Bank Lawyer's Blog

Hammer Time

A death in the family last week has sapped me of the time to blog and, more important, of the desire to blog about banking law matters. On the other hand, it's not every day that the Decider-in-Chief does a 180 degree turn and signs a bill he previously vowed to veto. Sure, it's an election year and ostensibly the Prez is worried about the public perception that Freddie Mac and Fannie Mae are in trouble (a perception fueled by uncomfortable facts), so I shouldn't be surprised by yet another broken promise by the White House. After all, this is a guy who has overseen one of the greatest increases in the federal deficit in history during his turn as everyone's favorite "compassionate conservative."

The initial reactions of affected parties to the bailout bill is amusing. Over the past few days, we've had HUD doing its own about-face, first publicly declaring that it wouldn't have regulations in place to implement the $300 million in FHA bailout loans until next year, and then, after public outrage was expressed by Senators Barney and Chris, assuring everyone who still cared to listen that the program would be up and ready by October 1, no problemo. People are sticklers for following the requirements of the Administrative Procedures Act only when they want to defeat governmental action, not when they want to expedite it.

Barney's also been jawboning lenders and servicers about how they'd better jump on the bandwagon, write down their loans to qualifying borrowers to 90% of current fair market value, and otherwise take it in the shorts for the good of the U.S.A. The FHA will make a convenient dumping ground for all the garbage in the loan portfolios, so it's likely that lenders and servicers will look seriously at offloading their most odoriferous subprime loans to the perfumed palaces of Uncle Sammy's subprime lender of last resort.

Barney's big stick to enforce compliance with this "voluntary" loan rescue is the threat of even tougher regulations next year after God-Emperor Obama parts the waves of the foreclosure tsunami with the rod of a veto-proof Congress and leads the subprime tribe into the promised land. Inasmuch as no man's wallet is safe while the legislature is in session, that's a threat that lenders, servicer, and even investors had better take seriously. Can you imagine a bullet-proof pack of hyenas led by Barney, Chuckie, Chrissy, Nancy and Dirty Harry getting down to business on the "real" Axis of Evil: lenders, servicers and investors? The victims of that pogrom will yearn for a gentle-like torture, such as that used by Sir Laurence Olivier's character on Dustin Hoffman's in "Marathon Man," drilling into an exposed molar without anesthetic while asking over and over, "Is it safe?"

On the brighter side of the legislation, some piggies are already lined up, grunting and squealing, at the public hand-out trough.

The measure also provides nearly $4 billion in grants to local governments to buy, demolish, or otherwise handle foreclosed properties that might otherwise stand vacant.

Colorado is expected to get $88 million of that total, according to Kathi Williams, director of the state housing division.

Nonprofit and local government representatives will meet soon to discuss how to use the money, Williams said. Local governments, rather than state officials, will decide how to deal with foreclosed properties, and methods may vary from one place to another, she said.

Among the possibilities: the money could be used to demolish vacant housing; to keep people in their own homes on a rental basis; to refurbish properties for use as affordable housing; or to buy and hold properties in a land bank.

Bet your bottom dollar: palms will be greased; quid-pro-quos will offered and accepted. No combo on the planet knows how best to quickly spend the public dollar than the match of local government and nonprofit agencies. Well, other than politicians and lobbyists.

Not all is lost for the forces of light, however, because this is the day that DAP died. The purveyors of this particular piece of pork, including homebuilders and their nonprofit enablers, are crying in their beer. This portion of the legislation will render moot the need for HUD to actually be able to follow the APA in abolishing DAP, so that high procedural hurdle has now been kicked off the track. On the other hand, DAPs demise, and the consequent positive effect on FHA loan defaults, is cold comfort, inasmuch as the net effect of this legislation is such that the federal debt ceiling was raised to $10.6 trillion.

As the headline of an op-ed piece in The Wall Street Journal last week so aptly announced, "Housing Bill Hammers Taxpayers."

We Will, We Will Wonk You!

In today's edition (tomorrow's edition, if you haven't crossed the International Date Line) of the Asia Times Online, consultant George Pugh has a rather "wonky" article on Collateralized Debt Obligations backed by subprime mortgages, how fraud by originators of those loans caused the bubble that has now burst, and how rating agencies may have dropped the ball by not properly accounting for fraud in their models. He asserts that the creators of CDOs, on the other hand, reacted properly to the prospect of fraud once they comprehended the breadth of the problem, even building their own processes to by-pass the rating agencies' flawed processes.

The authors of Bank Lawyer's Blog are not wonks. Rather, our day usually consists of sitting on a cabin porch in the backwoods of the Ozarks, picking out "Foggy Mountain Breakdown" on the banjo. When we begin reading an article that contains a technical analysis of CDOs, we're overcome with the irresistible urge to grab a .22 and go a-huntin' for varmints. However, there may be mortgage-backed wonks out there who will enjoy that aspect of the article.

Our interest was in Mr. Pugh's conclusions.

[I]t is clear that the frauds started with the people making fraudulent mortgage applications which were not caught by the people issuing the mortgages. The second conclusion is that the firms were only later involved and did not try to hide the problems in a meaningful way; though there may have been instances in some firms, it was by no means generalized.

[...]

Fraud distorts market signals for demand and more importantly growth in demand and price. In this instance, increased mortgage financing bid up existing stock and created a multiplier effect among existing home owners, who sought to reinvest their gains in larger properties. These price increases encouraged builders to build for the increased demand which was debt financed. Mortgage lenders were eager to keep up, and lowered their standards, even if no fraud was involved, to keep their competitive position. The risks were passed on to the purchasers, so the mortgage originators and their auditors simply did not see the contingent risk as large. It really doesn't take a lot of increase in demand to increase the growth in prices, feeding building and speculation.

Up to this point, it is clear that mortgage fraud fed the bubble and that subprime loans were in the center ring. There is strong evidence that the firms that stayed in the market behaved well when contending with the fraud involved in the underlying instruments. It is also clear that SEC regulations, especially Sarbanes Oxley, are totally worthless in preventing or detecting fraud. It appears that the politicians want to further regulate the firms rather than look to their own regulatory failures.

If you've got a problem with Mr. Pugh's conclusions, take them up with him. We're not necessarily defending his analysis of how the rating agency models worked (or, in this case, did not work) or the actions and omissions of CDO "creators." As the effectiveness of Sarbanes Oxley in detecting and preventing fraud in the subprime mortgage market, it's hard to argue that no federal or state law has proved effective in detecting or preventing it, at least until it ran rampant like a crazed water buffalo on acid. On the other hand, his allegations fit nicely with our own knee-jerk preferences, so we're happy to post them.

A Glass Half Full Kind of Guy

John Stewart riffed last week on IndyMac, Bernie Mac, Freddie Mac, Fannie Flag, Fannie Mae, Igor Stravinsky, and a ham sandwich. And even more.

A Slight Suprise About Subprime

The continuing legal education requirements of the various state bars are often the bane of a lawyer's existence. Sitting still and listening to lawyers talk about the law is as excruciating as--well--reading this blog, for instance. You all know how painful that can be, and some of you let me know it (anonymously, for the most part, because you understand that Texas is a concealed carry permit state). Imagine if you had to do 15 hours of it per year, and 3 hours of it had to be on ethics? I mean, ETHICS? What's that got to do with the practice of law in the 21st century? Sure, maybe Saint Thomas More worried about being the king's good servant, but God's first, but that ca-ca doesn't fly in the postmodern age (except, of course, when it hits the fan).

At any rate, against all odds, I was sitting around yesterday in front of my computer listening attentively to an online seminar about subprime lending and the law (the British Open being on the office's television set at the same time did not distract me in the least) and I actually learned something. Two of the panelists for this program were regulators: an Assistant Attorney General with the Texas Attorney General's Office and an attorney with the Office of Thrift Supervision. The moderator, a partner in a large Texas-based law firm, asked the government attorneys some questions about loan modifications and what their agencies could do to help prevent the wave of foreclosures of subprime loans and to force lenders to modify loans. After the standard qualification that any views expressed were their personal views and not the views of their respective agencies, the OTS attorney stated emphatically that the decision as to whether to foreclose on a delinquent loan or to modify it was a matter involving private contract rights between borrower, lender, servicer and investor, and the OTS had no authority to order any of the participants to modify a loan. The Assistant AG agreed, although she added that the Attorney General of Texas had "encouraged" servicers to modify loans whenever possible (the subject of a previous rant post). The OTS attorney stated that all of the federal banking regulators had also "encouraged" institutions that they regulated to consider modifications rather than foreclosure, but that the banking regulators had no legal authority to force any such action.

None of the foregoing is startling, except that the tone of the regulators was very matter-of-fact, compared to the strident loan modification shilling by the FDIC under Sheila Bair. Then again, none of the program's panelists appeared to be angling for a position in the Obama administration, so maybe that had something to do with their neutral tone.

The Assistant Attorney General was also asked by the moderator about examples of fraud by lenders against borrowers. She replied that the AG wasn't seeing as much fraud against borrowers by lenders as it was seeing fraud against lenders by various parties, including borrowers. Mortgage fraud, where the bank was the "victim," was a much bigger problem in Texas than instances where lenders victimized innocent borrowers. She stated that the AG's office had set up a hotline where borrowers could report fraud; however, the main "weapon" of the AG's office in this area is injunctive relief. The Attorney General can seek to stop patterns and practices of fraud and deceptive practices. If the borrower thought that he or she was entitled to financial recourse against lenders, the best course would be to hire an attorney and sue the lender in civil court. 

Not exactly a Marc Dann atmosphere here in Texas, is it?

Of course, a cynic might sneer that such an atmosphere breeds the Enrons of the world. Luckily, I'm an optimist, so I'd never even think, much less say, such a thing.

More On The "Blame Game"

Former CBS New Executive and current executive with National Public Radio, Dick Meyer, is also a blogger at "Against The Grain." A recent rant on the subprime mortgage crisis speaks to all sides of the political spectrum and tells everybody to stop the blame game.

One of the great tensions in the American spirit for the past century has been between traditional self-reliance and modern blamesmanship. Blamesmanship is winning now, and the consequences are economic, not just moral.

The first cousin of blamesmanship is the syndrome that turns grown-ups into victims, the social demand that for every bad thing there must be a victim and a villain. The American litigation system is our great monument to these most unattractive ethical postures. Lost money in the market? Sue. Suffered an untimely death in the family? Sue. Couldn't afford your credit card payments? Blame easy credit, declare bankruptcy and let someone else sue you.

[...]

The country is looking for whom to blame for the recession. Generally, the culprit is seen to be the easy credit that spawned the real estate boom. So the villains are promiscuous lenders and the Wall Street financiers who provided a secondary market for risky loans, thus shielding the big guys from risk and hanging little guys out to dry.

That narrative is broadly true. But it is only half the story.

The other half is the story of the consumers who took out the risky loans, the jumbo mortgages and the excessive credit card debt. The liberal spirit wants to excuse "the consumer" from any moral or economic responsibility because the consumer is the victim of vast economic forces and malevolent corporate predators.

Government ought to protect the little guy. Business ought not to prey on consumers. Well, yes, sure. But that, again, is only half the story.

Consumers ought not to carry debt they cannot afford. Borrowers are not exempt from being prudent or well-informed simply because loans are available. But such declarations are now considered illiberal, moralistic and unsophisticated. That means we are likely doomed to repeat our mistakes.

[...]

The culture of blamesmanship will help ensure that economic behavior remains insulated from ethical strictures or learning from mistakes.

It would be natural to wonder why so many consumers abandoned saving. Yes, it has become more difficult to finance a "middle-class" lifestyle and, yes, the gap between the super-rich and the rest is higher than it has ever been, to our knowledge. Those are factors, not explanation.

It would be natural to wonder why so many consumers took out loans on grossly inflated assets at interest rates that, while initially low, could increase wildly in the future. It would be natural to wonder why so many people bought things they plainly could not afford with credit cards. It would be natural to wonder why the pleasure of buying and having stuff so often outweighs the pain of economic risk and uncertainty.

Answering such questions leads to self-knowledge and changes in behavior. It is educative. Economic education, mixed with a smidge of fire and brimstone, is no longer a part of our schools' curriculum. That's a bad call.

Our focus, however, is now on apportioning blame between the financial foxes on Wall Street and the negligent regulators in Washington. And we should be doing just that — just not to the exclusion of looking in the mirror. And growing up.

Good stuff, no matter what your political bent. And sure to be met in certain quarters with snark and a sneer.

Dr. Strangebair

Sheila Bair doffs her cowboy hat, plunks her badonkadonk butt down on the anti-foreclosure missile from paradise, and rides that rock all the way to ground zero, her unbridled enthusiasm for borrower-over-lender bias evident until the final clueless nanosecond. So goes Indy, so goes the FDIC, so goes our financial system.

Ride 'em, Sheila, ride 'em!

Meanwhile, the last of the panicked insured depositors withdraw their insured deposits from IndyMac and receive an unpleasant surprise from the FDIC's uniformed and plainclothes "Withdrawal Discouragers" upon exiting the bank branch. While Sheila's all for cutting borrowers slack on the asset side of the balance sheet, it's a whole 'nother story when it comes to liabilities.

Is There A Full Moon?

The undertow generated by the sinking of the good ship IndyMac has pulled under some seemingly sane swimmers in the sea of financial services advice. One Internet guru, Christopher Penn (described on his blog  as a "visionary in new media" and the Chief Technology Officer of the Student Loan Network), entitled a post on Saturday "What if the FDIC fails?" Mr. Penn's advice to his readers is to become very nervous if the FDIC's reserve falls below $10 billion, and to consider moving money to foreign banks, because the FDIC might be wiped out by one or several big bank failures. I assume that Mr. Penn, being a hip young master of the new media, is too young to remember that when the late, not-so-great, FSLIC was surfing on the crest of a wave of insolvency and headed for a wipe out, Congress stepped in and rescued it. Well, destroyed it, actually, but saved the insurance fund and the depositors' insured deposits.

In the case of the present-day FDIC, the worst that is likely to happen is that the FDIC will increase assessments on member institutions to replenish the reserve, which will put further pressure on banks' earnings. Banks will likely respond by raising fees and you and I and the rest of the customer base will pay for it "in the end." The bottom line is that Congress isn't going to let the FDIC fail. Period.

Even if that unlikely disaster scenario were to unfold, which foreign banks would be an alternative safe bet to a US bank? The collapse of the FDIC would be such a catastrophic event that it would likely mean that the entire US commercial banking system was in meltdown mode. Do you think that would trigger a systemic, world-wide financial institution collapse? It's likely. Rather than telling readers to pull money out of US banks and put it into foreign banks, tell them to buy gold, concertina wire, claymore mines, plenty of AR-15 ammo, and a self-contained redoubt in the wilds of Idaho. Oh, yeah, and a decade's supply of Viagra, because you never know when you'll get down to a functioning drugstore again.

Personally, if we're going to start playing the "What If?" game, I'd like to pattern it after the old Saturday Night Live skit of the same name, and ask more entertaining questions, such as "What if Spartacus had a Piper Cub at the battle of Silarus?" Or, "What if the Man from U.N.C.L.E. went back in time and helped the pioneers fight dinosaurs?" Now, those are questions worth pondering.

Speaking of moon bats, Brett Arends of The Wall Street Journal thinks that insured depositors who participated in the run on IndyMac were irrational.

Reason for a run on the bank: Zero

Going forward, however, Brett does have three sound suggestions for those depositors who must keep uninsured funds in a bank account.

First, you could deposit $100,000 in one bank and then walk across the road and deposit another $100,000 in a second bank. And so on.

Second, you can take part in a program known as CDARS run by Promontory Interfinancial. Details are here. This allows you to deposit your money in one bank, which will then parcel it out in federally-insured $100,000 lots to various other banks. Net result: The whole thing is insured.

The third option? Keep hundreds of thousands of dollars, uninsured, in a single rickety mortgage bank. Wait for Charles Schumer to criticize that bank, and then drop everything and race down to the bank in a panic to withdraw all your savings at once.

Now, that's funny and not a bit wacky.

Let The (Blame) Games Begin

Friday afternoon's seizure of IndyMac Bank commenced an immediate flurry of finger-pointing that will likely continue for some time. As lawyer Gerry Comizio noted in a recent American Banker article on the event (paid subscription required), "With a failure of this size there's bound to be a lot of finger-pointing." Count on it.

Right out of the gate, the OTS put the blame squarely on Chuck Schumer's pointed little head, and offered up a fact sheet to show that the run on the core deposits of IndyMac that led to the liquidity crisis that was the immediate cause of the thrift's failure commenced immediately following Schumer's public leaking of his letter to the regulators about IndyMac. It will be hard to argue that Schumer's public statements and the ensuing run on the bank were not the immediate cause of the failure.

As to how IndyMac got to the point where it was vulnerable to the gentle ministrations of the always loud-mouthed Senator from New Yawwwk, that's a whole different story. Schumer's office issued a press release that blamed the failure on improper supervision by the OTS. There may be some truth to the accusation that IndyMac's undue reliance on Alt-A residential mortgage loans, and on brokered deposits to fund the same, will lead to a review of how and why IndyMac's financial condition deteriorated so rapidly under the fitful gaze of its primary regulator (and, to be fair to the OTS, under the gaze of its "backup" regulator, the FDIC). On the other hand, I recall several years ago reading many articles, and talking to clients in the residential mortgage business, about Alt-A lending being "not that risky," and certainly not as risky as subprime lending and other forms of "exotic" lending. It's not as if many of the finest "brains" on Wall Street weren't also caught flat-footed by the rapid deterioration of the credit markets. Regardless, the failure of IndyMac, the rescue-under-distress of Countrywide, and who-knows- what-future-failures, will be fuel for those who want to set fire to the OTS and see its ashes scattered to the four winds (including some rival regulators).

Not that any of the foregoing relieves Schumer from the fact that, as the French put it, he wears a chapeau d'âne.  When recently criticized for causing the run on IndyMac with his "leaked" comments, he alleged that IndyMac's problems "were caused by IndyMac's management and no one else." (emphasis mine). Today, he's alleging that they're the fault of the OTS, too.

"If OTS had done its job as regulator and not let IndyMac's poor and loose lending practices continue, we wouldn't be where we are today."

As they taught us in our trial tactics class in law school, our next question to Senator Schumer is " Were you lying when you said that no one other than IndyMac's management was responsible for its problems, or when you said that the OTS shares in the blame?" Reich gets a hat tip for at least admitting that his agency may have been less than perfect, even if his point was that he's a bigger man than Chuckie (not exactly a herculean task).

Mr. Reich responded that he was "willing to take the responsibility ... as the director for the good and bad things that happen here." "I wish the senator would take responsibility for his actions," Mr. Reich said.

Not a chance, John. Not a chance.

In times of crisis, what's required of those in charge are cool heads and steady hands. Instead, we get fingers pointing in all directions and "duck-and-cover" public posturing from our elected and appointed officials. Thus has it ever been and so it will always be, eh?

Things could be worse. Our elected leaders could be taking their cues from bloggers or, worse yet, blog commenters. After reading a recent string of mostly (but not entirely) inane comments about the IndyMac flap at an economics blog by folks with little demonstrated understanding of the banking system or the FDIC receivership process,  I was struck by the pithy summation of one jaded reader who'd likely found most comments to be as useful as a screen door on a submarine and who proposed that we scrap our financial institutions and financial regulatory structure "and replace them with snark and anonymous blog comments." Bravo, whoever you are.

If you've been through this before (and those of you who have, you know that I'm correct), you know that we'll only fully understand this debacle looking back, but as soon as we do, we'll start rewriting history to support our preconceived notions of what should have been, even if it wasn't what actually occurred. In the interim, books will be written by all kinds of "experts" and "insiders," much money will be made parsing the nuances, and yet, somehow, some way, we'll muck through it.

The Handwriting On The Wall Is All In Caps

The search term that brought a reader to this blog this afternoon, a reader who, according to my site meter, was accessing the internet from IndyMac Bank: "what happens in a thrift conservatorship".

Dude, I've seen it and believe me when I tell you: it ain't pretty.

Subprime Smackdown

According to Ben Bernanke, sometime next week the Federal Reserve Board will finally issue the useless regulations "cracking down on subprime and exotic lending" first proposed last December that even an empty suit like Jim Cramer understood "mean nothing." It's a classic case of fighting the last war while your enemies wage War 2.0.

As I've said before, most, if not all, of my clients will simply refuse to make any loans that fall under the restrictions of an expanded HOEPA, as they refuse to do today under the more constricted HOEPA regulations. While Bernanke stated that the FRB has listened to criticisms of the proposed regulations and incorporated some of the suggested revisions into the final regulations, he didn't give any clues as to what those revisions might be. Again, from my standpoint, it's a moot point. Most community banks will avoid these loans as they would the annual ACORN convention.

Speaking of ACORN, expect consumer advocates to bleat disapprovingly. They thought the proposed regulations were too lax. I can't imagine how bent out of shape they're going to be if the Fed actually adopted some of the suggestions made by lenders. Well, actually, I CAN imagine it, and it won't be pretty.

One of the more interesting aspects of The New York Times article about Bernanke's speech is that the last portion of the article is devoted to the poster child for consumer advocacy, FDIC Chairman Sheila Bair. This being The New York Times, you can bet that the reporter was proud of Ms. Bair's support of a tough crackdown on residential real estate lenders.

Among those who argued that the proposals did not go far enough was Sheila C. Bair, the Republican head of the Federal Deposit Insurance Corporation and senior members of the House Financial Services Committee.

Ms. Bair proposed making it easier for borrowers to sue lenders by eliminating the proposed requirement that the borrowers would have to establish a pattern of abusive practices. She said that forcing borrowers to show a pattern of abuse “clearly favors lenders by limiting the number of individual consumer lawsuits and the ability of regulators to pursue individual violations.”

Ms. Bair also recommended that the Fed eliminate a so-called safe harbor provision in the proposal that protects lenders who fail to verify the income or assets of a borrower in some circumstances.

It's cute calling Bair "the Republican head of the FDIC." Sheila's "Republican" in the same way Nancy Pelosi's Catholic. In this country, people self-define terms. Black is white, day is night. It's all just a matter of "personal opinion," right? Not to "go all Pontius Pilate" on anyone, but today's catchphrase is Pilate's classic "What is 'truth'?" The answer is "Whatever I say it is."

While no one wants to protect evil-doers from receiving their just deserts, complaining about regulations that apply to the institutions you regulate because they don't make it easier for consumers to sue those institutions hardly seems to be a position on the "right" side of the political spectrum. I thought that trial lawyers generally supported the Democrats.

As one banker told me recently, Sheila Bair might be the worst Chairman of the FDIC she'd ever seen, but then again, she was looking forward to eight years of an Obama appointee in the post, and there might come a day when we longed for the good old days of "Sheila the Sham." I responded that she made me glad that God gave man the gift of alcohol.

For those transfixed by the prospect of these upcoming final regulations, my final words are, Barn Door: Closed. Horses: Roaming Free.