Bank Lawyer's Blog

How To Win Friends

My most recent post last Thursday evening (no longer online) hyperlinked to, and quoted from, a story in National Mortgage News. The next day, while traveling without access to my e-mail, I received an e-mail from some jerk who claimed to be an editor at Source Media, the publisher of National Mortgage News, who complained that I did not give attribution to the story from which I quoted passages in my post. My correspondent, who will remain nameless (to protect the foolish), could have raised the issue in a thoughtful and polite manner, perhaps even suggesting that hyperlinking, which most bloggers believe (and have believed for years) is sufficient attribution to the source, is not acceptable to Source Media. Instead, here's how the e-mail opens:

Your "Bank Lawyer's Blog" reproduced big chunks, without attribution, of our May 18th story on nationalmortgagenews.com about the mortgage fraudster who got a 99 year sentence in Texas. You're a lawyer, you must have heard of the copyright law. Do the right thing.

I was using an in-law's Internet access to briefly check e-mail that evening, so I didn't have time for an extensive reply, but I did inform my accuser that I had linked directly to the article from which I had quoted, and that prior to accusing someone of violating a law, perhaps he should actually read it. I was steaming, and my wife asked me what had riled me. When I told her, she laughed with gusto.

"So, some pissant editor who doesn't understand what a link is, who works for some pissant paper nobody's heard of gets bent out of shape because some pissant blogger who writes some pissant blog nobody reads didn't do what he thought was a good enough job of giving a writer of an article in the pissant paper credit for writing an article that most people don't give a hoot about. Have I got that about right?"

She had nailed it. God bless Texas. She also reminded me that I had promised her that as I am going to turn 60 this year (even though, as everyone knows, 60 is the new 40), I was going to distance myself from people and things that anger me, like self-important editors who can't recognize or follow a hyperlink and the publications that employ them.

So, rather than get in a war of visual acuity with the Stevie Wonder of newspaper editors, I'm removing the specific sources of aggravation. I deleted the post that the pissant found objectionable, not because I think he had a valid point, but because (A) it links to a story in his publication, and publicizing that publication is something I've decided is not on my agenda, and (B) it wasn't that much of a blog post anyway. I was in a hurry to pack for a trip and threw out a drive-by piece of snarkiness (the kind my tens of readers have come to expect of the pissants who post here). The only person who thought it worthy of interest was the other pissant involved in this contretemps.

I don't subscribe to the print version of National Mortgage News (I get my mortgage news from more entertaining sources, like Housing Wire, but don't hold that against Housing Wire), so I can't cancel my subscription to that journal. However, tomorrow I'm canceling my subscription to The American Banker, another Source Media publication, to which I do subscribe (but as of tomorrow, no longer). I'll also delete any links on this blog to either publication or to any blogs they sponsor. I'll never attend another seminar they or any of their affiliates sponsor and I will not pass up the opportunity to relate this incident to anyone at any appropriate (or even inappropriate) time. I'm merely a dust speck in the blogosphere, so my feeble efforts will have no real impact on Source Media, but I'll have one less source of aggravation in my life.

As Fredo Corleone was to his brother Michael, Source Media is now and forever "dead to me."

Cleveland Reeks: Part Deux

Last January, when I referred to the city of Cleveland, Ohio as a "steaming heap of bat guano," I misspoke. The pile isn't "steaming," it's merely smoking. It's the mayor of Cleveland, Frank Jackson, who's steaming, most recently over a federal district court judge's dismissal of the laugh-worthy lawsuit filed by the city of Cleveland against investment banking institutions that securitized subprime mortgage loans. According to the city, the implosion of  subprime mortgage loans is the reason that Cleveland no longer "rocks" like it did when comedian Drew Cary based his hit television sitcom there. Therefore, the banks and investment banks that made and securitized such loans must pay Cleveland for the resulting downward slide of Cleveland from the rival of Florence that it was before the first subprime mortgage loan was made there to the Calcutta-like fetid slum it has since sadly become.  As I said last year, the suit was "an opportunistic, and in some respects ingenious and disingenuous, attempt to secure a federal bailout without actually using tax dollars..." I also made some other predictions about how this suit might play out and, apparently through the operation of pure dumb luck, I guessed correctly. From my January 2008 post:

Proving causation is going to be a bitch difficult task, especially when there are so many unclean hands touching not only the relatively recent subprime mortgage meltdown, but the apparent sink hole in which the City of Cleveland finds itself today. At least, if the Mayor is to be believed, the city is in need of hundreds of billions of dollars due to the devastation "caused" by CDOs, so things must be horrible there. Of course, the loss of over half of your population didn't happen overnight, unless there was a nuclear explosion I missed. Crime, poverty, high taxes, a business-unfriendly environment, a lack of cohesive vision for the future and the will to implement that vision even if it existed, all might have had something to do with Cleveland's present woes, and we'll see how the defendants parse the nuances and apportion the blame when they fire back at the Mayor. My guess is that the defendants' first order of business may be to try to get the suit removed to federal court from the home town Cuyahoga County Common Pleas Court. After that, I expect that there will be much maneuvering over motions to dismiss.

The defendants did get the suit removed to federal district court where judge Sara Lioi carved the mayor's backside a new opening that nature did not intend it to possess. As predicted, no causation could be shown by the city. From the recent article on dismissal in the Cleveland Plain Dealer linked above:

In a 36-page decision (download PDF file), Lioi ruled that the city's public nuisance complaint was "pre-empted" by a section of Ohio Revised Code that does not allow municipalities to regulate lending.

She also wrote that the city failed to demonstrate an unreasonable interference with a public right and that the city did not prove that the banks named in the suit caused the damages.

Application of the law, combined with a logical thought process: a toxic brew for any politician to swallow. Apparently embracing the positions that he's too dumb to be stymied by reality and that he'll cease litigating only when he's thrown out of office or the city runs out of money, whichever occurs first, the mayor vowed to appeal the dismissal. As one of the more charitable commenters to the newspaper article put it, "[t]his was a baseless attempt by an inept mayor to deflect scrutiny of his own administration. Frank Jackson is what's wrong with this country. This just shows why his kind should never be in politics or any position of power!" Other commenters were, shall we say, a bit more "blunt."

Rock on, Frankie!

Pushing Paper To No Purpose

Housing Wire today ran a story that discloses additional evidence that the federal government's push to modify loans as a means to keep borrowers in their homes and, eventually, stop the downward spiral of housing prices, is working as well as many of us thought it would. In other words, it isn't working well at all.

Fitch Ratings is joining a growing chorus of voices that say the recent refi deluge will not likely stave off an eventual mortgage re-default for the majority of takers.

Auction companies HousingWire is speaking to for its July 2009 feature on the topic are predicting the same outcome.

Fitch’s conclusion is outlined in a just-released report citing “information from servicers” as well as data from First American Loan Performance, which finds that re-defaults, 60 days or more, on U.S. residential mortgage-backed securities (RMBS) may hit 75% after 12 months.

Nonetheless, the rate of loan modification continues to increase with 7% of overall RMBS and 18% of subprime loans being redrafted through the end of last month.

“Loan modifications hold clear value for many homeowners provided the modified payments are sustainable, but more often than not reducing the home payments to an affordable level may not be enough to rescue borrowers who are overextended on other credit and expenses,” says Fitch managing director Diane Pendley. “With continued home value declines in many  markets, there is  growing evidence that some homeowners are voluntarily walking away from their homes even if they can financially afford to stay.”

The rating agency list six clear scenarios where re-defaults are likely to occur, including simple events, such as moving town for a new job and just leaving the property unoccupied to more shady instances where borrowers misrepresent owner-occupancy status in order to meet criteria for the Home Affordable Modification Program.

The Wall Street Journal (paid subscription required) also discussed another interesting finding by Fitch.

The Fitch report also raised questions about whether a decrease in a home-loan amount, known as principal reductions, is an optimal loan modification. Some mortgage-loan experts believe that the best way to help borrowers is to reduce the principal amount owed. The Fitch report found that loans that had decreased principal amounts, including by more than 20%, were still redefaulting in a range of 30% to 40% after 12 months.

When the dust finally settles, I wonder if we'll find that all these efforts to engage in "systematic loan modifications" did was to prolong the agony of many borrowers, increase losses to lenders, and delay the ultimate recovery of the residential real estate market? I'm not optimistic that we'll ever get an objective analysis of the issue, since so many powerful interests at the federal level have so much skin in the game. The spinning of the statistics will make a normal person dizzy, I assume.

Housing Wire's editor, Paul Jackson, has often observed that it does little good to modify a loan if the borrower's out of a job and can't afford any reasonable monthly payment, if the borrowers have so much other debt to service that they're doomed to insolvency no matter what adjustment is made to the amount of the monthly loan payment, or if the lender is dealing with the type of borrower who will walk away from a property that is "underwater" (whether or not the home loan payment is "affordable"). Fitch's latest data makes Paul look prescient.

So You Thought Being A Bank Director Was An Honor?

For the past year or so, Georgia has been a hot bed of failed banks. According to an "unnamed source" within the FDIC, it's about to become the bulls-eye of FDIC target practice that seeks to score big returns to the Federal Deposit Insurance Fund from the D&O insurance carriers who issued policies covering failed banks' boards of directors and officers.

The Federal Deposit Insurance Corporation is expected within weeks to start suing directors and officers of failed Atlanta banks, according to people familiar with looming litigation.

[...]

A source familiar with the FDIC’s local operations said suits will be filed within weeks against board members and executive teams for some of the 11 Atlanta banks that have failed, primarily looking for claims under directors and officers insurance.

[...]

“They’re pulling a page from the S&L playbook and going after the D&O insurance,” the source said, who declined to name any of the banks that will be sued.

Yeah, just let 'em all sweat, eh "unnamed source"?

A FDIC "named source" refused to divulge any specific plans to sue or not to sue. On the other hand, his beating about the bush certainly would lead you to assume that lawsuits are on the way.

FDIC spokesman David Barr said the regulator does not comment on possible future actions.

In the past, however, Barr said, the FDIC has filed suit against directors, officers, appraisers, law firms, accountants, or other groups it believed were grossly negligent and contributed to the failure of the bank.

“We sued quite a few different entities during that time,” he said.

Yes, they did, and I was in the thick of it. It appeared to many of us on the other side of the table from the FDIC (generally working through its sock puppet, the RTC) that the primary criteria used by the FDIC for deciding whether or not to file a lawsuit against directors, officers, accountants, appraisers, attorneys, janitors, pest exterminators, plant care technicians, and parking lot attendants who might, at one time or another after the end of the Civil War but prior to the arrival of Bill Clinton in the White House, been associated in some fashion with a failed savings and loan or bank were (A) is there an insurance policy we can go after and, if so, (B) whether the complaint or petition could survive a motion for sanctions under Rule 11. Often, settlements were hammered out or claims defeated by a clever tactic used by defense counsel: retaining the services of consulting and testifying experts who had actually worked or performed services for a bank or savings and loan and who analyzed the fact pattern against the way the banking business works in the real world, not in the mind of a bureaucrat or (shudder) a trial lawyer who, due to the broad conflict of interest rules of the FDIC, likely never had any practical experience with the banking transactions that were involved in the "gross negligence" claim.

Then again, some bankers, directors, and advisors actually committed misfeasance or, in some cases, malfeasance, and deserved to be sued. The problem is, the last time around, a lot of dolphin were swept up in the tuna nets along with the fish. I hope this time around, the FDIC isn't as trigger-happy. Bryan Cave partner Walt Moeling and Jones Day partner Chip MacDonald think that it won't be and that even if it is, it'll have a tougher time collecting on D&O policies.

Moeling said the FDIC pursues a case only if it believes it has a likelihood of success, and the legal costs would be less than any recovery.

But Moeling said he thinks the FDIC may have a tougher time recouping on D&O insurance claims in this economy.

“It’s hard to get around the fact we’re in an unprecedented economic downturn,” he said. “The regulators, including the FDIC, were telling everyone to prepare for a 100-year flood, and the 500-year flood is the one we got.”

And the burden of proving gross negligence, attorneys said, is a high bar.

“Just because a bank fails doesn’t mean the executives or directors haven’t performed their duty,” said Chip MacDonald, a Jones Day banking attorney. “Directors and executives are not supposed to be Superman.”

MacDonald said the most common claims under gross negligence for a failed bank include loans beyond the legal lending limit, insider transactions that are not done as arms-length deals, and criminal violations such as kickbacks or bribes for business.

Then we have Sheila Bair on May 18, 2009's Today show on NBC, who was interviewed by host Matt Lauer. When he asked her whether she ever thought that the economy would be this bad, she answered: ""No. Even I didn't think things would ever be this bad." If a prophet of Bair's stature couldn't foresee the damage (and she was being interviewed because she was a recipient of a "Profiles in Courage Award" due to her prescient warnings of subprime mortgage problems), how can mere mortals like bank directors be expected to foresee the future?

I'll also be curious as to what kind of intelligence comes creeping out of the regulatory woodwork once the FDIC starts going after directors and others associated with failed banks, and once old hands from the wars of the 1980s and 1990s, many of them still alive and kicking, step up to lead the defense. Were FDIC officials warned earlier in this decade by internal analyses of the danger lurking on the horizon? Were the bearers of this bad news and the news itself suppressed? Did anyone lose his or her job at any bank regulatory agency for being a Cassandra? I don't know for certain, but I have my suspicions. If the regulatory agencies, which have access to industry-wide information not available to the institutions they regulate, had advanced knowledge of a potential catastrophe and didn't raise the alarm because they didn't want to derail the mortgage lending and securitization engine that was running the country's economy at high speed off the rails, what effect might that evidence have on allegations by the FDIC that it was the "gross negligence" of bank directors and officers that was the primary cause of an institution's failure?

I'm merely asking the question. No need to get riled.

Obviously, we're in for some interesting discovery in the course of the upcoming litigation, aren't we?

It's All About Leverage

The problems that many smaller (and even some bigger) banks have in obtaining meaningful protection in contracts with third-party technology service providers is one near to my heart. The Tech Law Guy, Tom Hall, put up a post yesterday that gives businesses of all types, including banks, useful tips to deal with the process of negotiating a contract with a technology vendor.

Tom's basic premise is that the purchaser's options may be limited by the "leverage" that it has or does not have entering into the negotiations, and that leverage is usually a matter of whether or not the business has the option to walk away from a vendor and find another vendor for the same or a similar service. Increased leverage could also result from the fact that a business does not need to engage in the activity with which the vendor is going to assist the business. If the business terms or legal terms of the contract imposed by the vendor are too unfavorable to the purchaser, the business can say "No Thanks."

As Tom notes, times have changed in the technology services business.

I can recall when, many years ago, “negotiating” with IBM for data services meant haggling over volume discounts and service hours. There were competitors in the market, but none of them rivaled IBM’s reputation for service and cutting edge technology. With little competition, IBM had no incentive to change its standard terms and conditions

Today there is vigorous competition in most sections of the IT market. Few companies dominate their fields, giving Customers room to negotiate.

That ought to be the case, but I find that many banks fall in love with the product or service, hash out the basic business terms with the vendor, then get their lawyer involved to review the contractual terms. At that point, there often exists an emotional commitment by the client's business people to "the deal" that results in the bank agreeing to knuckle under when the vendor digs in its heels. Often,  the bank rationalizes the granting of concessions in some fundamental contractual benefits or protections that it wouldn't have to give if it, too, "dug in its heels." In essence, the bank begins to negotiate with itself, a process that seldom ends well for the bank. Tom recognizes this danger and suggests a solution.

Once Customer has said “You’ve got the deal,” Vendor has no incentive to make concessions. Better to award the contract only after the competing vendors have made their best offer on price and terms and standards and service levels and warranties, etc. Also, consider requiring vendors to comment on your standard contract terms as part of RFP. Vendors who request unreasonable changes, or an unreasonable number of changes, may be weeded out early in the process. Time spent on needless negotiation will only delay project completion and a difficult negotiation may portend a difficult relationship.

Doing an RFP makes sense for most major technology transactions, but some banks either lack the attention span or the in-house expertise to manage this process and won't spring for the cost of a third-party consultant to manage the RFP process for them. At the very least, the bank should have at least one alternative vendor in mind, and senior management ought to sit down with  the bank's legal counsel, before the business negotiations start, decide upon the "have-to-have" risk allocation and other critical contract provisions, and make those contractual requirements available to both vendors at the outset. The reactions of the vendors to those requests can make (or, at least, SHOULD make) a difference in the overall evaluation of the ultimate "winner." I've been involved in a number of transactions where the resistance of the vendor to the bank's customary risk allocation provisions (or other standard terms and conditions) was the deciding factor, even trumping price. In one transaction, the CEO of the bank observed that it appeared to him that at one specific vendor, the "legal tail seems to wag the business dog and they've forgotten who's the customer and who's the service provider. I don't want to deal with an organization like that." Of course, that observation is also a lesson to all bank lawyers as to how savvy clients view the role of lawyers for the bank who unreasonably scrap over every phrase in a contract. They might find their telephone silent when the next deal rolls around.

Again, as Tom says, it's all about "leverage."

Legend has it Archimedes said “Give me a lever and I will move the world.” The business lawyer might well say “Give me more leverage and I’ll get you a better deal.”

A little bit of forethought and preparation in setting up the process to purchase technology services so that contractual terms are thrown into the mix early, not late, can often add more leverage and, in the end, result in a better deal for the bank.

Dodd, Payday Lending, and Credit Card "Deadbeats"

Chris Dodd received kudos from consumer advocates for pushing the recent credit card reform bill through the Senate. After taking his bows, though, he must have heard the plaintive cry of his empty wallet, a cry that soon turned into a scream of "Feed Me! Feed Me!"

Being a consumer advocate, where did Chris turn for some ready cash? You guessed it: the payday lending business. Arthur Delaney at The Huffington Post, a place that usually goes easy on guys like Dodd, tried to run down the straight skinny and caught the payday lenders and Senator Dodd in an awkward embrace. Not that that stopped them from denials, mind you. When caught in the act, lie like you actually believe what you're saying and never back down. Eventually, the short attention span of the voter will turn elsewhere, to tonight's final American Idol episode for the season, for example.

Speaking of Dodd's credit card legislation, the credit card companies and bankers' groups have been using scare tactics about the horrible consequences that will ensue now that the credit card companies and banks can no longer gouge less credit-worthy cardholders price the risk of lending to those with less-than-prime credit. According the one line of attack, all this will mean is that those of us who pay off our credit card balances each month will have to start paying higher fees in order to "subsidize" the less creditworthy whom the card companies will no longer be able to hose charge appropriate risk-based fees and upon whom the companies will not be able to engage in such time-honored practices such as "universal default." I expect that there will be some changes to the way card companies squeeze water from stones, since the $15 billion or so that is generated by the banned practices will have to come from some other source or sources.

According to the American Bankers Association and others, card companies will now turn to "deadbeats," which is what they call folks like me. I don't carry credit card balances past the grace period. Therefore, I'm a lousy "earner" and, according to credit card company logic, it's only fair that I start paying my fair share because for too long I've been getting a "free ride" by maintaining an excellent credit score. I can see how not going into debt at ridiculously high interest rates and paying over-limit fees is unpatriotic. I feel so ashamed of myself.

And yet...

Dan Caplinger, a writer for the Motley Fool crew, a certified financial planner, a lawyer, and another credit card "deadbeat," doesn't intend to knuckle under to higher fees. He calls the attitude taken by card companies "patently ridiculous." Furthermore, he intends to react accordingly.

While it's easy to understand why card companies would like to find any way they can to earn profits, there's a simple reason why imposing fees on the customers they call "deadbeats" won't work: Unlike balance-carrying, interest-paying borrowers, we actually have a choice -- and we'll vote with our feet, happily leaving the credit card industry with even less revenue.

[...]

...[S]purning their top customers would end up hurting banks. Customers would turn back to cash, debit cards, and other payment methods, cutting into total card revenue. And after all the effort financial institutions have made to cross-sell credit card customers into other, more lucrative segments of their businesses, do firms really think their customers will stick with them if they renege on the promises that lured them in the first place?

Sure, I expect to see more rhetoric from card companies about how great a deal I and others with sterling credit have gotten over the years. But the card companies have earned a lot of profits from me, too. If they want to shoot themselves in the foot, we'll be happy to take our business elsewhere -- and take the revenue we generate with us.

Yeah, what Dan said.

More Stress In Store For Community Banks

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

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

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

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

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

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

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

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

Great news for community bank stocks, eh?

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

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

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

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

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

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

[...]

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

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

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

Are State AGs Getting Ready To Dogpile Subprime Securitizers?

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

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

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

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

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

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

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

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

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

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

Geithner's Growing Nose and Flammable Pants

 It's telling that so many observers are reacting with increasingly unbridled cynicism to every word that comes out of the mouth of Pinochio Tim Geithner.  Last week's guffaw-inducer was the statement that the CPP investments that are paid back by big banks will be used to help smaller community banks. The little guys were shut out of the initial rounds of TARP CPP investments, and those smaller banks that took it aren't doing backflips over the changes Congress and the U.S. Treasury Department made to the program after the fact. Now, few of the banks that qualify for CPP want to touch it with a ten-foot pole.

As The American Banker discussed late last week (paid subscription required) discussed late last week, the community banks that really need the additional capital aren't strong enough to qualify for it under standards set by Treasury and the federal banking regulators. If you're a very large train wreck, you get the U.S. government falling all over itself to force-feed you additional capital, but if you're a community bank train wreck that might be important to your local community but not within the daisy chain of anointed big boys, you're out of luck. The e-mail I receive from community bankers and their attorneys lately is spewing a new level of venom toward the regulators, none of which I intend to share with anyone, other than to speculate that what they've requested Sheila Bair do to herself is, I believe, physically impossible, even for a contortionist.

Bankers and their counsel cite instances of the FDIC pressuring community banks to withdraw their TARP applications, demanding increased levels of loan loss reserves, forcing the mark-down of carrying values of mortgage-backed securities and loans (especially commercial real estate loans), and otherwise paralyzing already gun-shy local banks and rendering them unwilling or unable to extend credit to businesses, much less to consumers. FinCriAdvoisor recently profiled the additional problem of federal banking regulators imposing higher levels of capital on otherwise well-capitalized banks through the issuance of Individual Minimum Capital Letters. One senior federal bank regulator's attorney even slipped up and came clean about the reason for the use of this latest "tool" in the "whack-a-community-bank" game.

OTS attorney Deborah Dakin, senior deputy chief counsel for Regulations and Legislation, in a talk at Pepperdine University School of Law, said that regulators are "feeling a lot of pressure" from Congress to increase enforcement orders against banks. Dakin declined comment to FinCri Advisor, but OTS spokesman William Ruberry confirmed that she made the "off the cuff" remarks, which were first reported by the American Banker.

That's right, it's not because the regulators would independently come to the conclusion that a well-capitalized community bank would have to raise capital levels to unprecedentedly high levels, but because they need to play the game of appearance-over-reality to placate federal legislators whose combined intellectual firepower makes a gerbil on a wheel look like Albert Einstein in comparison. Playing to the lowest common denominator; that's called "leadership" these days.

Simultaneously, the regulators and Geithner are squawking publicly about how they're going to help the little brothers of the BofAs and Citigroups by making all this cheap capital available to them so the small banks, in turn, can make more loans and dig us out of this economic hole that seems to grow deeper despite all the "dirt" being slung into it from D.C. You'd be stunned by the depths of the hypocrisy if you weren't already inured to it.

Not that community bankers would be standing in line to snatch up the new capital, even if Treasury actually intended to offer it.

"The biggest problem I have is the fact they have changed the rules so many times that as a chief executive officer of a company I have a very difficult time having a business partner in the form of the United States Treasury," [Heritage Oaks Bank CEO Lawrence] Ward said.

[,,,]

"I was shocked by it," said [Greater Southwest Bancshares Inc. CEO and past ICBA chairman Cindy Blankenship, who attended Geithner's speech. "Are there banks out there that still want the money?"

She reiterated ICBA's call for Treasury to bring in community banking advisors. "They don't understand community banking. They are from Wall Street. That's not a slam, but a fact. So when you have people inventing these programs, it would make a lot more sense if they asked for input," Blankenship said. "If they want to be helpful, they should ask what would help."

"This is not a slam, but a fact." It's a fact that is, in and of itself, a slam. Your federal government: once again, damned by the facts.

Of course, they don't "want to be helpful." They want to give speeches and issue press releases that give the appearance that they want to be helpful. After all, the average voter isn't reading the trade press. All that counts for the cynics in charge is to be able to fool most of the people, most of the time. At that task, they excel.

Shameless Shilling

I’m giving a one-hour webinar on May 28, 2009 from 12 pm to 1 pm Eastern Time on the legal risks to banks of using social media. It’s entitled “Banks and Social Media: De-risking the Legal Risk” and is hosted by Bankerstuff.com. It’s the last of three webinars in a series directed to bankers and their advisors on social media. The first is given on May 21 by Jesse Torres, a long-time banker and author of the blog Social Media and Banking, and the second on May 27 by Katie Delahaye Paine, a PR advisor to banks and other businesses, and who also blogs at KDPaine's PR Measurement Blog. There's also a "bonus webinar" (which I don't think is anything like the "bonus round" on "Wheel of Fortune") on June 11, 2009 entitled "Understanding the Digital Native" (for those who aren't already Digital Natives or who are members but lack self-understanding), given by Dan Fisher, CEO of The Cooper River Group. A link to the three-part  (plus one) series is here.

Incidentally, I receive none of the proceeds of my webinar and I am not otherwise compensated. It’s merely that I love to take abuse from listeners who know more about every subject than do I.

So, if you’ve got an hour and a few extra bucks to spare, come throw a few verbal rotten tomatoes. You might learn one or two things. I mean, stranger things have happened.

We interrupt this commercial message to bring you this late-breaking news flash from our 24-hour radio news source: The U.S. Economy is officially dead.