Bank Lawyer's Blog

Calling All Investors

The American Banker had an interesting article the other day (paid subscription required) about the private investors who the FDIC and other federal bank regulators are attempting to entice into making investments in banks and thrifts in need of cold, hard capital. According to a number of experts cited by reporter Kevin Dobbs, many private equity investors prefer to wait to invest in bank assets as they're shed by banks in trouble or by the FDIC after the banks fail (and perhaps, from the "ginormous" National Bad Bank of America to be run by Sheila Bair and the Dancing Bears, if that ungainly vulture vehicle ever gets airborne).

The two big reasons: regulatory scrutiny and the fact that bank assets continue to fall in value.

"I think ultimately you'll see more private-equity money going toward simply buying bank assets, not the whole bank," said Roger Lister, the chief credit officer of DBRS Ltd.'s financial institutions group.

[...]

"It's complex, it's regulated, and it's inherently levered, so traditional private-equity firms cannot lever their investment," Richard E. Thornburgh, vice chairman of Corsair, said in an interview last week.

[...]

Observers said how soon and how deeply private-equity investors jump into bank assets will depend not just on whether they believe the market for such investments has hit bottom, but also on regulators' attitudes.

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Gary Townsend, the chief executive officer of Hill-Townsend Capital LLC, said he does not see a bottom yet, though the fact that private equity players bought into an operation as deeply troubled as IndyMac with the intention of rebuilding could indicate the investors expect a bottoming out by yearend.

[...]

Michael Blumenthal, a partner at the law firm Crowell & Moring LLP and an expert on the distressed loan market, said there is substantial demand among private-equity investors, though they are still looking strictly for steep discounts.

"The reason that there wasn't a lot of this flow last year was because the institutions weren't willing to sell at rational prices," he said in an interview last week.

Not all observers are discouraged about the interest of investors in entire financial institutions, however.

"There will be more and more money going after banks," Jim Gardner, co-founder and chairman of Commerce Street Capital LLC, said in an interview this month.

Though he stopped short of calling an outright bottom on bank assets, he said that could happen this year, and therefore "it's no longer too early to invest in banks."

[...]

"There are literally trillions of dollars in private-equity money sitting out there waiting to be deployed," Mr. Townsend said in an interview this month. "And the interest in IndyMac is a good sign that some of that money will get put into banks."

From the narrow window of my cell in the far corner of the bargain basement of the world of financial institutions, I've seen plenty of interest by private equity in financial institutions themselves. Some investors are already invested in an institution that has been forced to take hits to its capital, and to salvage what they've already poured in, they are willing to bring more to the table. Most of them are savvy enough to realize that a well-capitalized bank will be a perfect vehicle to feast on the carcasses of their insolvent brothers and sisters. Obviously, they risk throwing good money after bad, if the Obama Administration's "Change We Can Believe In" turns out to be a false hope. At that point, as one investor put it to me, "the last thing I'll be worrying about is my lost investment in this bank. I'll be more worried about having enough gas for my generator and ammunition for my AR-15."

A second segment of interested investors in whole financial institutions appears to be waiting for the second coming of The Southwest Plan. The US government might become so cash-deprived and desperate that it resorts to filling the hole of insolvency with FDIC notes, and provides more aggressive forms of asset loss coverage than we've seen to date, and, perhaps, even "yield maintenance" on "covered assets." However, waiting for that will likely leave you out in the cold, because no matter how slim the pickings of private investors might eventually become, I think that from a political standpoint, that dog won't hunt. Ever.

Of course, that's just my opinion. I could be wrong.

A third group of potential bank investors seems to be channeling the spirit of Gerald Ford (the living Texas investor, not the dead President), and is considering obtaining a "shelf charter" from the OCC, securing approval to be placed on the FDIC's bidder's list, and then waiting to dump in capital only if it becomes the winning bidder for an FDIC-assisted acquisition of an insolvent thrift or bank. That's a relatively safe way of posturing yourself, but the downside is that Mr. Ford's group has thus far been outbid on two acquisitions by other bidders. You may end up going home from the dance holding onto nothing but your good intentions, which might make you feel good about yourself, but won't keep you warm in bed at night. While you're waiting for the right bank or thrift to pop up, others are busy scooping up branches, deposits and assets not only from the FDIC, but from still-solvent institutions looking to offload assets and liabilities.

Yet another group of potential investors plans to buy a bank or thrift of various profiles, sometimes a small shop, sometimes a larger one, at an attractive price, then grow the purchased institution, taking advantage of deposit and asset purchase opportunities that present themselves as the banking business contracts. The downside of this approach is that the FDIC (and some of the other regulators) are not keen on rapid growth, and certainly not on rapid growth through expensive and/or what they view to be "unstable" funding sources like brokered deposits or a "money desk." I've heard a very recent tale of woe of a group with just such a plan who couldn't satisfy the FDIC to approve such a plan regardless of the core capital ratio that the bank maintained. Trying to grow quickly through "core deposits" is nearly (or actually) impossible to do when every Tom, Dick, and JPMorgan Chase is chasing after them, although there will be opportunities to acquire them as more banks fail (whether the deposit premiums will be reasonable is another story).

I'm certain there are other groups of investors who have other specific types of plans to buy a bank in this "interesting time," in order to fulfill a master plan for creating wealth beyond all dreams of avarice. We'll likely see them unfold once the US Government stops diddling around, settles down on a plan (or two or three), and sticks with it (or them). The current difficulty for private equity is that, while its willing to take risks with its capital, it wants to be convinced that the folks in charge aren't suffering from "The Mad Cow." Thus far, nothing they've seen since last September gives them much confidence that all is well and settled in D.C. Once the rules of the game are set, the players who want to play that game will enter it. Until then, assets pose less of a risk than whole institutions.

PTSD Damages For A Non-Event

Two and one-half years ago, then-VA Administrator Jim Nicholson asked Congress for emergency funding of not less $160.5 million "for credit counseling and other measures to protect veterans and military troops whose sensitive personal information was stolen." Yesterday, the VA announced that it had agreed to pay $20 million to settle class-action litigation filed by five veterans groups as a result of that data theft.

Unfortunately for the taxpayers, there's a rub. As VA spokesman Phil Buhdan stated yesterday: "We want to assure veterans there is no evidence that the information involved in this incident was used to harm a single veteran."

It's even better than that. A lap top and external hard drive containing the data were stolen, and later recovered. According to FBI experts at the that time, the data had not been accessed by the thieves, much less used. In the intervening 30 months, not a single incident of identity theft or other unlawful use of the personal information was reported. So why pay $20 million?

The money, which will come from the U.S. Treasury, will be used to pay veterans who can show they suffered actual harm, such as physical symptoms of emotional distress or expenses incurred for credit monitoring.

[...]

According to the proposed settlement, veterans who show harm from the data theft will be able to receive payments ranging from $75 to $1,500. If any of the $20 million is left over after making payments, the remainder would be donated to veterans' charities agreed to by the parties, such as the Fisher House Foundation Inc. and The Intrepid Fallen Heroes Fund.

[...]

"This is a very positive result," said Douglas J. Rosinski, an attorney representing the veterans groups. "A lot of hard work went into finding a resolution that all the parties could be proud to say they were a part of bringing about."

$75 to $1500 a pop for "emotional distress." How many warriors will step forward and claim that prize? Not many, I bet.  As for credit monitoring, the VA offered to provide free credit monitoring for any veteran who asked for it, but it wasn't necessary, was it? We knew it was a waste of money in the summer of 2006, and the absence of any misuse of personal information in the intervening months has only supported that view. The VA fired the parties responsible for the lapse of security, and the OMB changed its rules to require encryption of laptop hard drives, and all that was done without prompting by a class action lawsuit. Therefore, no actual harm exists to be compensated, and no dysfunctional behavior was corrected by the litigation.

The folks that this class-action litigation serves are the plaintiffs' lawyers. They'll make a lot more per-person than $75 to $1500. They'll make millions. For that small cadre, this outcome is, indeed, "a very positive result."

G-Mac Steps Up Its "Regifting" Of Bad Loans

Freddie and Fannie aren't the only big loan investors who have been issuing massive loan "put backs" to their loan sellers. They've recently been joined by GMAC's Residential Funding Co., which, according to the Minneapolis/St. Paul Business Journal, "has nearly tripled the number of lawsuits it’s filing against mortgage lenders that saddle it with undesirable loans."

RFC brought about 20 suits in 2008 against lenders for not buying back so-called nonconforming mortgages they had sold to RFC. The company requires such buybacks when loans fall below a certain level of investment quality. In 2007, RFC brought about a half-dozen such suits, according to federal and Minnesota district court records.

While most of the suits appear to settle, a number have gone to trial. In the latter, RFC has won anywhere from a few thousand to a couple of million dollars. More important than the amount of any individual award, however, is likely the fact that the word is out that RFC is on the warpath, and that you'd better treat any buyback demand seriously. If you don't, RFC will "unleash the hounds."

RFC won't admit that it's altered its policies or procedures concerning buybacks.

RFC representatives would not explicitly acknowledge an increase in the number of cases it has brought against mortgage lenders, saying that the company has always filed such suits when they’re warranted.

“You may observe that [trend],” said Jeannine Bruin, director of mortgage communications at GMAC. “If there were [an increase], it’s not due to a change in the process. There may or may not be a trend, but nothing has changed in our process.”

The Journal observes that until 2007, RFC had not filed more than 6 such lawsuits in any single year. In 2008, the number shot up to 20 from 7 in the previous year. That's what we call a "spike." It may indicate that RFC's uncovered more "put-backable" loans, which is likely. Many of those, perhaps, have been put back to RFC itself by either Fannie or Freddie.

RFC sells some of the securitized mortgages to Fannie Mae and Freddie Mac, which can require RFC to repurchase nonconforming loans as well. Consequently, RFC is not profiting from the judgments it receives, said Don Heeman, RFC’s outside counsel from Minneapolis law firm Felhaber, Larson, Fenlon & Vogt.

“It’s a down-the-stream passing of the money,” Heeman said. “If there’s a [nonconforming loan] in the securitization pool, the obligation flows to RFC.”

The increasing number of nonconforming loans is directly caused by the housing crisis, Heeman said. “Let’s face it, the mortgage market is like every other market. It has its peaks and valleys.”

The valley in which it currently finds itself makes the Grand Canyon appear to be a shallow grave, in comparison. This "down-streaming" effect is further proof that crap does, in fact, flow downstream.

A tripling in the number of lawsuits is good news for trial lawyers. Not so good news for the rest of us.

Spinning TARP With Just The Right Velocity

A short article from Friday's St. Louis Business Journal crams a lot of viewpoints.

The article deals with the TARP CPP program, and complains that only four St. Louis banks have received investments from the Treasury under the program. The article's author further complains that even though 7,000 of the country's 8,000 banks are privately owned, most of the CPP funds thus far have gone to large, publicly-traded "giants" like Bank of America and Citigroup. On the other hand, the first bank executive who's quoted to the effect that the little guys are being passed over tells the author that his bank didn't want any of that stinkin ' TARP money anyway.

“We’re not a thought in their mind right now,” said Steve Baden, president of Royal Banks of Missouri, which had applied for $11 million but decided to withdraw because of the government stipulations that would come with the money. “The more we researched it, we decided we didn’t need it and didn’t want to take on the government as a partner.”

Steve sounds like the leaders of a segment of banks I've discussed the TARP program with, who'd rather drive red-hot darning needles through their eyeballs than jump in bed with the US Treasury Department. Well, any further in bed than the national banks and federal thrifts among them already are.

Other banks recognize the risk, but either really, really need the capital, or are afraid not to take it in light of the fact that the immediate future of banking looks as bleak as Britney Spears' SAT scores. They've rationalized away their traditional caution when faced with the prospect that the federal government can change the terms of your deal and you won't even have a breach of contract claim, which provided some (albeit cold) comfort to screwed "partners" of the US Government in the bank and thrift bailouts of the 1970s and 1980s.

The article also touches upon the fact that taking or not taking the TARP money can be a dicey public relations event.

Banks are under no obligation to say whether they have applied for loans, but if they receive a loan, it is publicly announced.

Heartland Bank, for example, won’t say whether it has applied. “There could be a negative spin if a bank applies and doesn’t get a loan,” said David Minton, Heartland’s president and chief executive. “Or you could apply and, after investigating it, decide to withdraw your application.”

The government won't announce whose applications have been denied, either, for the perfectly sane reason that a denial could cause a run on the bank. Some bankers have told me that they believe that the public announcement of approval of an application might lead current and potential customers to consider that you're a weak bank that needs a bailout.

It's enough to drive a marketing man mad, eh?

Talking From Both Sides Of Their Mouths

Steve Brown, the Real Estate editor of The Dallas Morning News, let loose a tirade on Friday directed at banks and their regulators over the "foreclosure flood" that is coming in commercial real estate.

The whole spectrum of borrowers, ranging from homebuilders to commercial building and landowners, has been cut off from new debt.

Even worse, lenders are calling in existing loans on some properties where borrowers haven't missed a payment. Or they are demanding that property owners pony up with cash to keep the loan.

If you had designed a plan to ensure the collapse of the property market, you couldn't do a better job than this.

[...]

During the next couple of years, loans on billions of dollars in local commercial properties will expire, and the owners will have to find new financing.

Unless the lenders change their approach, they can expect to foreclose on hundreds of local commercial properties.

Texans are sensitive to this sort of phenomenon, having lived through it 20 years ago. Seeing the handwriting on the wall, and understanding the pain embedded in its plain meaning, can make a man a tad cranky. On the other hand, Steve understands that the tightening of credit by banks is in large part the fault of bank regulators.

Politicians and economists are hollering for lenders to break the credit crunch logjam and make loans again.

But in the banks' back offices, federal regulators and bank examiners are whacking these guys in the head and telling them not to take on more real estate debt.

Indeed, they are demanding that lenders reduce the number of mortgages already on the books.

And whom are the lenders going to listen to – the economists and political leaders who are trying to pull our collapsing economy out of the ditch or the federal watchdogs who can shut them down and put them in jail?

Not really much of a decision there.

So after several years of making bad loans that got them into this mess, some lenders will torpedo their good loans and borrowers to make the situation worse.

Sounds like a plan to me.

Yeah, that's a plan alright. A plan for making a bad situation worse.

This is one of many reasons that bankers are as cynical as most other people, even more so, when it comes to some (although, not all) of the government bureaucrats they have to deal with on a daily basis. Federal banking regulators like the FDIC make public noises about how banks who receive TARP CPP investments, liquidity guarantees, and other federal assistance should monitor and report to the FDIC on a regular basis "to determine how participation in these federal programs has assisted institutions in supporting prudent lending and/or supporting efforts to work with existing borrowers to avoid unnecessary foreclosures." At the same time, bank examiners are forcing banks to decrease "risky" credit, tighten lending standards, write down the value of collateral supporting consumer and commercial loans, and set aside additional reserves against future loan losses, all of which reduces the ability of lenders to make loans. The regulators are exacerbating, not alleviating, the fear of lenders that is freezing the credit markets, as well as their ability to make new loans, notwithstanding the public posturing of people like Sheila Bair.

Steve Brown, in giving a good rant a public forum, serves a useful purpose in peeling back the veil of utter hypocrisy that covers Washington, D.C. like a thick coating of slime. Perhaps, one day, the roles of all of the players in this Greek tragedy will be revealed, and a full accounting will be made. I doubt it. If there's one thing at which our feckless leaders excel, it's covering their own backsides and shifting the blame.

Barney Goes To Bat For Beantown Bank: Big Deal

I wish I could get as worked up about the page one story in today's Wall Street Journal as many others have done. I simply cannot. The entire process of picking winners and losers in the bank bailout game totally lacks transparency and accountability. Cockroaches always roam in the dark, folks. Want to see them scurry to the sidelines? Turn on the lights. It's a law of nature. Seriously, you didn't expect that this was going on?

Try representing a bank that's having capital and/or management "issues," that's applied for TARP funds, and is desperately trying to get a straight answer from the regulators as to whether they will grant the bank enough time to raise the necessary private capital to match the TARP preferred stock investment, or whether everybody's wasting their time and money. Sometimes you get an answer, sometimes you don't, sometimes the answer's favorable, sometimes it's not, and you can't tell what is the reason for the difference. It's just...because.

The government doesn't have to justify the reasons for its decisions in picking winners and losers. If it did, if the decision-makers had to publicly justify the decisions they made as to who gets money and who doesn't, who lives and who goes bye-bye, how long do you think they'd stand straight in the face of the hurricane-force winds caused by equal parts gales of derisive laughter and howls of outrage, before being blown away? If they had confidence in the reasons for their decisions, why don't they explain those reasons publicly and in detail? What's your guess?

This is our government, my friends. A Congress dominated by the party of Barney and the Boyz, certainly, but chock-full of pachyderms just as venal and ready to intervene in the run for the gold. In a way, you can't blame them for figuring that anything goes, when as far as we unenlightened members of the public are concerned, the US Treasury Department and the federal bank regulators feed data into a mysterious black box, which then uses algorithms supplied by discredited Wall Street asset securitization model-makers to select the winners. Perhaps they throw darts at names tacked to the wall. Whatever the process, since all we can do is guess, don't be outraged that a herd of swine runs to the through and oinks loudly until it's filled by the mysterious food-giver.

I truly hope that this new crowd in the White House is really "the change we have been waiting for." I kind of doubt it. The change I've been waiting for is usually accompanied by a mushroom cloud.

Data Breaches: On The Rise and Striking the Heartland

While most honest citizens are recovering from the hangover induced by the Obama Inaugural Extravaganza, the few rotten apples in the barrel have been busy little bees. Last week, the WSJ reported that last year, businesses reported 656 data security breaches, up 47% from the previous year. Much of that increase may be due to the expansion of state laws that require notification of such breaches, according to the Identity Theft Resource Center. More distressing was the news that over 35% of the breaches were due to human error, and worse, that insider abuses that resulted in data breaches were double those of 2007. "The Bozo Factor" that affects employees can be mitigated by training, and by implementing policies and procedures that are rigorously enforced, but as we've noted before, a banker's worst nightmare is the rogue employee. If an employee's bent when he starts working for you, it's doubtful that any training will straighten him or her out.

Yesterday, the news did not get better. Heartland Payment Systems Inc., a major credit-card processor, disclosed a data breach "that analysts said may be among the biggest ever reported."

Heartland Payment Systems Inc. said Tuesday that cyber criminals compromised its computer network, gaining access to customer information associated with the 100 million card transactions it handles each month.

The company said it couldn't estimate how many customer records may have been improperly accessed, but said the data compromised include the information on a card's magnetic strip -- card number, expiration date and some internal bank codes -- that could be used to duplicate a card.

100 million rockets past the previous record of 45 million, set by TJX (which we last discussed here). Heartland's president said that his company was targeted by malicious software that "light-years more sophisticated" than what is usually downloaded from the Internet by your average stooge. This points up another problem we've often discussed: the crooks are smart cookies. Bet you a dollar to a donut that they came from Eastern Europe. That area of the world appears to be breeding gifted amoral cyber thieves at a rate that would make your average Mafia don green with envy.

An analyst at Forester Research estimates that the average data breach costs $300 to $600 in fraudulent purchases, fees and legal costs, for a total of hundreds of millions, perhaps in excess of a billion, of dollars to be spread around between Heartland, the card issuing banks, and others (including merchants who are duped by the fraudulent use of the stolen data).

It's tough becoming the poster child of data breaches. Coming in the midst of an economic maelstrom makes it all the tougher to deal with. On the other hand, most of the average citizenry will have little sympathy for Heartland. The man on the street may sell his e-mail password for a discount card to Starbucks, but he expects businesses, especially those that handle sensitive personal and financial information, to be impenetrable fortresses when it comes to data security. That may not be fair, but it's just the way it is.

Speaking of the TJX fiasco, the Maine Bureau of Finacial Insitutions released a report that showed the financial costs to banks in that state from the TJX and other data security breaches. The TJX breach cost banks from $60 to $32,146 in card reissuance expenses. H/t CSBS

Allegations of IndyMac's "Backdating": Worse Than We Thought?

A colleague from the West Coast sent along this tidbit from ABC News that apparently documents the efforts of ABC News rodent reporter Brian Ross to chase an unsmiling and silent Darrell Dochow around the block a few times, after which Ross let slip that inside anonymous sources (our favorite type, since cross-examination is impossible) have informed our intrepid scribe that the backdating shenanigans that Dochow is alleged to have allowed at IndyMac are worse than previously reported.

A brewing fraud scandal at the Treasury Department may be worse than officials originally thought.

Investigators probing how Treasury regulators allowed a bank to falsify financial records hiding its ill health have found at least three other instances of similar apparent fraud, sources tell ABC News.

In at least one instance, investigators say, banking regulators actually approached the bank with the suggestion of falsifying deposit dates to satisfy banking rules -- even if it disguised the bank's health to the public.

That's all Ross reports about the "three other instances." The letter from the Treasury Department's Inspector General, Eric Thorson, to Rep. Charles Grassley, that sparked this public dust-up, says only the following about thrifts other than IndyMac:

During our inquiry, we also discovered that OTS had allowed other thrifts to record capital contributions in an earlier period than received.

That's it. There's nothing in there about OTS officials promoting the idea of backdating capital contributions to thrift management. Nevertheless, Ross' piece is being cited by other "news sources" (for example, The Drudge Report), as "evidence" that other thrifts permitted unsupportable backdating of capital contributions and that the regulators suggested it in at least one case. These are strong accusations, which, if true, could further dim the already-bleak prospects for the survival of the OTS, so we'll see how this plays out. For some reason, until I see some source other than Brian Ross and his "anonymous sources" to vouch for these latest inflammatory accusations, I'll temper my judgment.

The rest of Ross' piece is a rehash of what we already knew about the IndyMac case. Oh, and there are also some bitter words from former FDIC spite-monger Bill Black. Black had his fifteen minutes of fame back in the late 1980s and the early 1990s when he was the Deputy Director of other defunct Federal Savings and Loan Corporation and a critic of all things S&L, especially of John McCain and the rest of the infamous "Keating Five." Black was present for the meeting of The Five with then chairman of the Federal Homes Loan Bank Board Ed Gray and other S&L officials in which the goal was to get the FHLBB and the FSLIC to treat Chales Keating and his giant S&L, Lincoln Savings, "fairly." Black lost that internal political battle when the FHLBB took the investigation away from him, but won the war when Lincoln Savings failed and Keating went to the pokey, and he's spent the ensuing years paying back the FHLBB and its successor agency, the OTS, by appearing on every talking-head TV gig he can hook, and being to the "go-to" guy for every print reporter who needs a "just like the old days" quote for any current banking crisis. He also wrote a book about the collapse of  of the S&L business. His "shtick" is a Michael Scheuer-like riff: "I was right. They were all wrong. Only I was strong and honest. The others were weak and/or corrupt. If they'd only listened to me, this could all have been avoided. But did they? Noooooooooo!"

No matter how correct he may or may not be on substance, the same old act wears thin from constant repetition.

"He's [Dochow's] the person that claimed that he looked into Charles Keating's eyes and knew that Charles Keating was a good guy and therefore ignored all of the professional staff that told him that Keating was a fraud, and he produced the worst failure of the Savings and Loan Crisis at $3.4 billion. Now he's managed more than triple that," said Black, now an economics professor at the University of Missouri in Kansas City, Missouri.

Yes, Bill, Dochow was connected with the Lincoln Savings fiasco. Yes, Bill, we know you got your feathers ruffled in the process. Yes, Bill, you were right AND EVERYONE ELSE WAS WRONG.

It was twenty-odd years ago. Get over it.

Preemption: High Tide?

When we discussed the US Second Circuit Court of Appeal's decision in December 2007 to uphold the principle federal preemption of the authority of state regulatory authorities to enforce state laws on fair lending against national banks, it generated a big yawn from us, because the decision was expected. On the other hand, we didn't  think that Eliot Spitzer would give up, and expected him to appeal to the US Supreme Court. He did (or at least his successor Andrew Cuomo did, inasmuch as Eliot Mess left office under a cloud of ignominy). On Friday of last week, the SCOTUS granted certiorari and will hear the case in its next term. Expedited briefing means that oral arguments might be heard as early as April.

At this point, I expect the SCOTUS to uphold the Second Circuit's ruling. The same broad preemption principles that were upheld in Watters v. Wachovia would seem to support the reasoning of the Second Circuit (and the district court) in Cuomo v. Clearing House Corporation. Nevertheless, with the change in administration (one not likely to be as forceful in its support for preemption in all areas as was the Bush administration), you have to wonder how strenuous the arguments will be when briefs are filed in March. Given the nature of the laws at issue in this case, you also have to wonder  if some of the preemption-supporting justices who formed the majority in Watters v. Wachovia (Alito?) might change their minds as to the reach of federal preemption. Justice Thomas recused himself in Watters v. Wachovia, but should be able to vote with his brothers Scalia and Roberts against pre-emption in this one.

Even should the OCC prevail as expected, there exists the risk that a ruling to uphold the Second Circuit might be the high tide of SCOTUS preemption rulings for national banks. With a new sheriff in the White House, with the Democrats in control of the House and Senate (although control in the Senate is not  filibuster-proof), and with preemption-hating Democratic leadership in Congress influencing the public debate, I can clearly see a scenario where Barney and the Boyz lead a charge for federal legislation that shortens the reach of national preemption as it applies to certain types of state laws such as those that are the subject of this action. I see much conflation in the public mind of predatory lending, subprime lending, discriminatory lending, unregulated and regulated lenders, banks and non-banks, into one big mess of "kill them all and let God sort the guilty from the innocent." When Joe and Jane Sixpack (and their elected representatives) are looking for scapegoats, national banks will do just fine.

As I said in October 2005, I think the states will continue to lose on these issues "unless Congress changes the law." At this point, it's merely a gut feeling and nothing more, but if there ever is a time that might be ripe for such a change, this year (or next, perhaps) might be that time. Regulatory reform legislation is coming to the banking industry, and the clipping of the wings of federal preemption might be part of that package.

The Dancing Bear Tires

The Wall Street Journal broke a story today that, thus far, has been ignored by most of the rest of the main stream media. It's Friday and Bank of America's and Citigroup's woes dominate the banking stories. Yet, this one's a little gem for those of us who appreciate irony.

Beal Bank, headquartered in Plano, Texas, is a buyer of distressed real estate loans, which they then work out for profit. We've previously talked about Beal Bank here and here. In 2001 and 2002, it bought thousands of subprime loans originated by the FDIC as receiver of the failed Superior Bank, which was seized by the FDIC in 2001. Following the seizure, the FDIC as receiver continued the subprime lending operations of Superior, which, as it turns out, wasn't a good idea, because those origination operations were grinding out loans by the carload that didn't meet various representations and warranties made by the FDIC when it sold the loans to Beal Bank. In other words, the FDIC seized a dysfunctional subprime mortgage lender and continued its errant ways, rather than shut it down. Hard to believe, but there you have it. The sordid details were laid out in a page one article in the Wall Street Journal in July of last year.

Beal sued the FDIC in 2002, seeking to force the FDIC to honor its repurchase obligations under the purchase and sale agreements. That's similar to what Fannie Mae is trying to force the FDIC to do in the case of IndyMac, although the IndyMac loans were not originated by the FDIC, but by the failed savings bank. The FDIC learned its lesson, obviously. An internal FDIC legal assessment discussed in the earlier Wall Street Journal article predicted that the FDIC's exposure to Beal Bank could be "as much as $70 million."

That guess was a tad low. In December, the FDIC settled for a reported $90 million. Neither side publicly announced the settlement. The article doesn't state why not, but perhaps the FDIC insisted upon a confidentiality provision in the settlement agreement, in an attempt (futile, it would seem) to avoid further public embarrassment. Beal Bank is privately owned and doesn't have to disclose the settlement and the FDIC obviously didn't see any upside in announcing that it paid through the nose for its past mistakes. To err is human, unless you're located inside The Beltway, in which case to admit human fallibility is grounds for being the main course in everyone's favorite game, "Who's For Dinner?"

$90 million might seem like a lot of cash, and it certainly is to Beal Bank, but it pales in comparison to the $10 billion Fannie Mae wishes to extract from the FDIC's hide. Perhaps that's why the Beal Bank litigation settlement will blow by with minimal damage.

Note that it took six years of litigation to wring a settlement from the FDIC, whose spokesperson stated, "The FDIC recognized throughout the litigation that there were substantial repurchase obligations based on the contract terms." Six years to settle on an amount, when liability was not really contested. How typical.

As one weary warrior put it so well, when you litigate with the government, you're "dancing with a bear." You only stop dancing when the bear gets tired.