Bank Lawyer's Blog

Life In The Not-So-Fast Lane

I'll be posting less frequently over the next two months, as I focus on the demands placed upon me by the nasty fact of life that I have to earn my keep. Inasmuch as one reader complained that I was posting too frequently, that should come as good news to some. Another reader whined that I wasn't giving away as much specific (free) advice on topics relevant to his particular niche of the financial services world as I used to do, so to him and others of a similar bent, this news will constitute no great loss.

Of course, if something really bugs me, I might be compelled to rant, if for no reason other than to infuriate a menopausal management consultant or two, who can then "dis" me on their blogs, yet fail to spell my name correctly. "Kevin" is a real tongue-twister, I admit. And I always reserve the right to change my mind for absolutely no reason at all other than my natural perversity. However, I don't intend to post four to five times a week as I've been doing the last couple of years, at least not until things settle down.

Y'all have a nice summer.

More About Confession

Last week, James Hagerty of The Wall Street Journal reviewed former subprime mortgage broker Richard Bitner's book "Confessions of a Subprime Lender" (which we discussed in April). Hagerty describes it as "an unflattering portrait of an industry that claimed to be all about helping people...achieve the American Dream but was really about grabbing loan-origination fees and foisting the dud mortgages on investors."

Among other astute observations, Hagerty gives Bitner his "props" (as we did) for not acting as an apologist for subprime originators.

To his credit, Mr. Bitner owns up to a fact that many lenders still haven't admitted: Just because Wall Street was willing to supply endless funding for crazy mortgages didn't mean that lenders were forced to make the loans. "We decided whether a borrower was a good credit risk and we funded the loans using our own money (before selling them to investors). No one else made that final decision," he writes.

The article also lists the manipulation of credit underwriting information and outright crooked practices by some originators. Among the practices excoriated by Mr. Bitner was the "piggybacking" of those with poor credit scores on the backs of those with good credit scores (a practice we've previously questioned). I haven't yet read the book, and the article doesn't clarify whether borrowers actively cooperated in these practices, or whether they were solely the result of greedy (and ethically challenged) loan originators.

As for the geniuses on Wall Street who funded this disaster, Mr. Hagerty's criticism is harsh.

They had plenty of brainpower but fell short on common sense. I look forward to reading their confessions.

I wonder if he means confessions of the literary variety or of the legal variety. Perhaps both.

H/t Housing Wire

The Terror of Truth

I warned you that this idea would spread like a plague, didn't I? No sooner do banks start winning litigation by telling the truth than institutions of higher learning start following suit. Duke University was sued by the University of Louisville for breach of a contract in which the universities had agreed that their football teams would play each other four times. Duke backed out with three games remaining. Duke's defense? As articulated by Above The Law, it was simple: "Our team sucks."

Duke's lawyers argued the Blue Devils, which have a record of 6-45 over the past five seasons, were so bad that any team would be a suitable replacement.

Judge Shepherd agreed in his summary: "At oral argument, Duke (with a candor perhaps more attributable to good legal strategy than to institutional modesty) persuasively asserted that this is a threshold that could not be any lower. Duke's argument on this point cannot be reasonably disputed by Louisville."

If this trend keeps up, trial lawyers will have to learn a whole new skill set, and an unfamiliar one at that: complete honesty. How much rust will have to be scraped off the moral engines of shysters everywhere to power up that existential leap into the void? I shudder to contemplate...

Thank all that is right and holy with the world that we still live in a land that honors "truthiness" above "truth," a land where even a beaten down war hero can still strike the pose.

Anti-DAP Bandwagon Gains Speed

Support for the FHA's efforts to ban seller-funded downpayment assistance (DAP) in connection with FHA-insured loans is gaining steam. The front page of today's The Wall Street Journal had a lengthy article on the subject that showed how certain homebuilders are using DAP to make "100% financing" pitches designed to move unsold inventory.

"I just smell a massive taxpayer burden coming," says Sen. Christopher Bond (R., Mo.), who calls the programs "too good to be true."

No kidding, Chris! Of course, the halls of Congress always smell like something crawled into the ventilation system and died. Upon investigation, it's usually discovered to be the dreams of the American taxpayer, so there's no telling what you're actually smelling.

We've made ourselves clear ad nauseum about our dislike of DAP. Inasmuch as misery loves company, we're happy to report that we're not alone.

"The inescapable fact is that seller-funded down-payment assistance is particularly susceptible to losses," says Howard Glaser, a mortgage-industry consultant and former official at the Department of Housing and Urban Development. "Too often today's seller-funded loan is tomorrow's foreclosure."

Paul Jackson at Housing Wire gathers the observations of other nay-sayers.

"If the only buyers the builders can bring in right now are those that require down payment assistance, and they have to get 'creative' with marketing to make it happen, you have to wonder if those are the borrowers we should be putting into homes in this sort of market," he said, under condition of anonymity.

"It’s an odd world where the FHA is the riskiest lender, but the truth is that we’d never lend under that sort of criteria."

[...]

"[T]he DAP programs simply keep contract sales prices inflated, channel fees into the pockets of ‘nonprofits’ who provide no other service than laundering money, and result in lower insurance premiums than FHA should be getting for loans with riskier profiles," said well-known blogger Tanta on the Calculated Risk blog, herself a long-time industry participant.

"These schemes also have the effect of artificially inflating nominal house prices, since the sale price is not the same as the amount netted, at the end of the day, by the seller," notes Felix Salmon in his highly-read economics blog at Portfolio.com. "I’m sure that a lot of politicians and realtors reckon that house prices need all the artificial inflation they can get at the moment, but my feeling is that over the medium to long term, no good can come of [DAP programs]."

As both the WSJ and Housing Wire point out, however, DAP has its defenders, particularly among the ranks of homebuilders and non-profit agencies that financially benefit from the program, as well as from a few politicians in Washington, D.C. who cater to those special interests, including Barney Frank and Maxine Waters. Even Frank, however, admits that DAP won't be left "untouched" by housing legislation currently being considered by both the House and the Senate.

I hope that it's not only "touched," I fervently desire that it be "molested" and left scarred for the rest of its short, miserable life, no matter how politically incorrect that desire might be.

A Disturbing Litigation Strategy

The American Banker (paid subscription required) recently put forth the startling proposition that when a bank is sued by a borrower, the best course of action may be...(gasp)...telling the truth! At least, that seems to the lesson of East West Bank (whose very name makes a lie out of the old saw that "never the twain shall meet").

When East West Bank in Pasadena, Calif., was accused of causing a borrower's default and subsequent bankruptcy, the bank offered to settle for $20 million rather than take its chances with a jury.

But the borrower, a seafood importing company, took the case to court, asking for $40 million plus punitive damages.

The gamble did not pay off.

Last month, a Los Angeles jury unanimously ruled that East West, a unit of the $11.8 billion-asset East West Bancorp, was not responsible for Ocean Fresh Trading Inc.'s demise.

The bank prevailed, in part, because it did not try to hide a conflict of interest involving an employee, his wife, and an Ocean Fresh competitor.

"The lesson learned is that banks can get fair trials, too, but you've got to take the high road and be completely up front if something was amiss," said Skip Miller, a partner at Miller Barondess LLP in Los Angeles who represented East West in the case.

Walter G. Moeling 4th, a partner with the Atlanta law firm Powell Goldstein LLP, said the ruling is particularly important given the current environment; the subprime mortgage crisis, mounting foreclosures, and the credit crunch have tarnished the banking industry's reputation, making it potentially more difficult to win in front of a jury.

"In this market, there is a pent-up sentiment, 'I'm not happy with financial institutions,' and juries are skeptical whether a bank is being greedy," he said. "They think, 'If this bank isn't shooting straight, I'm going to nail them,' so banks are better off owning up to their mistakes."

Man, if that lesson starts spreading, it's going to make it very uncomfortable for those of us who always advise banks to lie, then do our utmost to suborn perjury. I mean, what's this profession coming to when people start winning cases without shading the truth? Plus, as Pontius Pilate sneered, "What is 'truth'?" Talk about shifting paradigms!

The American Banker issued a correction that the bank actually offered the plaintiff less than $20 million to settle. How much less is not stated. Let's hope it was a lot less, because then whoever decided to reject the offer will feel less like he just stuck his last dollar in a slot machine that rolled up two sevens, then a friggin' clown's face. So close, yet so far.

According to the article, the plaintiff's attorneys "did not return calls for comments." They're probably out (a) using a sump pump to transfer Stolichnaya directly from a Russian tanker into their waiting mouths, and (b) drafting an appeal.

Above and Beyond

Recently, Ben Worthen's Business Technology Blog at The Wall Street Journal had a short post about what a nice job Kalamazoo County State Bank did in responding to a "phishing" attack on the bank's customers. The attack came to Worthen's attention because Ben received one of the phishing e-mails and, being the reporter he is, he called the bank and spoke with the bank's CEO about it.

Jim MacPhee, CEO of the bank, was well aware of the problem by the time we reached him. He tells the Business Technology Blog that his bank’s "phone lines lit up like a Christmas tree" as soon as the email went out. When he arrived at work Wednesday morning, his voicemail was full, as were the mailboxes of most of his staff. Many of the calls were from concerned customers, but there were also calls from people who didn’t have accounts at his bank, but who wanted to make sure that he was aware that someone was using the bank’s name to commit fraud.

The phony e-mail wasn't generated by the bank, or by a hacker who breached the bank's system and was using the bank's e-mail. It was just the usual phishing fraud: "they just used widely available software to make the email appear like it came from the bank. Basically, they were picking on the bank."

While cautious lawyers might have told Mr. MacPhee to keep the bank's involvement to a minimum (subject to its duties to file a SAR and otherwise report the incident, as required by applicable law), luckily for the bank and its customers, Mr. MacPhee decided to go the extra mile.

But while KCS Bank may be off the hook legally, it has a responsibility to its customers to resolve the situation, MacPhee tells us. So it worked with the bank’s Internet Service Provider to track the email to a computer in Virginia, and managed to shut down the 800 number, although it was operational for nearly 24 hours. MacPhee also posted a warning on the bank’s Web site announcing that criminals had targeted the bank’s customers.

"Doing the right thing." It's good for the reputation, and just look what this little bank got out of the deal by doing it: a feature in a main stream business publication that shows how much it values its customers. Of course, Mr. MacPhee ends the article with a wish for its customers' welfare that might be raising the bar a bit too high. Nevertheless, it's always good to hope for the best.

"We just hope no one is stupid enough to fall for it," he says.

A cynic might respond with H.L. Mencken's famous line: "Nobody ever went broke underestimating the intelligence of the American public." Being eternal optimists, we'll decline to do so and instead, join Mr. MacPhee and hope for the best.

Lawyers All The Way Down

If the old adage that "bad facts make bad law" is true, then perhaps a correct corollary is that "bad times make good lawsuits." The recent firings and demotions of highly placed executives at very large financial institutions like Wachovia and Washington Mutual may have started a "trickle down" effect that has led to "rifts" between officers, directors and shareholders of much smaller community banks, rifts that have, in turn, led to litigation. At least, that's apparently been the case in Atlanta.

The housing market's collapse has opened rifts and created new tensions within metro banks' leadership ranks, stressing organizations recently accustomed only to growth.

The trend of new bank formation has given way to CEOs and directors now resigning and, at one bank, shareholders suing.

[...]

At Alpharetta-based Alpha Bank & Trust, a group of shareholders are attempting to change the bank's strategic direction and board changes through a lawsuit, filed May 27 in Fulton County Superior Court, after that bank dismissed its founding CEO earlier this year. Alpha Bank opened in 2006, rapidly expanding its real estate loan portfolio in 2007 as the building boom slowed.

[...]

Bankers said the real estate market's rapid downturn added pressures that can dramatically change how a bank's leadership works with each other, sometimes catastrophically.

"It can destroy an organization," said Sonny Deriso, chairman of Buckhead-based Atlantic Capital Bank and longtime bank executive and attorney. "When everyone's squared off, it's too late to be settled amicably."

According to one expert opinion, much of the "squaring off" may be the result of the unrealistic expectations of investors who've not been through a prolonged economic down cycle in their short, sweet lives.

Deriso said that infighting can be worse among Atlanta banks that were created during the boom solely to be sold after a few years of operation.

"Many shareholders and management did this to grow something that could turn around and sell, and you can't do that right now. It becomes a long-haul prospect that many may not be comfortable with," he said.

Rather than facing reality and accepting the fact that even old hands didn't foresee that this freight train would jump the tracks so suddenly and violently, and just buckling down and settling in until the economy improves, many dissatisfied bankers and investors are turning to America's favorite weapon of mass destruction: trial lawyers. No one should be surprised that this is the result in a nation raised on Short Attention Span Theater.

Stephen Hawking's A Brief History of Time begins with an anecdote.

A well-known scientist (some say it was Bertrand Russell) once gave a public lecture on astronomy. He described how the earth orbits around the sun and how the sun, in turn, orbits around the center of a vast collection of stars called our galaxy. At the end of the lecture, a little old lady at the back of the room got up and said: "What you have told us is rubbish. The world is really a flat plate supported on the back of a giant tortoise." The scientist gave a superior smile before replying, "What is the tortoise standing on?" "You're very clever, young man, very clever," said the old lady. "But it's turtles all the way down!"

No, mam, it's lawyers all the way down.

Risk Mitigation And Subprime

Not surprisingly, some mitigation firms think that one way to resolve the credit crisis is to use more risk mitigation services. Naturally, we at Bank Lawyer's Blog believe that the key to resolving the crisis is to  pay more billable hours to bank lawyers.

At least one risk mitigation expert seems to support the theory of some observers that when it comes to subprime, there was "a whole lot of fraud goin' on."

Risk mitigation firm Digital Risk LLC, Maitland, Fla., has found 50% to 60% of the subprime and alternative-A mortgages from the last few years that it has examined due to contract breaches contain significant misrepresentation or fraud, according to Bruce Miller, who was recently named to head the company's New York-based structured finance consultancy practice.

Mr. Miller, the former founder of Credit Suisse's conduit and credit products group, said traditional methods of analyzing such loans have proved insufficient and he has come to believe that every subprime/alt-A loan originated in the past few years should get a third-party review. Information on original loan "tapes" for these mortgages cannot be counted on, he said, adding that he feels rating agencies, as well as other market participants, have largely been "defrauded" when it comes to this information.

Payment histories that were once commonly seen as a good way to size up loan quality are no longer enough because they may, for example, show a borrower has a fairly good track record and only one 30-day delinquency on its loan while hiding the fact that the same borrower owns five other properties he has been flipping, Mr. Miller said.

Without knowing what percentage of alt-A and subprime mortgages that Digital Risk "examined due to contract breaches," it's impossible to determine whether or not the problem of misrepresentation or fraud is widespread or not. The fact that Digital Risk is making a living from reviewing loan portfolios where the investor is alleging (we assume) breach of representations and warranties in the loan sale agreement is support for our previous posts on the increasing incidences of loan repurchase demands by loan purchasers.

I have to admit that I'm not sure I believe that there are many borrowers out there with a "good track record" as far as payment history is concerned but who are also flipping five other properties. I'm not saying it hasn't occurred, I'm merely saying that the possibility wouldn't necessarily motivate a loan purchaser to drop a bundle of cash on Digital Risk. Nevertheless, you can't blame the guy for making his pitch.

He's also dissing automated valuation models.

Automation valuation models at the ZIP code/metropolitan statistical area level also may be insufficient ways to size up such loans, which really need to be analyzed in terms of the individual property as well as in terms of whether a pattern of fraud has been detected in the region if one wants to derive any value from them, said Mr. Miller. "Everything revolves around getting as granular as possible. Otherwise it's the classic 'garbage in, garbage out.'"

Well, "garbage in, garbage out" is a good general statement as to most aspects of the subprime mortgage market over the last five years. On the other hand, how much "getting granular" an investor can afford might depend, ultimately, on how solvent the seller is. If your seller is listed on the "Implode-O-Meter," then the expected recovery on a lawsuit for breach of contract might not justify getting very "granular." Just sayin'.

Speaking of "garbage in, garbage out, it appears that Mr. Miller made money on both ends of this business cycle.

Mr. Miller also noted that due diligence firms' role has changed dramatically since the days when he founded the Credit Suisse conduit and credit products unit. "It's not just due diligence on the inbound/new origination [business], it's a very different role," he said, noting also that demand for advisory/consulting work of this nature has grown notably in the last 18-24 months.

That's certainly an example of being able to hit the sweet spot no matter what the market throws at you, isn't it? Just like attorneys, investment bankers turned risk mitigation experts can make money no matter which way the economic winds blow.

Exercise In Futility

When consumer advocates last year called for a 60-to-90 day nationwide moratorium on residential loan foreclosures, we thought that it was a dumb idea. Holden Lewis of Bankrate.com also questioned the utility of such  a moratorium and asked an embarrassing question.

For example, if a six-month halt to all foreclosures merely delayed a consumer's foreclosure for six months instead of preventing it, that homeowner would rack up seven months of unpaid interest charges instead of one month.

Who would be responsible for paying the extra amount: the servicer, the investors who own the loan, the borrower?

Our guess was "the lender."

A Massachusetts law that went into effect last month extends from 30 to 90 days the "right-to-cure period" before a lender on a 1-to-4 family mortgage loan can foreclose on a defaulting borrower. According to Housing Wire, the immediate effect of the law was to reduce the number of foreclosures, but guess what? Homeowners aren't curing their defaults and, therefore, the lull is expected to be temporary. Once the additional 60-day right-to-cure period expires, the  number of foreclosures will shoot right back up.

"We are in the midst of a foreclosure tsunami here in Massachusetts, and this storm is not going away any time soon," said Sheila Farragher-Gemma, co-founder of ForeclosuresMass.com. "The new filing requirements have created a situation similar to the eye of a hurricane — it may seem calm now, but the storm will come raging back with even more force in the days ahead."

Farragher-Gemma said that "nothing has changed in the Massachusetts real estate market," and that the extension likely won’t do much beyond extend the inevitable for most troubled homeowners.

Actually "something HAS changed" in Massachusetts. Lenders who otherwise could have taken title to the collateral earlier are being forced to eat an extra two months of interest, while borrowers get to live another sixty days payment-free, even though delinquent. All this was expected. This is another classic example of a state law that serves no purpose other than to make it appear that government officials are actually accomplishing something, when what they're really doing is sticking it to lenders. In an election year, that's a demagogue's favorite trick.

One more reason not to make mortgage loans in Massachusetts.

The Good, The Bad, And The Clueless

Over the last couple of weeks, we've seen a demonstration of venality and/or ignorance at the top of the food chain in our nation's capital and a demonstration of impressive competence among the rank and file. We'll take them in reverse order.

The Wall Street Journal's Damian Paletta had a front page article the week before last on the FDIC's seizure of the insolvent First Integrity Bank in small town Staples, Minnesota. It's an excellent "fly-on-the-wall" account of how some old and, I assume, new hands at the FDIC stage the logistical maneuver of taking down a broke bank with minimal muss and fuss. It demonstrates how much nuts-and-bolts competence exists among the career types who toil away day after day in these agencies below the radar screen of the main stream media. Political appointees come and go, often with minimal lasting effect. It's the grunts in the trenches that keep the wheel turning.

On the flip side of competence we have the shining examples of the Chairmen of the Senate Banking Committee and Budget Committee. Both men received favored loan terms from their favorite mortgage banking whipping boy, yet both tried the Sergeant Schultz defense when called out on it.

Senator Kent Conrad, Democrat of North Dakota, said Saturday that he would donate $10,500 to charity and refinance a property loan after suggestions that he and other prominent Washington figures received preferential treatment from Countrywide Financial Corporation.      

Though Mr. Conrad, chairman of the Budget Committee, said he was not aware of any favoritism shown by the lender that has come under scrutiny in the mortgage crisis, he said a review of e-mail traffic suggested that the loan fee for a beach house may have been reduced because of his status, while a second loan called for an exception by the company.

He's giving ten grand to Habitat for Humanity and calling it even. I wonder why they didn't let Jeff Skilling do that?

Chris Dodd, who's been trying to pass legislation to "fix" the credit crisis and "reform," also got a "Friend of Angelo" loan also claimed he had no idea that his loan terms were below market.

Like Mr. Conrad, Mr. Dodd has said he was unaware of any special treatment in loans for a town house in Washington and a home in Connecticut. As chairman of the Senate banking committee, Mr. Dodd has been central in developing a legislative response to the housing foreclosure crisis.

I admit, it sounds plausible that Dodd wouldn't know market loan terms from the Dead Sea Scrolls. That defense has a "if it don't fit, you must acquit" ring to it.

Although other big wigs, including Alphonso Jackson, Donna Shalala and Richard Hoolbrooke, were also on Angelo's list, the stories don't include Dan Walker, the FDIC official featured in Paletta's story. I guess when it comes to Friend of Angelo loans, the ham-and-eggers need not apply.

UPDATE: 6/16/08: From an editorial in today's The Wall Street Journal about "FOA" loans made to politicians:

The Countrywide Financial sweetheart loan scandal continues to grow, spreading to Senators and other Beltway potentates. We are about to find out if Congress's passion for investigating business ethics extends to conflicts of interest and cash that involve fellow Members.

Take Senator Kent Conrad, the North Dakota Democrat whose office issued a Friday statement saying that "I never met Angelo Mozilo." What he did not say then but admitted under later questioning by a Journal reporter is that, although he may not have had a face-to-face meeting with the Countrywide CEO, Mr. Conrad had called Mr. Mozilo and asked for a loan. The result was a discounted loan on his million-dollar beach house and a separate commercial loan of a type that residential lender Countrywide did not even offer to other customers, regardless of the rate.

So after calling the CEO of a company with various matters before the Senate, asking for a loan and then receiving at least two sweetheart deals, Mr. Conrad now says: "I did not think for one moment – and no one ever suggested to me – that I was getting preferential treatment." Lawyers will immediately wonder if this isn't a version of the "ostrich defense," which judges describe during jury instruction as willful blindness or deliberate ignorance. For what other reason, besides preferential treatment, would one call the CEO of the mortgage company? Does Mr. Conrad call August Busch IV when he wants to buy a six-pack?

Almost as breathtaking is Senator Conrad's attempt to use a charitable contribution for the estimated amount of any mortgage savings – $10,500 – to make the issue go away. So while the Senator says he did nothing wrong, now that his nonmistake has been discovered he'll nonetheless give away the nonspecial treatment cash. There is ample evidence here to warrant an investigation, including subpoenas for relevant documents.

[...]

Congress also needs a full accounting of the contacts between Countrywide and the politicians receiving favors from the lender. Did Countrywide ask for and receive assistance from the Friends of Angelo? With Senate Banking Chairman Dodd at the center of the scandal, ranking member Richard Shelby (R., Ala.) and House Financial Services Chairman Barney Frank (D., Mass.) will have to lead the inquiry.

But taxpayers should not have to wait for the results of an investigation. Democrats in Congress are trying to pass a bailout for mortgage borrowers and lenders like Countrywide, and they have been holding reform of Fannie Mae and its cousin Freddie Mac hostage to get President Bush to agree. Mr. Dodd is one of the main hostage-takers. It is time he and Mr. Frank dropped this political ransom-taking and finally subjected Fannie and Freddie to tough oversight. This means giving a regulator the power to set their capital ratios and portfolio securities limits, so that taxpayers have some protection against their potential losses.

Meanwhile, until it is clear how much Countrywide will benefit from Senator Dodd's proposed $300 billion mortgage rescue – and exactly how Mr. Dodd came to do business with Countrywide – Congress should call a halt to legislating bailouts. Taxpayers deserve no less.

As Clint Eastwood's character William Munny told Gene Hackman's character Little Bill in the movie Unforgiven, right before Munny blew Bill's head off, "Deserve's got nothin' to do with it."

Don't hold your breath waiting for Congressional investigations of Kent and Dodd. Also, don't get in the way of the speeding bullet train called "The Bailout Express." Op-Eds in The Wall Street Journal will have as much of an effect on Congress as a lecture from The Decider in Chief.