Bank Lawyer's Blog

Blowing The Fog Away

One of the country's leading behavioral economists, Sendhil Mullainathan, who currently teaches at Harvard but was the CFPB's head of research, recently gave an interview to the American Banker's Kevin Wack, in which Professor Mullainathan made some points that concern CFPB critics like the author of this screed sheet, but also contain indications that at least some true believers in behavioral economic theory are fair minded enough to understand the dangers of pushing the envelope with any economic theory.

First, the scary part.

Mullainathan teaches at Harvard, and he is the co-author of a new book, "Scarcity," that has important implications for the consumer finance industry.

The book argues that the short-term thinking of many poor people — who worry about how to pay their immediate bills without much regard for their long-term financial outlook — is a psychological consequence of the scarcity they face. Their lack of money taxes their mental bandwidth, and leads them to a narrow, short-term way of thinking.

The book draws analogies between people who are poor, people who are extremely busy, and people who are lonely. In all three cases, people lack something they need, and it clouds their judgment.

"You might see someone who's poor go to the mall and buy something that they don't need," Mullainathan explains. "And you'd be like, 'How can somebody at the edge waste so much money?' Now, picture someone else you know who's so busy, but goes and spends hours wasting time on the Internet. And you might say: 'How could someone who's so busy end up wasting so much time?' And those are so very similar behaviors on some level."

Thus, the contention is that poor people are too dumbed-down by their lack of funds to think straight. Who'll do their thinking for them? Why, the not-so-poor people who work for the CFPB, that's who! If salary level increases brain power, then The Adjustment Bureau ought to be crawling with Einsteins.

Do you see the danger of this line of thinking? I do. Apparently, so does the intellectually honest Professor Mullainathan, at least he does while answering a question put to him by Wack.

You alluded to an argument that some conservative critics of behavioral economics have made, that this is just sort of a way to put a veneer of academic responsibility on paternalism. Do you think that's a real danger, or is it kind of a caricature of what's going on?

I think it's a real danger. I'll give you two very extreme examples. When you look at drug behavior for diabetics, that has really large consequences, when diabetics fail to take their medication. Like 100,000 limbs are lost every year because people aren't taking their meds. This is a pill with very few side effects. I mean, it's just a no-brainer.

Drinking sugary sodas? Now, that's a much harder case to make. Because soda provides some utility, and there's no doubt it has some health costs. It's easy to imagine somebody looking at that tradeoff and saying, "Fine, I'm going to live a little bit less in my life. But I love the utility. I want to drink it."

Somewhere what ends up happening is: the same principle tries to be applied to the soda case. You can see it already happening, and I think it's a legitimate concern. I think that what's a mistake is saying that because we have that legitimate concern, we shouldn't do anything.

The word "legitimate" raises the question as to whether the conclusion drawn by the economists regarding the "problem" are supportable: a shortage of money clouds the judgment of poor people. Let's assume that empirical research supports that conclusion. The next question becomes what, if anything, is the "something" that should be done about it and, assuming that there is a public policy consensus by a majority of American voters that "something" should be done, what, exactly is that "thing" and who or what should "do it." 

These are all legitimate issues to be considered and debated. Unfortunately, there doesn't seem to be much debate, at least in the political arena. Instead, there seems to be an agenda that is being pushed that it is the duty of the government, particularly the executive branch, and particularly the federal executive branch, to protect the "brain fogged" from the the consequences of their own behavior, even if the "victims" don't want that protection and even if opponents think that adult citizens need to be responsible for the consequences of their own decisions, whatever the reason for their particular "brain fog." My lack of sex may fog my brain to the point that I spend money on a Corvette convertible, damning me to a protracted battle with monthly car payments approaching four figures, as well as to the ridicule of my peers, but is that the responsibility of the government to prevent? If so, I wish to hell they'd been on the case.

Much of our consumer-focused economy is based on the fact that businesses influence the consumer to purchase "stuff" he or she doesn't really "need" in an absolute sense, based on unconscious motivations that cloud the consumer's judgment. Madison Avenue was built on the bodies of bikini models draped across the hoods of sports cars. The implications for the future of our economic system, and, ultimately, our political system, extend beyond the relatively low-hanging fruit of payday lending or overdraft fees.

So, let's keep the "debate" going, even if for the folks in agencies like the CFPB, the "debate" is likely over. They're busy grinding out empirical research that will demonstrate that payday lending is just the tip of the iceberg. There will be all kinds of "brain fog" from which the "unfogged" must save those without the cerebral wattage to power through the problem to the "correct" solution.

Cordray: No QM? No Worries, Mate!

Richard Cordray told attendees at the 100th Annual Mortgage Bankers Association Convention that "in many cases, non-qualified mortgages with the right underwriting are perfectly fine even if they fall outside the QM boundaries." "In many cases." "Perfectly fine." These are words that plaintiffs' lawyers love to lance.

Where he stops short — or simply doesn't go — is in explaining how lenders know at the beginning of the origination cycle that what they've done outside QM in terms of underwriting is sufficient enough to protect them later on if someone were to perhaps raise an ability-to-repay claim.

Lawyers up for litigation love gray lines, but those wanting to prevent future ability-to-repay litigation are likely to prefer black and white rules. Cordray shows optimism around the idea that responsible lenders are still safe outside QM, but no specifics were given on how the CFPB would address non-QM lending decisions down the road if a default were to occur. Yet, he seems to be saying don't over worry as long as standards are in place.

[...]

He added that the definition of a qualified mortgage already covers most of the loans made today. And even loans not covered by QM can still be generated as long as lenders use “sound underwriting standards and routinely perform well over time," the director told the MBA crowd. Again, what does 'perform well over time' mean? That part is not as clear.

This is all par for the course for a man whose theme seems to run along the lines of "Sure, we have unbridled discretion and power to enforce our ideological agenda of ensuring that every Tom, Dick, and Harriet gets the 'fair deal' to which they're entitled by dint of the fact that they were born on this planet, but don't worry about all that because we're really a bunch of great guys and gals who pop frosties and eat red meat, just like you reactionary savages soon destined to be caca-canned into the trash bin of the historical dialectic." In other words, "trust us; we're the government."

Cordray also reiterated the "assurances recently embodied in the regulatory guidance on the risk of having a "QM and Nothing But QM" lending philosophy.

Cordray further noted that lenders who refuse to lend outside QM will be at no greater risk, absent other factors, of facing fair lending allegations.

"Absent other factors." Like, for example, your failure to lend to anyone from Neptune or the dearth of credit granted to one-legged, humped-backed snow monkeys. Those factors might paint an entirely different picture of the bank, a picture less like the Mona Lisa and more like The Picture of Dorian Gray.

The folks at Ballard Spahr give a much less snarky summary of the reasons why "absent" is a loaded term.

While helpful, the statement’s benefit for creditors is quite limited because other factors must be “absent” for a creditor making only QM loans not to have an elevated fair lending risk. Most notably, creditors still face the possibility of fair lending challenges to their application of QM standards to protected class applicants. The statement cautions creditors to “continue to evaluate fair lending risk as they would for other types of product selections, including by carefully monitoring their policies and practices and implementing effective compliance management systems.” Also, neither the U.S. Department of Justice nor the U.S. Department of Housing and Urban Development participated in the statement.

To some up all of Cordray's assurances in two words: "cold comfort."

The Long-Range Consequences Of Adopting The Mating Habits Of A Praying Mantis

The Boston Business Journal's Matthew L. Brown articulated the thoughts of many banking executives and attorneys when the news broke last week that JPMorgan Chase had agreed to pay the US Government a whopping $13 billion to settle claims arising, principally, if not exclusively, out of the steaming heap of goat custard that lay beneath the surface of Wamu and Bear Stearns. Chase bought those gems at the behest of the US Government in 2008 as part of the efforts of the governemt to prevent a meltdown of the US economy over the subprime mortgage securitization crisis and its consequences. As we discussed a few years ago, in the case of Wamu, Chase and the FDIC have been locked in mortal combat over whether the less-than-clear acquisition agreement and related documents required Chase to assume the liabilities related to that custard or whether it stayed with the FDIC as receiver for the Wamu. That battle continues and may be impeding the finalization of settlement documents.

Brown's point is more general and far-reaching. He claims that by asking Chase to step in and rescue the government from the consequences of those two entities going down in flames, and then beating Chase about the head and shoulders with a hockey stick for sins committed by those two entities prior to Chase's purchase of them, the government is jeopardizing the chances that any major players will ever step into the breach again in such a fashion, at least without a lot of belt-and-suspenders language i the acquisition documents that makes it perfectly clear, particularly to a federal court, exactly what liabilities are being assumed and what liabilities are not.

However, Brown argues that going after Chase for the liabilities of Bearn Stearns and Wamu is also egregious because of the respective responsibility of the two combatants in this aftermath--Chase and the US Government--for the losses.

Big banks’ mortgage securitization and credit derivatives practices in the years before the collapse were reckless, self-serving and parasitic. We’ve also learned — from books like Charles Morris’ "The Trillion Dollar Melt Down," published in March 2008 — that they were decipherable and predictable.

Regulators didn’t bother to decipher or predict the meltdown. And in the case of Bear Stearns and WaMu, they didn’t seem to do much regulating, either.

A $13 billion settlement will only sting JPMorgan Chase a bit. The more fervent feelings appear to be on the government’s side as it hustles for little bits of cash to cover for its own ineptitude.

"Hustles for little bits of cash." He's right, of course. Compared to the total amount of money and asset value lost by the perfect storm of stupidity, incompetence, greed, and venality by so many players in the game, including the executive and legislative branches of the US government, $13.1 billion is a pittance. Still, it's a lot of money to most bankers, and Brown's parting shot sounds prophetic: "It’ll be a long time, indeed, before a big bank answers the federal help line."

CFPB Doing An End-Around Dodd-Frank

The Wall Street Journal on Friday discussed the continuing efforts of the CFPB to circumvent to clear intent of the Dodd-Frank Act, which does not permit the CFPB to regulate the credit practice of automobile dealers. It's doing in the same way it (and other financial institution regulators at the federal level) regulates retail merchants, tribal online payday lenders, and other "unsavory" sellers of goods and services that people desire: by pressuring the banks that service them to act as the CFPB's deputy sheriffs.

Big banks, responding to demands from the U.S. consumer finance regulator, are turning up pressure on auto dealers to prove that they aren't unfairly marking up the cost of car loans to women and minorities.

The scrutiny is setting off a bigger battle in Washington over the role of the U.S. Consumer Financial Protection Bureau, which was prohibited from policing car dealers at its creation in 2010.

[...]

The CFPB does oversee banks and other lenders, and in March the agency warned them they had to ensure that car loans complied with fair-lending laws. The move has banks actively confronting dealers about their lending practices, raising the ire of dealers who say the regulator hasn't provided evidence that a problem exists.

Of course a problem exists! Automobile dealers are making money! That simply can't be right.

According to letters from banks to dealers that were reviewed by the WSJ, banks are apparently using the flavor of the moment of the Obama administration: disparate impact. If the bank performs a statistical analysis and determines that, for example (as did our favorite champion of consumer rights, Bank of America), of all loans sent by a dealer to the bank, female borrowers were charged a dealer discount (markup) of one-third of one percent more than were male borrowers, then that must be evidence of discriminatory lending on a prohibited basis. It's the same theory that consumer advocates at the US Justice Department and HUD have been pushing the past few years and that they will continue to push until the Supreme Court tells them to knock it off.

One dealer complained "There is no way to know why the bureau believes there is a problem in this area—or what standards it is using to measure lender compliance with the law." The bottom line standard is that the Bureau knows it when it sees it, pal. It then will perform a perfectly unbiased regression analysis to back up a claim of disparate impact. Where's there's smoke, there's fire, even if the fire, and the smaoke, are caused by the CFPB rubbing a bank and a dealer together until sparks fly. In the case of automobile dealers, it can't do this directly, so it expects the banks that it supervises to do the job for it.

Although the article notes that a couple of senators are making noises about why the CFPB isn't giving the public a chance to comment on these standards, I wouldn't hold your breath that Congress will take any action. Even Democrats who recognize the inherent end-run the CFPB is doing around the partisan Dodd-Frank Act determination that automobile dealers were off limits, there's no public relations upside to taking the side of a business that consumer advocates are painting as just another profit-hungry leech, sucking the blood from the proletariat. That's something only "Repthuglicans" would do.

I think we'll have to await the SCOTUS ruling in Township of Mount Holly v. Mt. Holly Gardens Citizens. K&L Gates partner Melanie Brodie told an audience last month in Dallas, if the Supreme Court strikes down the use of disparate impact under the Fair Housing Act, it's likely to have a "crossover effect" on the ability of the CFPB to use the same theory under the Equal Credit Housing Act. One way or another, let's hope we get some "certainty" in this area, soon.

I'm attending the Harland Financial Solutions Network of State & Federal Counsel 2013 Conference this week, and speaking on a panel with Rick Eckman of Pepper Hamilton LLP and Keith Rabenold, Deputy GC of Harland Financial Soultions, on technology service agreements and third party relationship issues. Therefore, I'll be "off-blog" until next week.

Hating A Hate Crime Torpedoes A Bank Bailout

Recently, a too-small-to-save community bank in Bridgeport, Connecticut failed. So far, so what? If it's not run by the likes of Jamie Dimon, you know it's not going to get a bailout. In fact, the bank had been denied TARP capital. What's an interesting wrinkle in this sob story is that the bank. the state's only minority-owned bank, had lined up a White Knight, one Donald J. Vaccaro, who had the cash to buy and recapitalize the bank and was raring to go. Unfortunately for him, the state and federal banking regulators determined that he just couldn't pass the "integrity test."

Did he machine-gun a busload of nuns? Strafe an orphanage? Break wind in the vicinity of an open flame? No, something much worse: he was arrested (but never convicted) of a "hate crime." The "crime" was uttering a racial epithet.

State and federal regulators got stuck on Vaccaro's arrest, which happened in 2012 at an Oscar party in Hartford, on the felony charge and four misdemeanors. He allegedly was bounced out of Real Art Ways when he allegedly grabbed one woman's breasts. He later allegedly told the bouncer, "You never should have touched me, you black mother-[expletive]," according to police.

Vaccaro has consistently denied that he touched anyone or used any racial slurs.

He was granted accelerated rehabilitation by the courts, a special form of probation that would erase the record of the arrest if probation is successfully completed. The probation period has been shortened once, and is now set to end in February.

Let's leave aside the First Amendment implications of the entire concept of "hate crimes." There's no sense in opening up that can of worms. If Vaccaro in fact uttered such a racial slur, it certainly would not make him the preferred provider to capital to Connecticut's only minority-owned bank, would it? Yet, here was the bank's founder seeking his capital. Not only that, the NAACP publicly gave Vaccaro a clean bill of health reputation-wise and supported his proposed acquisition of the bank. In light of that, you'd think that the regulators' fears of "reputational risk" (cited by the state banking authorities) would be assuaged. If he'd insulted Norwegians ("You never should have touched me, you pasty-faced mother-[expletive]," of course, then I doubt he could have effectively marshaled a respected Scandinavian-American advocacy group to come to his aid. But in this case, the premier advocacy organization for the minority group he'd allegedly insulted told the world that the guy was not a "hater."

In addition, it seems to me that the accelerated probation is indicative of the fact that the local authorities did not consider him a serious offender. Once probation was completed, which was to be in less than six months, the crime would be expunged from the record. It would have been as if it had never happened. So, doesn't it seem a tad unfair to base your decision primarily on an arrest for a crime that will, shortly, have never existed? I realize that bank regulators regularly time travel through worm holes, so everything that has ever happened or will happen is, for them, occurring right now, but still...

The bank's founder and CEO, Peter Hurst, put it poignantly.

"It was one bad night in February 2012," Hurst said. "Should that be enough to let a bank fail? I just don't get it. I don't think I ever will."

In the interest of fairness (which is seldom a concern on this blog), the linked story discusses the Federal Reserve Board's "stinging" letter of rejection of Vaccaro's application, delivered after the bank failed, which cites other "unexplained" past arrests of Vaccaro and investigations of Vaccaro-related enterprises. None of those incidents appeared to present hurdles that could have not been leaped, however. In addition, the state banking commissioner's comments make clear that the primary factor in the rejection of Vaccaro's application was the hate crime arrest.

To cut the chase, the regulators didn't think that Vaccaro was their kind of guy. Which, in a sane world, might be a reason to praise Vaccaro, not to bury him.

Waters Wants Banks To Bail Out Federal Workers

Some of the folks who helped bring about the partisan gridlock in D.C. that led to a federal government "partial shutdown" now want banks to step into the breach and make things better for those affected by the intellectual and moral bankruptcy of our political class.

Rep. Maxine Waters, D-Calif, spearheaded a concurrent resolution, along with 30 other policymakers, urging institutions such as banks and consumer reporting agencies to work with customers affected by the shutdown.

"The shutdown of the federal government has forced thousands of people into financial distress through no fault of their own,” Waters said. "Financial institutions should not penalize — or profit from — those affected by these difficult circumstances."

The proposal calls on institutions to identify customers affected by the government halt and asks the entities to adopt flexible arrangements to help borrowers meet debt obligations.

Among those "flexible arrangements" is forbearance for late payments, including waiver of late fees and penalties.

"Every day, I am hearing from federal workers from across my district about the financial hardships they are facing due to this government shutdown," stated Congresswoman Donna F. Edwards, D-MD.

She added, "For federal workers who have experienced three years of a pay freeze, and sequestration that forced many to take unpaid furloughs earlier this year, they should not be penalized now by their financial institutions due to circumstances beyond their control."

"Penalized"? That's stretching the victimization mentality to the point of near insanity. If they miss a payment and get hit with a late fee and/or default interest, that's what called getting exactly what you bargained for in the agreement you signed. People have lost their jobs by the boatload since 2008 because the economy hit an iceberg. I guess federal employees are entitled to special treatment, though, particularly when the cause of their unemployment woes is the inability of politicians in both parties to understand that politics is the art of compromise.

"Forbearance" was a dirty word for people like Waters and Edwards when community banks were hit by an economic tsunami in late 2008, a circumstance "beyond their control," and a circumstance due, in no small part, to failed federal government policies promoted by people like Waters to make maximum amounts of credit available to people with insufficient incomes to actually pay it back. As Kevin LaCroix recently noted, FDIC lawsuits against former officers and directors of failed banks are proceeding at a blistering pace because community banks failed at a blistering pace in 2010. No cries from members of Congress for the FDIC to cut them some slack could be heard at that time.

You couldn't write fiction that included characters this cynical and hypocritical. No one would believe it. Unfortuantely, in real life, truth is often stranger than fiction.

Incidentally, credit unions and community banks were offering assistance to furloughed federal employees before cycnical pols like Waters and Edwards opened their well-glossed pie holes. The last thing in the world that a small business, with its finger firmly on the local pulse, needs is a Washington, D.C. political hack telling them to "do the right thing."

Fired Examiner Blows A Whistle On The FRB of New York

Although most of the financial institution-related whistleblower stories you read about have to do with some big bank stifling intrepid employees who only want to do the right thing, it appears that putting a cork in an employee's mouth is a practice not confined to big banks. Government regulators may be getting into the act, as well.

A former employee has sued the Federal Reserve Bank of New York, saying she was wrongfully terminated because she refused to change the results of her investigation into the banking firm Goldman Sachs.

Carmen Segarra filed her federal lawsuit against the New York Fed on Thursday in Manhattan.

Segarra's lawsuit says the New York Fed interfered with her examination of Goldman Sach's legal and compliance divisions and directed her to change her findings. She says she refused and was fired three days later, in May 2012.

I know of examiners who've been ordered to change examination findings by superiors. In those cases, it was because the examination findings were not supported by those pesky irritants called "facts," and their supervisory superiors were stricken by a sudden attack of integrity. It happens.

Segarra claims that's not the case in her case.

Segarra's finding led to the New York Fed's Legal and Compliance risk team to approve downgrading Goldman's annual rating pertaining to policies and procedures, the lawsuit said.

It's not clear if the approval led to an actual rate change, but the lawsuit said two Fed officials, named as defendants in the lawsuit, were concerned that a downgrade would hurt the Wall Street bank financially.

Naturally, the FRBNY denies the allegations. Goldman Sachs affects not to know what the heck any of this could be about, since when it comes to compliance with rules and regulations, GS makes like the College of Cardinals and follows not only the law's letter, but also the "holy spirit" that animates it.

If the claims of Ms. Segarra are not supportable, expect a vigorous defense by the Fed. Otherwise, this may all be settled sub rosa and this might be the last press report you'll ever read about it.

More Pertinent Than The Three Rs

In a recent article in the ABA Banking Journal, attorney Harold P. Reichwald advises directors who are serious about responding to the banking regulators' emphasis on enterprise-wide risk management to pay attention to what he calls "the five C’s of board governance:  Competency, Collegiality, Confidentiality, Communication, and Culture."

As Howard warns, these aren't the only principles of board governance with which directors should be concerned. On the other hand, "they are a set of principles that must be present, lest the bank inevitability suffer unanticipated losses." And if the bank suffers unanticipated losses that are serious, the directors may anticipate that the bank's primary regulators will take note and may even sanction the bank, and the directors, for such losses. If the bank fails, the FDIC may eventually come calling, and it won't be to have friendly chat.

Although all five points are worth noting, one struck home with me in light of what I, and colleagues with whom I work, have learned from our representation of management and boards of failed banks. That point is the second C, Collegiality.

Here's what Howard has to say about that.

Collegiality stresses the importance of trust among the board members and the encouragement of board members to voice their opinions fully, including expressions of differing points of view.

It encourages respect for all views expressed by individual directors and discourages attempts at private decision-making or influencing management away from the boardroom.

It demands that the board be seen as acting with one voice in making decisions—even when there are dissenting views expressed in deliberations prior to a vote.

Those of us who have been around the banking business through many business cycles have seen the negative consequences that can result when dissent at the board level is suppressed. There is nothing more detrimental to the health of a community bank (and to the health of its directors' pocketbooks) than a "strong" majority shareholder/director or board Chair who runs meetings like a religious revival, with only one preacher preaching and the rest of the attendees screaming "Amen!" I've talked about the dangers of this personality type in previous posts.

I understand Howard's point about the Board "speaking with one voice" even when there is dissent. However, it is also important that legitimate dissent (as opposed to the never-ending nay-saying of a professional gadfly who could stand in the middle of the Gobi dessert at high noon and argue that he's in Antarctica at midnight) be reflected in the board minutes, as well as the response to that dissent, and also an articulation of the reasons why a majority of the board decided to vote contrary to the opinion of the dissenter (if that is the board's decision). The board should be able to show that it considered the pertinent information and issues, pro and con, and made its decision in a disinterested manner after due deliberation. The goal of this process is to satisfy the requirements of the business judgment rule, not necessarily to prove that the decision was "right" in hindsight. As one federal district judge noted in ruling in favor of directors of a failed bank, the business judgment rule protects directors even when they might be inept.

Therefore, "collegiality" as proposed by Howard is an attitude that fosters respect for the opinions of all borad members so that they feel free to voice contrary views. It does not mean that everyone "goes along to get along." 

2013: The Year of The Lawsuit

Not long ago, The Washington Post ran an article that discussed how the FDIC has filed "a flurry of lawsuits" against officers and directors of failed banks. The recent "flurry" is due to the fact that the three-year statute of limitations is running out on banks that failed in 2010, a "banner year" for bank failures. Obviously, the FDIC doesn't want to let that limit expire without preserving its right to squeeze some blood out of the turnips.

As The Post points out, filing the lawsuit is not the end of the game. The cases can drag on for years.

There have been repeated delays as defendants seek to have cases thrown out and argue that their bank was the victim of a bad economy — not negligence.

[...]

“We generally don’t have people come in saying, ‘We’re really sorry we caused the bank to fail, here’s a check,’ ” said Richard Osterman Jr., acting general counsel at the FDIC. “We have to investigate, uncover information, subpoena records, do depositions and often file actions.”

Osterman was the head of the "bad bank" side of the FDIC prior to becoming acting general counsel, so his wry observation is spot on.

Alston & Bird's Mary Gill also states an obvious truth about litigation of all types.

“Federal litigation is inherently a slow process,” said Mary Gill, a partner at Alston & Bird, who specializes in director and officer, or D&O, litigation. “There have been discovery disputes that have arisen in many of the cases, which has somewhat slowed the pace of the litigation.”

And we can't forget the unstated truth that when attorneys bill by the hour, many hours must be spent. I believe that's a law of nature.

As the article also observes, the longer these cases drag on, the lower the FDIC's ultimate recovery may be. That's due to the fact that the D&O insurance policies (in most cases, the major "fund" out of which FDIC recoveries will be paid) cover litigation costs and litigation costs are applied against the policy limit. While the personal assets of the defendants can theoretically be tapped, in reality many of those defendants don't have the net worth to pony up much, or the net worth they have is ensconced in exempt assets. 

A couple of knowledgeable attorneys, Chris Cole and David Baris, are correctly quoted as observing that (1) unlike the S&L meltdown of the 1980s, there's less blatant fraud this time around the horn and a much better basis for arguing the the officers, and certainly the outside directors, could not have anticipated the steamroller that started flattening the economy in 2008; and (2) the practice of many of many community banks of having directors sit on the bank's loan committee and approve commercial loans is going the way of the passenger pigeon. Also, although Osterman correctly states that the fact that bank examiners did not criticize (and often praised) directors and officers credit practices that are not being severely criticized (in hindsight) by the FDIC, does not give the directors an automatic pass on a negligence or breach of fiduciary duty claim, it is a hurdle for the FDIC to jump.

Nowhere in the article is there any discussion that the overwhelming majority of the officers and directors being sued served community banks. The big boys were bailed out. The little guys were too small to save. But, apparently, not too small to second-guess and to sue.

The Writing On The Wall Is In ALL CAPS

As reported today by The Wall Street Journal (via Housing Wire), Chase "has launched an internal review of its commercial-lending clients that is expected to result in the elimination of relationships with companies that pose a greater risk of fraud or money laundering and are viewed as risky to J.P. Morgan's reputation." Payday lenders, pawnshops, check cashing businesses, and "certain automobile delaers" are on the chopping block. According to the folks at Seeking Alpha, what those business share is a common trait: political incorrectness. Although the WSJ article stated that the businesses that have already been cut off were not disclosed, Seeking Alpha noted that Cash America already publicly disclosed that its relationship with Chase has gone by the boards.

Those who think that this cutback by Chase is totally unrelated to the push by the FDIC and other federal regulators (and NACHA) to squeeze banks out of the payday lending servicing business, which, in turn, squeezes payday lenders out of their business, since a lack of access to the banking system means they can't process their payments, are likely smoking hemp. The FDIC recently "clarified" its position on this issue by paying lip service to the concept that banks could process payments for "higher-risk merchants" as long as they properly managed the risks (whatever that means), the folks at Ballard Spahr cut to the chase about the implications of what the FDIC thinks is "higher risk."

The FIL asserts that higher-risk activities are typically characterized by high rates of return, high rates of unauthorized transactions, consumer complaints, and regulatory or criminal actions. The FDIC's reference to high rates of return comes amid reports that the Department of Justice is taking the position that rates of return exceeding 3 percent should raise red flags. In our view, any focus on return rates is questionable and overly broad in the context of a product serving a population with serious credit and liquidity problems.

I guess the regulators would prefer that the "population with serious credit and liquidity problems" be served by organized crime, at least until the the ideologues loose in our financial and political systems achieve their goal of government control of the financial system.

As we've speculated previously (as have others), the regulators don't like certain lines of business and don't want anyone involved in those lines of business, whether they're banks or non-banks. They're going to do everything they can to make sure that those businesses are hamstrung and, eventually, driven out of business. Certainly, they're doing what they can to make it "risky" for banks to finance those businesses or to process their payments. I assume that the major offense of such businesses is that they charge high rates and fees to compensate for the higher risk of non-payment presented by the "borrowing base," which makes perfect business sense but violates a basic tenet of fairness in a world where an unelected group of bureaucrats gets to decide what is and what is not "fair" and to manage the allocation of credit in the economy according to their perceptions of "fairness."

We'll see how well those banks who, unlike Chase, decide to stay in these "risky business lines" effectively manage the risk in the view of their primary federal regulator. We've already been informed by one bank that their primary federal regulator told them that with respect to the "risky business" for which it was processing payments, the lender had to ensure that the business was operating in accordance with all federal, state, and local laws, including verifying that each branch office had all necessary permits from the applicable municipal authorities. Ponder that requirement for a minute and tell me why the bank could not rely upon what has previously been deemed to be satisfactory assurance by the regulators: the representations, warranties, and indemnifications of the business, backed up by sufficient due diligence (including evidence of insurance) to make sure the business could stand behind those representations, warranties, and indemnifications. Even Chase wouldn't have enough resources to verify that every branch of the third-party customer was, in fact, properly licensed and permitted under municipal ordinances.So much for the rule of reason applying to "risk management."

If this doesn't unsettle you, you're likely not a proponent of the free enterprise system, and think this all heading down the right path. The rest of us are "concerned."