Bank Lawyer's Blog

Hear Me Now and Believe Me Later

In The Land of Liars, it's occasionally hard to separate the professionals from the merely proficient amateurs. However, when I'm in desperate need of affirmation that the spirit of the late, great Tommy Flanagan has not departed our nation's capitol, I need search no further than the latest news story about the Queen Bee of prevaricators, Hilarity Clinton.

Democratic presidential candidate Hillary Clinton would not bail out big banks to save them from collapse in the event of another financial crisis, she said on Tuesday.

During a late night television appearance with comedian Stephen Colbert, Clinton said her priorities were focused on raising the minimum wage and bolstering the middle class.

"If you're president and the banks are failing, do we let them fail?" asked Colbert.

"Yes, yes, yes, yes... " Clinton said.

No, no, no, no...

In 2008, when she was a beloved senator from the Empire State, Clinton gave a hearty thumbs up to bailing out the big banks. That was the smart move. As Hank the P warned us then and since, it was either TARP or "disaster."

In 2015, of course, she's running against an opponent who was one of the small minority of senators to vote against the bailout bill. Bernie was anti-big-bank then and he's never changed his tune. Lindsey Graham may have amusingly tweaked Sanders last night by claiming that he honeymooned in the Soviet Union and has never came back, but the dude has one thing that is rare in D.C.: integrity.

There's also the nettlesome problem that Lizzie Warren is the left's darling and she's opted out of the race this time around. To assure herself of the nomination, Clinton has to try to pull as many Spouting Bull supporters as she can away from the grumpy old man. Telling Colbert that she'd let the big banks fail plays well with a crowd that doesn't let reality get in the way of ideology. She's like Ted Cruz in that respect, I suppose.

If we ever were to face the prospect of the collapse of the banking system again and Clinton was at the nation's helm, she'd steer the ship full speed ahead into the bailout iceberg and be the first one in a lifeboat. Count on it.

She's not in Flanagan's class, but she's close. Really, really close.

The Fed On MJ Banking: Nyet

Over the summer, while I was downing cold beers by the barrel rather than blogging, the Federal Reserve Bank of Kansas City and the NCUA finally acted on the applications of Fourth Corner Credit Union for, respectively, a "master account" for access to the Federal Reserve System and for insurance of share accounts. In both cases, the answer was not only "No," but "Hell, No!" Fourth Corner sued both the NCUA and the Fed. last week, the Fed filed a Motion to Dismiss Fourth Corner's complaint that ought to send a chill down the spine of every bank in Colorado, Washington, Oregon and Alaska that thinks it can "work around" the federal banking regulators on the Supremacy Clause when it comes to banking a state-legal, federal-illegal marijuana business.

In broad strokes, the Fed alleges that federal law, in this case the Controlled Substances act, trumps state law on marijuana use by virtue of the Supremacy Clause of the US Constitution. This should be "Hornbook Law" to any bank regulatory attorney. The manufacture, sale, and distribution of marijuana is prohibited by the Controlled Substances Act. Therefore, "any affirmative action that Colorado has taken to facilitate the distribution of marijuana is preempted by federal law."

In the present case, Colorado attempted to grant TFCCU a charter that would, in effect, intentionally allow TFCCU to aid and abet violations of federal law by offering banking services to businesses engaged in the manufacture and/or distribution of marijuana. Such an act is preempted by federal law and is void and without effect...The Court would not aid other such attempts--such as if Colorado enacted a scheme to allow trade in endangered species or trade with north Korea in derogation of federal laws, and then chartered a credit union to handle finances for companies conducting such illegal trade...TFCCU is not an entity that can be recognized under federal law" and the credit union's complaint must be dismissed.

Beyond the "master account" and insurance of accounts applications at issue here, the Motion to Dismiss contains a broad condemnation for any existing financial institution--credit union or bank--that thinks that it is somehow safely avoiding federal criminal law prosecution and/or bank regulatory agency enforcement action because it follows the "FinCEN Guidance" issued in early 2014 that, in turn, followed the "Cole Memorandum" guidance provided to US Attorneys on prosecutorial discretion in the area state-legal marijuana businesses. The Fed contends that such "guidance" is not a protection from criminal prosecution (which the guidance itself states, if read carefully). Even if it affords such protection, the Fed makes clear that the Fed would not be bound by it.

The Fed also makes clear that it considers any financial institution that engages in providing financial services to a state-legal marijuana business to be engaging in aiding and abetting a criminal activity under federal law, and that federal law controls. Under that analysis, the Fed should, if it is consistent, take enforcement action against any Fed-member bank that is so engaged. I fail to see why the OCC, FDIC, or NCUA would take a contrary position.

An anonymous (naturally) critic from Dogpatch, U.S.A., attempted to leave a comment on the blog a few months ago that criticized my support of (the critic's phrase) "federal infallibility" regarding state marijuana laws. The poor soul apparently conflated "Papal Infallibility," a theological doctrine of the Roman Catholic Church, with the constitutional principle of "Federal Supremacy. The issue at stake is not who is "right" or "wrong" regarding whether the manufacture and distribution of marijuana for recreational use should or should not be illegal, it is whose law prevails when state and federal law conflict on this matter. My view is that federal law prevails and that any financial institution (and its directors, officers, and employees) that "banks"  a state-legal marijuana business is running a serious risk of being hammered by different federal agencies for violating federal criminal laws.

If your credit union's or bank's business plan is "I feel lucky today," more power to you. I think that you're playing with fire and not wearing an asbestos suit.

Wallison Whales On Dodd-Frank

While he'll convince no one in love with Big Government of his thesis, the American Enterprise Institute's Peter Wallison is making the case that recent academic research supports the proposition that Dodd-Frank and other regulatory burdens imposed by the federal government in the wake of the economic recession of 2008 are hampering the economic recovery of the U.S. (hat tip to a community bank CEO and blog reader for sending me the link).

First, a study by Michael Bordo and Joseph Haubrich showed that recoveries after financial crises are actually sharper than other recoveries. After studying 27 recession-recovery cycles since 1882, they concluded that “the stylized fact that deep contractions breed strong recoveries is particularly true when there is a financial crisis.” So we should have expected a steep recovery after the sharp 2008–09 recession rather than the stuttering and stalling economy we have experienced.

Also, studies of Dodd-Frank’s effect have shown that the regulatory burdens imposed by that law have been particularly harsh for community banks. The Fed defines community banks as banks with $10 billion in assets or less; 98.5 percent of all US banks fall into this category. A 2012 Government Accountability Office study showed that 7 of the 16 titles in Dodd-Frank had potential adverse effects for these banks, and studies by scholars at George Mason University and Harvard’s Kennedy School have found significant compliance cost increases attributable to Dodd-Frank. “Since the second quarter of 2010,” said the Harvard study, “around the time of [Dodd-Frank’s] passage, we found community banks’ share of [US banking] assets has shrunk drastically—over 12 percent.”

Of course, the regulatory costs to community banks are not a new story; Congress has been attempting to mitigate these costs for years. What is new is the data that shows the effect of these regulatory costs on small business and hence on economic growth.

Wallison asserts that the vast majority of small businesses (traditionally, the primary drivers of job growth) require bank financing because they do not have the access to capital markets that larger business have. Increased regulatory costs mean less credit. Less credit means slower growth. Slower growth means less job creation.

This is where the costs loaded on small banks begin to affect US economic growth. Regulatory costs affect small banks more than large banks because the costs are largely fixed and large banks by definition have a bigger asset base over which to spread these costs.

When a small bank is required to hire a compliance officer, that is an employee who is not making loans or producing revenue. When the Consumer Financial Protection Bureau—set up by Dodd-Frank and the bane of small banks—sends out a 1,099-page regulation on mortgage lending, that means a community bank must engage a lawyer to interpret the new regulation, a compliance officer to apply the regulation in individual cases, and a tech firm to retool its mortgage underwriting system. All costs, no revenue, and fewer funds to lend. When a bank examiner criticizes a loan because the bank does not have audited financial statements for a customer who has never missed a payment in 20 years, that forces a bank to revise its business model and change its customer relationships. Again, costs for the bank and less financing for the small business.

If the costs Dodd-Frank has imposed on small banks are hurting small business, we should see a significant difference between the growth rates of small and large businesses since 2010. That is exactly what the data shows. In a Goldman Sachs report published in April 2015 and titled “The Two-Speed Economy,” the authors found that firms with more than 500 employees grew faster after 2010—the year of Dodd-Frank’s enactment—than the best historical performance over the last four recoveries. These firms largely had access to the capital markets for credit. However, jobs at firms with fewer than 500 employees declined over this period, although this group had grown faster than the large-firm group in the last four recoveries.

Here, then, is the source of the slow recovery from the 2008–09 recession. Although 64 percent of net new jobs in the US economy between 2002 and 2010 came from employment by small business, this source of growth has disappeared since the enactment of the Dodd-Frank Act. While larger firms have access to credit in the capital markets, millions of small firms, limited to borrowing from beleaguered community banks, are not getting the credit they need to grow and create jobs.

As I said above, Wallison won't convince the Bernie Sanders/Elizabeth Warren crowd with facts. One of the commenters to Wallison's article makes this point ably.

To blame the slow recovery on Dodd Frank is frankly hilarious. It defies logic. Big banks were the major contributors to the 2008 recession and their failure to re-inflate the lending system after the government had made them whole will go down as one the major acts of treachery against small business. Small banks are doing poorly for a far different reason. See the growth of a strong aggressive regional banking structure.

You'll notice that, unlike Wallison, no studies or statistics are cited by the commenter to back up his arguments or even his factual assertions, nor to counter those that support Wallison's arguments. Instead the basic ad hominem attack is made that Wallison's position is "hilarious."

No, it's anything but "hilarious." As people who have actually made a career in the community banking business understand, it is many things, but "hilarious" is not among them.

Community Banking: Back To The Motherland

A man who spent his working life successfully building a de novo community bank into a powerhouse that made himself and his fellow shareholders wealthy has started over using the same scheme. Unfortunately, this time around, he's not doing it in the United States.

You might call Vernon Hill a reverse Paul Revere. Most Americans like to believe that the U.S. is still a land of opportunity, the place where anyone can start a business and make a profit. But Mr. Hill issues a warning that rings loud and clear: The British—and others—are more inviting than we are.

“The regulatory environment has become so onerous in America that it is now easier to start a business in England than in the U.S.,” Mr. Hill says—and he would know.

That's right: the U.K. a nation that, 70 years ago, embraced the welfare state with open arms, is a better place to start and build a community bank than the land of the overregulated and the home of the Franken-Dodd Monster.

“When I went to Britain I thought the regulatory environment would be much worse,” he says. “It’s infinitely better there.”

The problem in the U.S. starts with towering federal regulations, such as the voluminous reporting and compliance rules in Dodd-Frank, the financial reform act that recently celebrated its fifth birthday. “Regulators are making it impossible for the medium and small banks to comply with the rules,” he says. “The burdens get so intense that it is destroying the small and medium-size banks in America.”

The result is that Dodd-Frank, a law intended to take on the systemic risk of “too-big-to-fail” banks, is multiplying the problem. “The big banks that are too big to fail are bigger now than ever, but the regulations have trickled down to the smaller banks that didn’t cause the financial crisis” Mr. Hill says. As a result, community banks are disappearing. “When I started my first bank in the 1970s there were 24,000 banks in America,” he says. “There are now 7,000 banks. It may soon be 500 or even fewer.”

According to Hill, Dodd-Frank is not the only spewer of regulatory offal. The BSA and the CRA get equal billing as soul crushers.

“The feds have taken anti-money-laundering rules to the extreme,” Mr. Hill says. “We have to monitor every deposit account every 24 hours. Somebody’s monitoring your account every day.” That’s invasive and expensive.

He laments that the Community Reinvestment Act, a catalyst of the 2008 subprime mortgage crisis, still hasn’t been repealed. “We are literally required to make loans that we know are going to fail,” he says.

Finally, the little guys are also being beaten down by the Mini Me's of red tape.

Then there’s the tangle of local regulations that every American small business must cut through. “You don’t need a building permit in Britain. Here [the U.S.] you have to get permits and you have to get inspections,” he says. All that can eat up months and months. “I can build 100 branch banks in Britain before I can get one built in the U.S., thanks to regulators.”

The linked article gives details on how Hill personally made hundreds of millions for himself (and billions for all of the shareholders) in the U.S. and how he's on the path to do the same thing in the U.K. It also gives his parting advice for US regulators.

What to do with banks that are too big to fail? Mr. Hill doesn’t hesitate. “You have to make them smaller,” he says. “You break them up.” He says that at one point there was a rule that barred any one bank from holding more than 10% of the country’s deposits, but that some institutions, such as Bank of America, have now edged above that figure. He views that as dangerous.

And how much should we be worried about overregulation—or competition from abroad? “Here’s my story in a nutshell and I hope Washington is paying close attention,” Mr. Hill says. “A very successful American business model has been transferred to Britain, where it’s even more successful because it doesn’t have to deal with the same burdens of government.”

He continues: “The politicians keep talking about fairness and helping the little guy. But it’s the little startup businesses that get hurt the most from the heavy hand of excessive government regulation. How is that fair?"

It's not fair. That's why Hill's "outta here" and "over there." He may be starting a trend.

Class Action Chum

Financial institutions and class action lawyers mix as well as Donald Trump and Carly Fiorina, so the latest news from Ballard Spahr about a new "coalition" of sharks in Sin City is bound to cause bankers everywhere to break out in a nasty rash.

Approximately 50 cases have been filed recently in Nevada state and federal courts against furnishers of information and credit reporting agencies (CRAs) for alleged Fair Credit Reporting Act (FCRA) violations. It appears that consumer rights attorneys have teamed up with consumer bankruptcy firms to monitor credit reports over the course of a debtor’s bankruptcy case and then sue creditors and CRAs after discharge if the debtor’s credit report inaccurately reports debts after the bankruptcy.

As the alert notes, individuals who alleged that they have been harmed by the inaccurate reporting of a debt  that has been discharged in a bankruptcy proceeding have a private cause of action under the FCRA against a creditor that failed to report to the credit bureaus that the debt had been discharged. Of course, the class action attorneys make a nice pile of cash, which has absolutely nothing to do with the matter. It's all about getting "justice" for the debtor.

Banks and credit unions will need to take this trend into account, and ensure that their reporting policies and procedures are hyper-vigilant so that inaccurate reporting to the credit bureaus does not occur. While this has been the case for some time in theory, in practice some institutions appear to have been relying on the theory that if the error is inadvertent, they might get a pass if they correct it as soon as they become aware of it. The "flurry" of new lawsuits makes it clear that the sharks are circling, that reporting inaccuracies are "chum," and that the the plea of "no harm, no foul" will be drowned out by the screams emanating from the bank's dismemberment by a veritable "sharknado" of vicious hammerheads and, perhaps, a few oversize "great whites."

Small Bites of the Apple

It's a drop in the bucket, but for hundreds of community banks lost in a regulatory dessert, even a small amount of water is welcome.

The U.S. House of Representatives unanimously passed legislation Tuesday that would ease regulatory rules for small community banks.

Congressman Scott Tipton, R-Cortez, has proposed the Small Bank Exam Cycle Reform Act, H.R. 1553, to help well-managed community banks.

[...]

The Small Bank Exam Cycle Reform Act amends the Federal Deposit Insurance Act to raise the qualifying asset threshold from $500 million to $1 billion for the 18-month exam cycle [as opposed to the current 12-month exam cycle].

This would allow an additional 676 banks across the U.S. to qualify for a longer exam cycle. Under the act, small banks would be able to better focus their employees and resources on serving the banking needs of customers, he said, rather than on onerous paperwork.

The longer exam cycle for smaller banks also should be a cost-saver.

Let's hope that in the land of grid-lock, the Senate can manage to pass what ought to be a fairly noncontroversial bill.

In terms of overall regulatory relief, this may not seem like much. On the other hand, it's something.

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On a completely unrelated subject, I have received a couple of inquiries from readers as to "what I am hearing" about the FFIEC's Cybersecurity Assessment Tool. In the interest of brevity (a welcome relief to most readers), here's what the Chief Cybersecurity Officer of one of my larger ($20 billion+) banks offered me:

We do have it and have looked it over. Basically, if an organization has a decent security program with a foundational framework, it is nothing to worry about. I wouldn’t say it offered much value, but validation.

I suppose that if a bank is behind the curve, then the "Tool" may be more useful than simply a "check" on what you have already considered. As with relatively recent vendor management and social media guidance, and before that, the multifactor authentication guidance for online banking, the regulators seem to be putting out material for folks who are in need of catching up with their more sophisticated brethren. Moreover, even for those who believe that they are locked and loaded, it provides "validation" that you are not missing something fundamental.

Operation Choke Point Lawsuit: The Plaintiffs Are Still In The Game

While some pundits think that Operation Choke Point is a dead issue, as evidenced by the FDIC's recent guidance that claimed that they were only kidding when they labeled entire lines of business as "high risk," the folks at Ballard Spahr note that the lawsuit filed by the payday loan industry against the bank regulatory agencies continues to forge forward. On September 25, the federal judge hearing the case "rejected most of the arguments in the agencies’ motion to dismiss," allowing the lawsuit proceed.

The agencies first challenged plaintiffs’ standing to sue. While acknowledging that the denial of banking services establishes one necessary element of standing (an “injury in fact”), defendants argued that the plaintiffs do not satisfy the two remaining elements, namely causation, a link between the defendants’ actions and the plaintiffs’ injuries, and redressability, evidence that a favorable ruling will redress the plaintiffs’ alleged injuries.

According to the defendants, the plaintiffs’ injuries resulted from independent decisions by their banks rather than the agencies’ guidance documents. Judge Kessler notes that the plaintiffs’ burden of eventually proving their “third party” causation theory−that the defendants’ conduct compelled the banks to deny them service−will be substantial. However, taking as true all of the plaintiffs’ factual allegations, as is required when deciding a motion to dismiss, she determined that the claims satisfy both the causation and redressability requirements.

The judge also found that the agencies' subsequent "guidance" that "urged" banks to take a risk-based approach on a client-by-client, rather than industry-by-industry basis, does not render the controversy "moot."

Although she agreed that the agencies’ subsequent pronouncements have largely superseded earlier Choke Point guidance, Judge Kessler rejected the defendants’ contention that this alone renders moot all of the plaintiffs’ claims. In particular, she notes that the plaintiffs claim they have been stigmatized and deprived of their ability to engage in a legally permitted business, all without constitutionally required notice and opportunity to be heard.

The judge dismissed claims based upon alleged violation of the Administrative Procedures Act, ruling that agency "guidance" is not final agency action. That is technically correct. However, as those of us who see the consequences of failing to follow agency "guidance," including the inclusion on examination reports of MRAs (matters requiring attention) for "violation" of "guidance," the way the agencies use guidance might be considered by a cynic as an end-around the APA. Luckily, I'm an optimist and would never suggest such a thing.

As I've previously assert, I think that the only thing that will ultimately drive a stake through the heart of Operation Choke Point will be a change in the White House in 2016. Until then, I hope that the plaintiffs continue to keep fighting the good fight.

Parsons Parses Franken-Dodd

Richard J. Parsons, who, prior to becoming an author on all things banking, was a career executive with Bank of America, is expressing his pessimism (sub. required) about the possibility of regulatory reform making it through Congress this year. The reason Parsons's pessimism: "ideology."

Two clashing worldviews dominate the conversation about bank regulation today. The first espouses the self-correcting power of the invisible hand of free markets. This ideology prevailed in the era of Ronald Reagan and Margaret Thatcher. But in the aftermath of the financial crisis, it seems to be losing steam.

The other ideology, backed by President Obama and Sen. Elizabeth Warren, fashions banking as a public utility to be controlled by elite central planners who are unsullied by self-interest.

Politicians compromise. Ideologists don't — even when they are confronted with "inconvenient facts.''

Today, there are 1,524 fewer banks with assets under $1 billion than there were on June 30, 2010 — just a few days before Dodd-Frank was signed into law.

Dodd-Frank = fewer banks is a popular mantra. Personally, I think the trickle-down burden of Franken-Dodd and the swing of the regulatory pendulum from lax-to-overbearing in the wake of the 2008 financial system meltdown have both played in a role in the incredibly shrinking community banking industry. However, as one of the anonymous commenters to linked article points out, economies of scale have also played a role. So have artificially low interest rates for the last seven years and the difficulty of making money on the interest rate spread. As we've also discussed, the paucity of de novo banks in the current economic cycle has played a role.

That said, Parsons point about the desire of Elizabeth Warren and her tribe of like-minded leftists (Parsons accuses FDIC Voice Chairman Thoma Hoenig of being in her camp, which may come as news to Hoenig) to make the banking business a "public utility" falls on open ears. We agree that many on the left would love the US to adopt the Canadian model of only a handful of banks, all micromanaged by the federal regulators-with Congressional input, of course-to serve the overridng social engineering goals of those who always exit stage left. The fewer the number of banks, the better able their regulators will be to "manage" them.