Banking Law Prof Blog

Warren Buffett Comments on the Subprime Mortgage Lending Crisis

Excerpt from Warren Buffett's current Letter to Berkshire Hathaway Shareholders: 

"Some major financial institutions have, however, experienced staggering problems because they engaged in the “weakened lending practices” I described in last year’s letter. John Stumpf, CEO of Wells Fargo, aptly dissected the recent behavior of many lenders: “It is interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine.”

You may recall a 2003 Silicon Valley bumper sticker that implored, “Please, God, Just One More
Bubble.” Unfortunately, this wish was promptly granted, as just about all Americans came to believe that house prices would forever rise. That conviction made a borrower’s income and cash equity seem unimportant to lenders, who shoveled out money, confident that HPA – house price appreciation – would cure all problems. Today, our country is experiencing widespread pain because of that erroneous belief.

As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out – and what we are witnessing at some of our largest financial institutions is an ugly sight."

Link:  http://www.berkshirehathaway.com/letters/2007ltr.pdf

(ag) April 2, 2008, in Lending Issues

Enron & Jeff Skilling - Still in the News

Today's Wall Street Journal has a short "Today's Agenda" item at the bottom of page one, letting us know that:  "A court will weigh overturning the conviction of Jeffrey Skilling, the government's only unalloyed courtroom victory in its Enron probe."

The Fifth Circuit Court of Appeals will hear arguments from the former Enron CEO Jeffrey Skilling that his conviction and 24 year sentence should be reversed because he claims that prosecutors withheld 400 pages of notes from FBI interviews of Andrew Fastow which might have been exculpatory.

Link for more details:  http://letterofapology.com/category/enron/

(ag) April 2, 2008, in Corporate Governance.

Alphonso Jackson - Fraud Fallout at a Bad Time

Just when plates are full-to-overflowing with housing-related issues, the Secretary of Housing and Urban Development Alphonso Jackson announced his resignation yesterday so that he can "attend more diligently to personal and family matters."  His euphemistic resignation statement, naturally, makes no reference to the pending criminal investigation relating to his role in awarding HUD contracts.

Link to article:  http://www.chicagotribune.com/news/nationworld/chi-hud-official-quitsapr01,1,7990065.story

HUD Announcement:  http://www.hud.gov/news/release.cfm?content=pr08-046.cfm&CFID=5265834&CFTOKEN=17118067

(ag) April 1, 2008, in Economy

Treasury's Blueprint for Regulatory Reform

Today, Treasury Secretary Henry Paulson announced the much anticipated "Blueprint for Regulatory Reform."  Good news:  Secretary Paulson recognized that "Our first and most urgent priority is working through this capital market turmoil and housing downturn, and that will be our priority until this situation is resolved.  With few exceptions, the recommendations in this Blueprint should not and will not be implemented until after the present market difficulties are past."  Another reason not to expect quick adoption is that Congress must vote on the plan -- and that's not likely to happen before the Presidential election next fall.  As you can tell, I'm not a big fan of rushing into big regulatory changes that follow too closely on the heels of a national crisis.  That's because I've seen what usually happens.  Two words:  Sarbanes Oxley.  Two more words:  Unintended consequences.

Highlights of the Plan:
1.  The Federal Reserve becomes the "Market Stability Regulator," replacing its more limited role of bank holding company supervisor.  The Federal Reserve would have authority to gather information from commercial banks, investment banks, insurance companies, hedge funds, commodity pool operators -- but not to focus on the "health" of any particular organization, just the impact on "overall financial stability."

2. All federal bank charters would be combined into one charter and all federal bank regulators would be combined into one "Prudential Financial Regulator," with a role similar to the Office of the Comptroller of the Currency (just change the name & keep the current OCC staff would be my guess -- although the OTS says it's not going down without a fight).

3.  A new "Business Conduct Regulatory" is part of the proposal, to achieve greater consistency across product lines, including consumer protection, disclosures, business practices, chartering and licensing & enforcement.

The Plan supports "objectives based regulation, a flexible framework that fosters and embraces innovation." That part of the plan should be hard to swallow in light of the current debacle spurred in part by innovation such as teaser-rate ARMs and Bear-Stearns-like insurance swaps.  On the other hand, we don't want strict regulation for its own sake alone.

Near Term Recommendations include:
1.  Enhancement of the President's Working Group on Financial Markets to include all federal financial regulators, with a mission to coordinate the U.S. regulatory community, mitigate systemic financial risk, enhance financial market integrity, promote consumer and investor protection, and support capital markets efficiency and competitiveness -- a tall order! One wonders what sort of powers will accompany that charge.

2.  Creation of a new Mortgage Origination Commission, although states will retain some authority for regulating mortgage origination practices -- unless, of course, they are preempted.      

Intermediate Term Recommendations: 
1.  New oversight for the payment and settlement systems, headquartered in the Federal Reserve.
2.  Merger of the SEC and CFTC.
3.  New Optional Federal Charter for Insurance -- replacing states as primary regulator for insurance for over 135 years.
4.  Revocation of the Federal Thrift Charter.

Secretary Paulson likens this proposal to the 1991 "Green Book" which eventually resulted in passage of the Gramm-Leach Bliley Act.

Link:  http://www.treas.gov/news/index1.html

(ag) March 31, 2008, in Federal Banking Agencies

Let's Not Be Hasty

An interesting article in the American Banker for April 26, 2008, is entitled "Financial Execs Urge Rapid Regulatory Reform." Well, let's see what this is about!  Representatives of the Financial Services Roundtable (with membership comprising the 100 largest integrated U.S. financial firms) say they would like to see a single federal regulator as an option for financial firms AND a regulatory system based on broad principles and prudential oversight.  The article suggests that the Bear Stearns collapse has triggered these proposals, that they will enable regulators to respond to similar crises more expeditiously, and that they should be adopted post haste. 

Wait a minute:  The Financial Services Roundtable was arguing for a single regulator and more flexible, principles-based regulation long before now.  And most observers believe that we will see Congressional response to the subprime mortgage and financial markets crisis.  Those of us who have seen how heavy-handed Congressional response to crisis can be hope not to see reforms that are rushed through.

(ag) March 27, 2008, in Federal Banking Agencies/Subprime Lending

Reviewing the Fed's Interest Rate Cuts

Are the interest rate cuts by Federal Reserve Board's Federal Open Market Committee (FOMC) producing the intended results? You be the judge.

Members of the FOMC for 2008

• Ben S. Bernanke, Board of Governors, Chairman
• Timothy F. Geithner, New York, Vice Chairman
• Richard W. Fisher, Dallas
• Donald L. Kohn, Board of Governors
• Randall S. Kroszner, Board of Governors
• Frederic S. Mishkin, Board of Governors
• Sandra Pianalto, Cleveland
• Charles I. Plosser, Philadelphia
• Gary H. Stern, Minneapolis
• Kevin M. Warsh, Board of Governors

Federal Reserve Chairman Ben Bernanke

List of FOMC interest rate adjustments in reverse order:

March 18, 2008 - Target federal funds rate reduced 75 basis points - from 3% to 2.25%.  FOMC Statement indicates weakened economic activity, financial markets under stress, and deepening of housing contraction on the one hand and increased inflation on the other.  Two FOMC members, Dallas Federal Reserve Bank President Richard Fisher and Philadelphia Federal Reserve Bank President Charles Plosser,  dissented from this action, arguing that 75 basis points was too aggressive.

Dallas Fed President Richard Fisher

Philadelphia Fed President Charles Plosser

January 30, 2008 - Target federal funds rate reduced  50 basis points from 3.5% to 3%.  Dallas Fed President cast the sole dissenting vote, preferring no reduction at this time.

January 22, 2008 - Target federal funds rate reduced in an unscheduled FOMC meeting 75 basis points from 4.25% to 3.5%.  William Poole voted against this reduction and Frederic Mishkin was absent.

December 11, 2007 - Target federal funds rate reduced 25 basis points from 4.5% to 4.25%.  Eric Rosengren  voted against this reduction, preferring to reduce the rate by 50 basis points.

October 31, 2007 - Target federal funds rate reduced 25 basis points from 4.75% to 4.5%.  Thomas Hoenig voted against this reduction, preferring no change at this time.

September 18, 2007 - Target federal funds rate reduced 50 basis points from 5.25% to 4.75%, pursuant to unanimous vote.

August 17, 2007 - Target federal funds rate unchanged from 5.25% pursuant to unanimous vote.  FOMC Statement says, "The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets."

August 7, 2007 - Target federal funds rate unchanged from 5.25% pursuant to unanimous vote.

June 28, 2007 - Target federal funds rate unchanged from 5.25% pursuant to unanimous vote.

May 9, 2007 - Target federal funds rate unchanged from 5.25% pursuant to unanimous vote.

March 21, 2007 - Target federal funds rate unchanged from 5.25% pursuant to unanimous vote.

January 31, 2007 - Target federal funds rate unchanged from 5.25% pursuant to unanimous vote.

December 12, 2006 - Target federal funds rate unchanged from 5.25%.   Jeffrey Lacker voted against, preferring to raise rates 25 basis points.

October 25, 2006 - Target federal funds rate unchanged from 5.25%.  Jeffrey Lacker voted against, preferring to raise rates 25 basis points.

September 20, 2006 - Target federal funds rate unchanged from 5.25%.  Jeffrey Lacker voted against, preferring to raise rates 25 basis points.

August 8, 2006 - Target federal funds rate unchanged from 5.25%.  Jeffrey Lacker voted against, preferring to raise rates 25 basis points.

June 29, 2006 - Target federal funds rate raised 25 basis points from 5% to 5 1/4%, pursuant to unanimous vote.

May 10, 2006 - Target federal funds rate raised 25 basis points from 4.75% to 5%, pursuant to unanimous vote.

March 28, 2006 - Target federal funds rate raised 25 basis points from 4.5% to 4.75%, pursuant to unanimous vote.

January 31, 2006 - Target federal funds rate raised 25 basis points from 4.25% to 4.55%, pursuant to unanimous vote.

___

(ag) March 26, 2008, in Economy/Interest Rates

Commercial Real Estate Concentrations - The Next Problem Loan Category?

FDIC has issued a Financial Institution Letter (FIL 22-208, March 17, 2008) reemphasizing the importance of risk management strategies and strong capital to back Commercial Real Estate and Construction & Development concentrations. As our economy edges toward recession, losses in these loan concentrations will undoubtedly increase.  The Federal Banking Agencies are trying to give advance guidance in this arena.

Link:  http://www.fdic.gov/news/news/financial/2008/fil08022.html

(ag) March 25, 2008, in Lending Issues

Points to Ponder Regarding the Subprime Mortgage Market Collapse

My conclusions:

   1. There’s blame enough to go around.
   2. Those who do not remember the past are condemned to repeat it.
   3. If it sounds too good to be true, it probably is.
   4. If you don’t understand it, don’t invest in it.
   5. What goes around comes around.
   6. It’s still good to be the little pig who built his house of brick.
      
"It's sort of a little poetic justice, in that the people that brewed this toxic Kool-Aid found themselves drinking a lot of it in the end." - Warren Buffett, commenting on banks and investment banks that designed and marketed complex investments that have since gone sour, as reported by Reuters News.

(ag) March 25, 2008, in Subprime

It's Not Sexy But It's Still an Examination Concern

Flood Insurance continues to be a bank examination issue.  It may not have the pizzazz of complex financial issues, but for those banks doing a traditional lending business and for borrowers seeking plain vanilla home mortgages, it's still important.

The Federal Banking Agencies have issued a Revised Q&A (updated from the 1997 version) to aid compliance.

Link:  http://www.occ.gov/ftp/bulletin/2008-7.html

(ag) March 24, 2008, in Lending Issues/Federal Banking Agencies

FACTA and ID Theft

"FACTA and Identity Theft" is the topic I'm currently working on.  I speak at the Texas Bankers Association Legal Conference on Friday this week, so expect a posting of my paper next Monday.  Here's a link to a shorter piece summarizing new FACTA Regulations for 2008:

Link:  http://law.lexisnexis.com/practiceareas/Emerging-Issues

(ag) March 24, 2008, in FACTA

Fed's New Approach - Shades of FSLIC in the 1980's?

Mergers of underwater thrifts with slightly stronger ones postponed the S&L crisis of the 1980s --- but only for a time; meanwhile, ultimate losses had increased.  Could this be deja vu? Last week, the Fed & Treasury encouraged or arranged for JPMorgan Chase to offer to acquire Bean Steans, the investment firm going down for the third time as a result of the subprime mortgage crisis.

What about good old "moral hazard"?  It's an economic axiom that people take more risk with other people's money than with their own.  Is assisting this deal by guaranteeing $30 billion of Bear Stearns' troubled subprime mortgages rewarding not only Bear Stearns & its shareholders for bad decisionmaking but also JPMorgan Chase, which almost certainly had significant exposure resulting from credit default swaps?

Of course, if you approve of this bailout, you believe that it saves the financial markets from worse problems.  But have we seen the last of struggling giants in need of government assistance?  I think not.  So where does it stop?  Is this type of deal only masking and delaying problems?  And what about the homeowners facing foreclosure?  Should we bail out the big boys and leave mom & dad in the lurch?  But wait, even on the individual mortgage level, how do we separate the real victims from speculators?

This subprime mortgage situation has so many levels of risk-shifting.  It looks like a nation-wide shell game.  Not even the experts have unraveled all the financial machinations that spun out of subprime mortgages, so we still don't know where the actual losses will reside.  And it's impossible to tell when enough government assistance is enough -- and when it simply makes a bad situation worse.

Interesting links:

"In the Fed's Crosshairs:  Exotic Game"  http://www.nytimes.com/2008/03/23/business/23gret.html

" When feds save greedy firms, economy and morality collide" azcentral.com http://www.azcentral.com/news/articles/0323biz-moralhazard0323.html

New development:  Bear Stearns shareholders complain that $2 per share is too low.  JPMorgan Chase may increase its bid to $10, but the regulators reportedly don't like that.

Link:  http://news.yahoo.com/s/ap/20080324/ap_on_bi_ge/jpmorgan_bear_stearns

(ag) March 24, 2008, in Economy, FRB 

The Fed Tries New Tricks

You really have to give Federal Reserve Chairman Ben Bernanke an A+ for effort.  As the financial markets continue to struggle, the Federal Reserve is inventing new tools to inject liquidity into the market and calm investor fears. 

Today, the Fed announced a new Term Securities Lending Facility (TSLF), pursuant to which the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program).  The Fed is working to design an auction process for making these securities available.  Auctions will be held on a weekly basis, beginning on March 27, 2008.

The Federal Reserve is working very cooperatively with central banks in the other G-10 countries to head off more serious global economic problems.

Link to FRB Press Release:  http://www.federalreserve.gov/newsevents/press/monetary/20080311a.htm

And how are these measures being received?  Very favorably!  The Dow Jones Industrials posted their largest one day gain in five years.

Link to news story:  http://biz.yahoo.com/ap/080311/wall_street.html

The only problem is:  Banks are still not lending.  (Hey, once burned twice shy!)

Link to news story:  http://finance.yahoo.com/banking-budgeting/article/104605/Fed-Pumps-More-Money-Into-Financial-Markets

(ag) Tues., Mar. 11, 2008, in Economy

Two Major Concerns for Bankers

FDIC posted its Ombudsman's Report for the last six months of 2007, indicating that bankers are concerned about two main issues:
1.  The Subprime Mortgage Crisis & FDIC's proposals for dealing with it; and
2.  Bank Secrecy Act (BSA) - the cost and the impression that information submitted is not used.

In addition to reporting complaints in these two categories, the FDIC tries to explain why these should not be such cause for concern.

Link:  http://www.fdic.gov/regulations/resources/ombudsman/feedback/message0308.html
(ag) Mar. 10, 2008, in FDIC

Not a Pretty Picture for Banks

FDIC's Quarterly Banking Profile for the Fourth Quarter 2007 is a bit grim.

• Quarterly net income for FDIC-insured institutions declined to a 16-year low.
• Record high loan loss provisions, record losses in trading activities, and good will impairment expenses were significant negative factors.
• One in four large institutions lost money in the fourth quarter.
• Net interest margins continue to decline.
• Full-year earnings fell to a 5-year low.
• Net charge-offs rose to a 5-year high.
• Three FDIC-insured institutions failed in 2007.

There is some good news:

• Asset growth remains strong.
• Domestic deposits posted record growth.
• Trust income rose.

Link:  http://www2.fdic.gov/qbp/2007dec/qbp.pdf

(ag) Mar. 5, 2008, in FDIC.

Chairman Bernanke Reports to Congress

Today, Federal Reserve Board Chairman Ben Bernanke presented the Semiannual Monetary Report to Congress before the House Financial Services Committee.  Most of the report discussed the deteriorating economy, noting that the Fed's balancing act now tips toward encouraging economic growth rather than  dampening inflation.  The Fed is striving to implement monetary policy "properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures."

Sluggish economic activity in the near term is almost a dead certainty.  There is substantial risk that " the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further."  Consumer price inflation has increased, so although Bernanke did not say it, we could be headed for a bad combination of stagnant economy + inflation = stagflation.

Bernanke noted that "monetary policy works with a lag," so it will be some time before we can determine whether the FOMC's aggressive reductions in the target federal funds rate of 225 basis points since last summer are accomplishing the desired results.

Other reportable items include:  1.  The Fed's proposed HOEPA regulations on which comments are still being received and evaluated.  After much berating by Congress, the Fed finally did get around to formulating proposed HOEPA changes.  2.  The Fed is engaged in informal encouragement to lenders to work with borrowers facing foreclosure.   It is difficult to make this sound impressive.  3.  Final Truth in Lending Act Rules should be forthcoming.  New credit card disclosures will be part of those rules.  4.  Separately, the Fed plans to use Federal Trade Commission Act authority to issue rules regarding unfair and deceptive practices by credit card issuers.

Link to testimony:  http://www.federalreserve.gov/newsevents/testimony/bernanke20080227a.htm

Link to other viewpoints about the testimony:  http://www.forbes.com/markets/feeds/afx/2008/02/27/afx4705136.html

(ag) Feb. 27, 2008, in Economy/Interest Rates