with the recent stress tests of the largest 19 commercial banks will be applied, with less flexibility and custom-cutting, to smaller banks. Other experts quoted by FinCriAdvisors think that as these stress tests take place, it will have the effect of driving bank investors away from community banks and back to the bigger banks, which is the opposite of the case has been recently. Here's why:

The customized loss estimates on various asset classes came from a negotiated consensus between the banks and stress test examiners, Harenza says. The same thing happened regarding pre-provision reserves. "The moral of the story is that it was tailor made to each of the 19 institutions," he says. "The banks contested and arm wrestled the government." As a result, Citigroup went from needing an additional $35 billion in common equity to just $5.5 billion, he says, citing a Wall Street Journal report.

But regional and community banks will not be able to offer input to examiners and will not receive tailored loss estimates, Harenza says. Yet several analytics firms - Barclays Capital, SNL Financial, Sterne Agee Research - already have released "bank of the envelope" estimates of TCE shortfalls by non-core banks. "Now what you have are buy and sell recommendations on small- and mid-cap organizations made on flawed analyses. That's a killer," Harenza says. "This may not only impact valuation and ability to raise capital, but competitive position as well."

Great news for community bank stocks, eh?

One other reason that community bank stocks may suffer vis-a-vis the big banks is that the big 19 received "the federal government's imprimatur," which gives those banks an advantage.

Since the financial crisis emerged, many depositors and investors have abandoned core banks in favor of community banks in a flight to safety and easier loan terms, Harenza says. "Now, when the government stands up and says half these guys are healthy and it won't let any of them fail, it has to hurt community banks." In addition, by making the test results, earnings projections and capital plans of core banks transparent to the investment community, it leaves a "big question mark" about the relative safety of community banks that are not subject to such transparency and hurts their ability to raise capital.

One commentator opines that this situation won't hurt the "good" community banks much, and I think that I agree as to those publicly traded banks. If you're a community bank that is held privately, however, this could hurt private capital raising efforts (outside of TARP, with all of its baggage).

When I first started to read this article, I thought that they might be making a mountain out of a molehill (not that there's anything wrong with that in the blogosphere) because stress testing is something I've seen clients go through voluntarily in the past and it is not a new concept. However, Smith alleges that this time the testing will be different.

Smith says stress testing is not new, but the emphasis represents a real "shift" to a more "holistic" approach to bank examinations and "decided emphasis" on TCE , in large part because investors demand it. "The stress test was in many ways field testing how these things work" for all institutions, he says, noting that such tests previously focused on discrete areas of an institution, not the entire company. He also suspects regulators had been jointly developing the approach before the crisis erupted, perhaps in reaction to Basel II. "We genuinely believe this signals more of an aggressive, holistic, comprehensive approach to bank supervision."

In addition, the focus on TCE is here to stay, Smith says. "It's like a big balloon - you blow it up and start to press it in from one side, the stress keeps pressing, pressing, pressing. Is there a way to prevent it from bursting?" if products sour, economic pressures build and capital becomes scarce, he asks. "What the Fed is saying is that in order to manage this properly you have to stress test them all" and use TCE as a buffer.

[...]

...[T]he stress test methodology is a strong indicator that all regulators are moving toward highly customized, portfolio specific analysis resulting in individualized capital requirements that includes analyses of past loan performance, portfolio composition, origination vintage, underwriting standards, borrower characteristics, geographic distribution, international operations and business mix.

One more thing to keep community bankers tossing and turning all night long. On the other hand, for outside experts who can assist community banks with such analyses and provide them with independent support to justify the specific capital levels they maintain, this may be a fruitful time.

It's amusing that while this story asserts that the stress tests are evidence that the regulators are moving toward "highly customized. portfolio specific" capital requirements, Warren Buffet and Charlie Munger complained a few weeks ago that the stress tests didn't make sense because they were a "one-size-fits-all" exercise that didn't take into account each bank's unique business characteristics. Of course, their remarks were made prior to the release of the tests, so maybe Warren and Charlie have changed their minds. They haven't said, although Buffet bought more Wells Fargo stock prior to the announcement that as a result of the stress tests, Wells Fargo had to raise an additional $13.7 billion in capital. As the Motley Fool pointed out yesterday, Wells Fargo's subsequent stock offering diluted Buffet's holdings (along with other common shareholders) by 9.2%. I imagine that Warren is even less of a fan of stress testing today than he was earlier this month.

Are State AGs Getting Ready To Dogpile Subprime Securitizers?

A recent piece of litigation (an investigation actually, but it would likely have ripened into litigation) that settled last week seems to me to be indicative of what suits may come.

A the settlement agreement entered into by Goldman Sachs (not to be confused with "Goldman Sex") and the Attorney General of Massachusetts was announced on May 11, 2009 by the AG's office. That agreement requires Goldman Sachs to pay $60 million to (as BankThink's Emily Flitter puts it) "halt the state AG’s investigation in to whether it engaged in deceptive practices while securitizing subprime mortgages." Goldman didn't admit wrongdoing, as is customary in such settlements, but just coincidentally agreed to modify subprime loans that it owns to Massachusetts residences, including agreeing to write of chunks of the principal owed. I don't think that you'd agree to do that unless you thought you had some exposure. The loans in question were securitized by Goldman Sachs and the AG was investigating whether Goldman Sachs had engaged in deceptive practices.

As Ms. Flitter noted, there are only 714 affected Massachusetts borrowers, and the cost of modifications is "relatively" small ($50 million as the cost of the modifications and a $10 million payment to the Commonwealth of Massachusetts). She and others cited in the post also correctly observe that the "monkey see-monkey do" attitude of other state attorneys general could up the ante considerably, not only for Goldman Sachs, but for other securitizers, as well.

“Once this kind of thing becomes popular, you’re going to get a number of attorney generals that are going to jump on the bandwagon and bring some suits,” said Ron Glancz, a partner at Venable LLP. “It’s a way for the attorneys general to reach the investment bankers and the folks that do the securitizing of these assets. It seems in this case they’ve also reached the servicer, because Goldman is a servicer of some of these mortgages.”

Glancz said the lawsuits could prove an expensive prospect for the investment banks, and the future cost of securitizing assets would likely increase.

“This really raises some issues now as to what’s the due diligence that a bank has to do on its own loan portfolio,” Glancz said.

“I would call this decision sort of precedent setting…It will make the investment community sort of leery about what they securitize. From the consumer standpoint they’re going to say this is absolutely right. But if you’re going to look at it as an investment banker it creates an additional expense.”

Glancz said the long-term effects could be mixed. “I don’t know where it’s going to dry up the securitization market,” he said. “In the long run, is this good for the securitization market or is it bad? I don’t know.”

You have to admire a lawyer who publicly admits that he doesn't know something. That runs against the grain of a profession filled with people who think that because they know a lot about a narrow subject, they know a lot about everything. Like the arrogant jerk who writes this blog, for example.

I think that Ron's right on the money that this could be the start of a trend. If it worked once, why not try it 49 more times and see how much blood you can squeeze out of the same turnip, and out of all those other turnips left planted in the soil of Wall Street? As to the long-term effects on the securitization markets, I think that those markets are so hosed, and that the likelihood of a market for securitized subprime loans developing in my lifetime so remote, that I doubt that we'll see much of an effect on that market due primarily to AG's going after securitizers or servicers. If it causes banks to have to perform more dur diligence on loans that are securitized, I doubt that many will bemoan people the additional cost. Among many problems with subprime and other not-ready-for-prime-time loan types that were securitized in the last decade, a lack of due diligence by securitizers (and the rating agencies that were in bed with them) was one right up near the top of the heap of causes of the mess we're now trying to dig our way out of. The pendulum may swing back too far to the conservative side for awhile, but we could stand a little of that swinging.

Safe Harbor = Trial Lawyers' Relief Act

The Senate passed S 896 today which, among other things, would protect loan servicers from lawsuits by investors if the servicers modify or refinance loans to borrowers under one of the thus-far unsuccessful federal loan modification loan programs, such as (No)Hope For Homeowners (see Section 201 of S. 896). Servicers want that protection because investors have already launched lawsuits against large servicers (such as Bank of America) that have agreed to engage in systematic loan modification programs promoted by the FDIC, Treasury and the current Administration.

I thought that the "safe harbor" idea was boneheaded when Sheila Bair first floated it over a year ago. In today's political climate, boneheadedness rules the day. When I discussed this topic a few months ago, I predicted that it would result in a litigation bonanza for trial lawyers who actually think that the 5th Amendment to the US Constitution might provide a basis for suing the US Government in the US Court of Claims. In Monday's The Wall Street Journal, investor advisors Eric Brenner and Hamish Hume made it clear that argument has legs.

By rewriting contracts so that servicers can overturn well-established rules regarding priority among creditors, the proposed safe harbor runs headlong into the Takings Clause of the Fifth Amendment. That provision is intended to prevent the government from forcing an unlucky few to bear public burdens that should be borne by the population at large. The investors in securities backed by first mortgages manage these investments on behalf of employee pension funds, charitable organizations, college endowments, 401(k) plans and many others. The Constitution protects against irrational legislation that takes valuable contractual rights from investors to line the pockets of big banks.

[...]

The government has tried ripping up financial contracts in the past only to get burned in the process. Two decades ago, in the Savings and Loan Crisis, regulators entered into contracts with financial institutions that took over failing thrifts. Congress then substantially eliminated the benefits contained in those contracts. What followed was years of costly litigation that eventually compelled the government to pay damages. The value of those damages may run into the billions of dollars. Congress should not make the same mistake this time.

Well, the Senate made the same mistake, and the House has passed an even more generous safe harbor provision. Let's all get ready to go Dancing With The Bear, one more time.

Putting Reverse Spin On TARP Marketing

One small bank has taken a lesson from recent snarky marketing campaigns by other banks that didn't take TARP preferred stock investments through the US Treasury Department's Capital Purchase Program and have been playing on the public's anger over "bank bailouts." Millennium Bank of Edwards, Colorado, announced recently that it had received $7 million of capital through apreffered stock purchase by the US Treasury Department through the CPP, and that its receipt of such an additional proves that it's a healthy bank, not a sick one, like...oh...maybe...a bank that didn't get a CPP preferred stock investment.

"We are pleased to participate in the program, which is a reflection of our company's continuing strength," Donald Mengedoth, Millennium Banks' chairman and CEO, said in a statement. "The capital investment allows us to expand our ability to generate quality loans to families and businesses within our communities and support the economy. Further, this allows us to pursue growth and opportunities presented in today’s economic environment."

Millennium Bank has remained well-capitalized by federal banking standards, and the addition of new capital will increase its regulatory capital ratios by approximately 25 percent, officials said.

"It is important to note that the Treasury is providing this program to healthy banks that are well managed and well capitalized," Mengedoth said. "The CPP is not a 'bailout.' As the Treasury notes, only healthy banks that lend to their communities are eligible."

Given the recent public sniping by a few non-participating banks against their brethren who've grasped the brass ring of TARP capital, and the bashing of banks who take the government's money by certain members of Congress eager to play off public anger to their political advantage, I think Mr. Mengedoth's public posturing of the CPP investment is a smart move. If he's attacked, as Plains Capital in Texas was attacked, for participating in this program, he can turn the accusation around and publicly ask whether any bank that decided not to take TARP money did so because it thought it would be turned down. Only "healthy" banks qualify for CPP investments, after all.

In some ways, it's a sad state of affairs that such marketing tactics are necessary. On the other hand, folks like Mr. Mengedoth can honestly state that they didn't start these "spin wars," they're just defending themselves with a little "preemptive strike."

KPMG: Stomped By The Elephant

Yesterday’s news that the trustee in bankruptcy for former subrime mortgage giant New Century (one of the first big subprime lenders to fail a couple of years ago) had sued KPMG and its international parent over the collapse of New Century didn‘t really come as a shock. When a company that big fails quickly and spectacularly, you know that its auditor has put its professional liability carrier on notice. You also know that the bankruptcy trustee is going to squeeze as much blood as he or she can out of the auditing turnip for the benefit of the unsecured creditors. However, today Francine McKenna at re: The Auditors, focused her keen eye on the matter and dug out some gems, including one near and dear to our hearts. That one was actually uncovered by Francine two years ago, the first time she wrote about New Century, and which she reiterated today. Discussing an SEC investigation, she notices some lapses in securities disclosure documents [emphasis Francine's]:

There are 17 pages of discussion of general and REIT specific risk associated with this company, but no mention of the specific risk of the potential for their banks to accelerate the repurchase of mortgage loans financed under their significant number of lending arrangements….it does not seem that reserves or capital/liquidity requirements were sufficient to cover the possibility that one of or more lenders could for some reason decide to call the loans. Did the ratios drop? Were they delivering their monthly compliance certificates to all the lenders? Were those accurate and truthful? Did the lenders have the right to call the loans unilaterally? It does say that if one called the loans it is likely that all would. Didn’t someone think that this would be a very big number (US 8.4 billion) if that happened?… I find it very curious that no matter how much auditing and disclosing goes on, we continue to see “rapid, unexpected declines” in once high-flying companies that suddenly teeter on the edge of bankruptcy, even though the best and the brightest are supposedly “Keeping Watch” for us as their auditors.

As regular readers know, I’ve been yipping and yapping like an annoying little Shih Tzu about the primary danger of the “mortgage banking” business model for the little over five years this paltry blog has been in existence: the “Elephant in the Room,” investor-forced repurchases of loans. As Francine rightly points out, when you originate and sell a volume of loans many, many times the amount of your capital and liquid assets, you're facing tremendous potential risk if your underwriting is not, shall we say, “robust.” In seventeen pages of discussion of risk in a disclosure document, repurchase risk is never mentioned. That’s striking.

The Chairman of the Board of a small FDIC-insured financial institution once told me that his institution had outstanding loan sales of many thousands of times its capital. Yet, the specific federal regulator overseeing that institution consistently failed to ever ask the institution how it intended to cover that risk and, in fact, spent relatively little time evaluating origination and underwriting controls as opposed to the regulatory “flavor of the month,” such as Bank Security Act compliance, consumer protection law compliance, or other less critical areas. He wondered whether the regulators “got it.” I don’t know whether or not they ever “got it,” but you have to wonder if auditors failed to "get it," as well.

Francine makes other interesting points, among them:

• Suing the international parent of US accounting firms is a trend that we’ll continue to see.

• The emphasis of the complaint on a lack of “independence” might reflect a lack of sophistication by the plaintiff’s counsel as to the nuances between “independence” and simple negligence, although, to her, “[t]his one seems clear cut enough on the negligence and professional malpractice points alone.”

• “Rolling over and playing dead for the sake of the business is not an ‘independence’ violation, I’m sorry to say.” Lines like that keep me coming back to Francine.

• KPMG still audits Citibank and was the auditor of Countrywide. How much more fun can they stand? Moreover, “who’s next?”

TARP's A Tar Baby

A senior executive of a regional bank recently expressed to me his exasperation with the federal government's handling of the Capital Purchase Program (now renamed the Capital Assistance Program) portion of the Troubled Asset Relief Program in the typically blunt fashion of a Texan.

"I realize it's politically incorrect to use the word "retarded," but that sure as hell describes the government's job so far. If they set out to deliberately screw the thing up they couldn't have done a better job of it."

His ire was directed at the fact that the government solicited healthy banks to participate in the CPP program. The government encouraged banks to take the additional capital to shore up their balance sheets so that they would feel comfortable enough with their excess capital cushion that they'd take the risk of future deterioration of existing asset values and lend to business and consumer borrowers who were screaming "Show Me The Money!" Those banks who took the money are now being painted by other banks who did not take the money as being somehow "irresponsible." Simultaneously, public  posturing by Congressional hypocrites in response to press reports that some large banks who participated in the program (or other forms of assistance) have been paying big bonuses to executives and/or spending lavishly on marketing trips has prodded the Obama administration, including "The Change We Have Been Waiting For,"  to make noises about how it will put the clamps on all banks who take "bailout" money. Frankly, many banks who took the money feel like they've been "screwed," and not in the pleasant sense of that word.

Bankers are increasingly asking themselves whether taking government funds is a good deal — and coming up with more reasons not to.

Restrictions on pay and dividends are one thing, but healthy banks are more troubled by the change they perceive in the Treasury Department's Capital Assistance Program. What was billed last fall as a way to spur healthy banks to lend more is now seen as assistance for weak banks.

"The complete spirit of this deal changed," said Blake Chatelain, the president and chief executive of Red River Bancshares Inc. in Alexandria, La. "Every bank's concern was that the public would understand it was for healthy banks to improve the economy. Along the way the entire spirit of the deal changed to, if you are taking the money from the government then you did something wrong and we are going to control you."

The $5.4 billion-asset Iberiabank Corp. in Lafayette, La., is the first banking company in the country to announce it is giving back the money it received from the Treasury.

"We have gotten the message that if you took" government funds "you are open to all kinds of changes to the way you do business," said Daryl G. Byrd, Iberia's CEO. "We don't think that would be good for our shareholders or the community we serve."

Chicago's Northern Trust Corp. on Friday sent Rep. Barney Frank a letter saying it would repay its $1.6 billion after a storm of negative publicity this week tied to the sponsorship of a golf tournament.

Rusty Cloutier, the president and CEO of the $1 billion-asset MidSouth Bancorp Inc. in Lafayette, said he is meeting with government officials in Washington next week and plans to pose one question: "Do they really want the community banks to be partners with them to help solve the problem they've got, or is this money just for bad banks?"

Depending on the answer, his company might return the $20 million in government capital it received, he said. "My bank is saying, 'Look, if you-all are saying this is for troubled banks, that's not us. We're in good shape.' So if that's the message, we'll just send them a check."

Even JPMorgan Chase's Jamie Dimon, a favorite of the Obama administration and a smart cookie, wishes that he'd never sold his soul to "Dark Knight" Paulson, according to some press reports. Unfortunately for Jamie and his little brothers in the banking biz, TARP appears that it might be the federal government's version of The Hotel California: you can check in, but you can never check out.

Lawmakers removed one obstacle last week by eliminating a requirement that firms raise a corresponding amount of private capital before repaying Troubled Asset Relief Program funds. But other issues remain.

Under the law, bankers must first consult with their federal regulators before repaying money, and observers say winning approval is likely to be tough in the current environment. Regulators want banks to have more capital right now — not less.

"They have to prove to their regulators they are financially sound without Tarp, and given how conservative regulators are these days, that's not going to be the easiest thing," said Kip Weissman, a partner at Luse Gorman Pomerenk & Schick PC.

The Obama administration opposed the provision in the economic stimulus, arguing that it would undermine the law's goals. Also, the law does say the Treasury Department must first write regulations outlining how bankers may repay Tarp — and it would not be the first time an administration delayed writing rules it did not support.

"Some banks have already said they want to repay the government ASAP," an administration official said on the condition of anonymity. "This could have the unintended consequence of firms choosing not to participate in ways that would be helpful to getting credit flowing, including homeowners, auto loans, and small businesses."

Allowing some institutions to repay Tarp funds early could create problems for the companies that do not.

For example, if JPMorgan Chase paid back its money early, but Citigroup Inc. and Bank of America Corp. did not, that could create more problems for those two firms.

"For those that can afford to buy back, does that mean you are healthy?" asked Lisa Andrews, a special counsel at Kelley Drye & Warren LLP.

"What does that mean for those that can't?"

The Treasury may also make bankers wait until regulators complete their stress tests of the largest institutions.

The banks "are all going to be on the sidelines getting ready for the Treasury's stress tests," said Brian Klock, senior vice president of equity research in the San Francisco office of KBW Inc.'s Keefe, Bruyette & Woods Inc.

"I don't expect to see a rush of banks that are going to do this until then."

Mr. Weissman agreed with that prediction. "The worst concern from a regulatory standpoint is a large bank gave back the money but failed the stress test," he said.

Banking companies, especially large ones, may also want to wait and see what the government does to help remove toxic assets from their books. The Obama administration has said it wants to start a public-private fund to purchase illiquid assets.

"It will be difficult to figure out how many assets the banks can afford to put off their balance sheet," said Tom Parliament, the president of Parliament Consulting Services Inc.

"Until it becomes clear how much capital they need, they will hold on to it."

[...]

"You may go through a lot of pain and suffering to get out of Tarp," said V. Gerald Comizio, a partner in the corporate department at Paul, Hastings, Janofsky & Walker LLP.

So, as "TARP Remorse" begins to sink in, banks who feel it will find themselves increasingly embittered as regulators make public noises as to how the banks should submit detailed reports about how they're using the money to make loans to "credit-worthy" borrowers, all the while putting the screws to banks behind the scenes to tighten up their underwriting standards and deny credit to small business borrowers, many of whom have paid their operating lines on time but don't meet the new restrictive "debt service coverage" requirements that business bankers tell me they are being encouraged to apply going forward. As the economy continues to crater and the public blames banks (and everyone other than itself) for the mess we'll be mired in for some time to come, look for many of those banks who foolishly believed the Feds when they said "We're from the government; we're here to help," look for the first opportunity to "bail out" of CPP, CAP, CRAP or whatever other anagram is used to refer to the brier patch they've jumped into. More expensive private equity infusions will look a lot less expensive than they did last fall.

I think the "success" of the CPP/CAP will be but one more reason to encourage the average voter to adopt the following slogan for the 2010 congressional elections: "Throw out ALL the bums!"

Under Their Thumb

This weekend, the talking heads on the Sunday morning news shows were in full bleat about how the federal government must "nationalize" (only temporarily, of course) some of the biggest, most troubled banks, in the manner of Sweden, so that the government can stabilize them, clean them up, change their diapers, give them a bottle, burp them, put them down for a little nap, and then find a nice foster home for them. Today, the federal banking agencies and the Treasury Department issued a joint statement saying, I think, that "nationalization" wasn't going to happen. I say, "I think," because one can never be certain when bureau-speak means what it says or the exact opposite of what it says. Ask me in a year, and I'll tell you what the joint statement actually meant.

Today's Wall Street Journal (paid subscription required) made it clear that the federal government doesn't need to make a legal case for nationalization, because it's already "in fact" nationalized Citigroup.

"Between the capital injections and the asset protection, you've already got de facto nationalization of Citigroup," said John Duffy, chairman and chief executive of Keefe, Bruyette & Woods Inc., a New York investment and research firm that specializes in the financial-services industry.

Shareholders often don't need a 51% stake to effectively control a company. The largest shareholders are typically the most influential, and that is likely to continue to be the case if that big shareholder is the U.S. government.

"The government already has a lot of latent control in Citigroup, and when it wants to flex its muscles, it can. I imagine we will see that control become more explicit rather than implicit," said Bert Ely, principal at Ely & Co., a financial-services consulting firm in Alexandria, Va.

"Latent control." Not so latent, if you ask me. Maybe the Treasury Department's influence doesn't technically meet the definition of "control" under Regulation Y. Nevertheless, the way Citigroup turned tail and abandoned its banking brethren in the fight against cram down in bankruptcy, and its suddenly seeing the light on massive loan modification programs, are clear indications that when it comes to doing the government's bidding, Citgroup is "actually" under the government's thumb.

The Treasury (and the FDIC for that matter) can truly sneer, "Common stock? We don't need no common stock!"

In honor of Citigroup's status as the Treasury's new body servant, we bring you this excellent rendition of the Rolling Stones' classic, "Under My Thumb," performed by three of Treasury's  Gruppenführers assigned to "advise" Citibank.

Bank Lawyers' Advice About TARP: Don't Walk Away, Run!

A few days ago, we posted about the increasing number of community banks that had been approved for capital investments through the TARP CPP program, but that had decided to pass on taking the capital. Today, Law.com discussed one of the reasons why: the banks' lawyers are scaring the bejesus out of them.

Those lawyers were nearly unanimous in saying that banks of all kinds are becoming more cautious about participating in TARP, with some even backing out of the program after Treasury has approved them for funding. And in some cases, lawyers say they are actively advising institutions against seeking the bailout money.

[...]

Among the banks' concerns: limits on executive compensation and government oversight that could extend to tracking how every TARP dollar is spent. One clause in the general TARP agreement says Congress can amend the lending terms at any time, and that a participating bank must adhere to any such amendments, including compensation rules and loan requirements, Gustini and others say.

"That pushed a lot of banks away from the deal," says William Luedke IV, a Houston-based Bracewell & Giuliani partner who has met with boards from about 50 financial institutions interested in applying for TARP money. Of those, he says, only 15 have followed through and "the interest is tapering off" as Obama, Geithner and others talk openly about increased oversight.

We've harping about Section 5.3 of the Securities Purchase Agreement since it first reared its ugly snout. We're pleased to see we're not alone, since we love being close to the madding crowd

Several lawyers say the most troubling new conditions are coming from the Office of Thrift Supervision, the federal agency that regulates thrifts (savings banks and savings and loan institutions). The OTS sent out a letter last week saying any holding company running a thrift that receives TARP money will have to remain a so-called "source of strength" for the thrift, says David Baris, name partner at Kennedy & Baris, a five-lawyer boutique that has advised about two dozen institutions on TARP applications.

This "source of strength rule" requires holding companies to maintain a certain level of capital that is earmarked specifically for propping up its thrifts, lawyers say. And if a thrift under its control were to fail, a holding company that had pledged to be a "source of strength" would be on the hook for that thrift's losses, say Baris and Robert Freedman, name partner at Silver, Freedman & Taff, a Washington, D.C.-based boutique that has advised about 20 TARP applicants.

Baris, who serves as counsel for the American Association of Bank Directors, is leading a group of lawyers who have drafted a letter to the OTS urging the agency to drop the rule. They also plan to ask the OTS to void any agreements with thrifts who applied and received money before OTS instituted the rule.

"We're opposed to the agreement," Freedman says, "and we're counseling a lot of clients not to do it."

I don't have time to go into the history of the OTS' version of the source of strength doctrine, but the OTS has been trying to back-door its way into an enforceable version of that doctrine for years. If they want to make it explicit, and require a Net Worth Maintenance Agreement from holding companies that take the CPP funds, just like in the bad old days, that will kill CPP as far as federal thrifts are concerned. 

In this case, attorneys really appear to be the "deal killers" they're so often accused of being. Those banks that take their advice will likely live to not regret it. As to those banks that listen to legal advice and, in Blagojevichian fashion, decide to ignore it, some of them fit the profile sketched by Bill Ludtke.

"If you have a real need, that can overcome a lot of a bank's principles. You gotta do what you gotta do."

And when the piper eventually comes calling, you gotta pay what you gotta pay.