Bank Lawyer's Blog

Any Takers For TARP II?

2009-11-09T21:33:00-06:00

TARP II (aka Son of TARP, TARP, Jr., TARP Lite, Tofu TARP, One-Horse TARP, and Diet TARP) is hardly out of the starting gate but is already down on the track with a broken ankle and looks like it might have to be eunthanized.

Several community bankers in the Tampa Bay area are saying “no thanks” to the proposal, and an investment banker questions whether the institutions that need the capital the most would qualify for the funding Obama is offering.

[...]

Many bankers are hesitant to have the government involved in their business any more than it already is, said Paula Johannsen, managing director of The Carson Medlin Co., an investment banking firm in Tampa.

[...]

“Unless the approval criteria is amended in some form, for most banks in the Tampa Bay area, TARP will remain out of bonds,” said Bill Short, president of Clearwater-based Old Harbor Bank.

The government can change the rules after a bank accepts TARP funding and that concerns many community bankers, said Jerry Campbell, chairman, president and CEO of HomeBanc in Tampa.

“If you are flat out desperate, you will take it. If you are not and you have another way around it, you’ll do everything to avoid taking it,” Campbell said.

This echos what we've heard from community bankers in other areas of the country. The most frequently heard cause of reluctance to take TARP, Jr. concerns the problem pinpointed by Jerry Campbell: the government changes the deal on you after you've signed on the dotted line. The federal government has proven itself to be as trustworthy in honoring the terms of a deal as a Capo in the Gambino crime family.

"A deal's a deal." Except when Uncle Sammy's your counterparty.

Handwriting on the Wall?

2009-11-08T21:36:00-06:00

In mortgage banking, the "elephant in the room" used to be repurchase obligations. That elephant (just like Sarah Palin) "went rogue" over the past two years and as a result, mortgage loan investors are busy trying to ensure that if you pay it forward, you sure better be able to buy it back,

Fannie Mae...updated its eligibility requirements for lenders wanting to sell and service residential first mortgages, according to the new selling guide released Friday.

To do business with Fannie Mae, lenders must now have a net worth of at least $2.5m — 10 times the previous required net worth — plus a dollar amount equal to 0.25% of the outstanding principal balance of any Fannie Mae portfolio it services.

In the April 2009 version of the guidelines, lenders needed a net worth of at least $250,000 and an additional dollar amount equal to 0.20% of the portfolio.

This exercise in barn door-shutting makes sense. Many mortgage originators who operated as toxic waste disposal plants during the last orgasmic flurry of residential credit debauchery were sadly deficient in capital and unable to withstand the weight of all their chickens coming home to roost simultaneously and pooping on their shoes when Fannie Mae and Freddie Mac started putting loans back to them faster than Paris Hilton sheds "fiancees." Nothing depresses an investor like Uncle Freddie or Aunt Fannie more than trying to force a corpse to do anything, much less honor its contractual obligations. Requiring ten times the capital that it previously took to be a mortgage seller might help weed out the less (financially) stable originators. At least, that's the hope.

What this type of requirement will also do is accelerate the consolidation of the residential mortgage origination business, which consolidation has been ongoing since the subprime mortgage meltdown commenced and originators started dropping like passes thrown anywhere near Terrell Owens. Last month, Bloomberg noted that over half the single family originations in this country are now made by three entities: Wells Fargo, Bank of America, and JPMorgan Chase. Bank of America wants to increase its percentage another 10%. Obvously, independent originators are worried.

Daniel Crockett, head of Franklin, Tennessee-based Franklin American Mortgage Co., among the largest independent mortgage lenders, said yesterday at the conference that consumers should be wary of increased concentration.

“Competition is the greatest form of regulation,” he said.

Yeah, competition worked great at regulating the mortgage business so far this decade, didn't it? We had plenty of competition, much of it engaged in a race to the bottom.

Don't expect the regulators to back you up on that contention, Daniel. Sheila Bair's previously stated publicly that she believes that the entire mortgage banking business model (what she calls "the originate and sell" model) is "broken." I don't think the model itself is broken, although I do believe that some of the players themselves had broken ethical and moral compasses. It doesn't matter a fig what I belive, however. I suppose Ms. Bair, and perhaps some other federal banking regulators, would like to see banks hold on to more of the loans that they originate. Certainly, a preference for "originate and hold" would require that mortgage lenders be quite large if they're to do large volumes of originations and control costs through economies of scale, both of which are necessary to make money under that business model. A preference for such a model might also lead you to suspect that banking regulators would prefer that loan originations occur through in-house employees of the lender, and that all the guys who operated as "free agents" in the last deluge of home mortgage lending, who produced all the garbage and quickly pushed it out the door to generate fees, simply dry up and blow away.

If the current trend continues, the big banks will be taking this business over and dominating it completely. The independent mortgage broker may ultimately become as rare as a Republican politician who yearns to become "the logical successor to George W. Bush."

Of course, none of us know that such consolidation is inevitable or what, definitely, will become of independent mortgage brokers. If we were that bright, we wouldn't be writing or reading blogs as puny as this one. Instead, we'd have banked our fotune in the Grand Caymans and would be having our liver Rolfed so that we could start consuming our second pitcher of Mai-Tais with Catherine Zeta-Jones, while we watched our eight adopted multi-culti kids frolic in the sea from the deck of our yacht anchored off Hapuna Beach.

Still, if I were an independent mortgage broker, I'd be looking for a "dependent" safe harbor, one that's FDIC-insured.

Looking For Lessons in the Madness

2009-11-05T21:25:00-06:00

While most of the press focused on the FDIC's use of the cross-guaranty provisions of FIRREA, a couple of other interesting tidbits floated to the surface near the shipwreck that occurred last Friday when the OCC sank, and FDIC took control of, nine banks owned by FBOP. One of those tidbits was the fact that earlier last Friday, Tim Geithner, who had flown to Chicgo, announced that the FBOP's community banking arm, Park National Bank Initiatives, had been awarded $50 million in tax credits. No one told Tim that the bank was being closed later that day. While the FDIC keeps the closing information a state secret, I had several interested observers break into hearty guffaws at the thought that Sheila Bair had stuck it to a guy who once cursed her (and other bank regulators) out for not being a team player (meaning that she should stop thinking for herself and become part of the "Yes, We Can" hive). The Treasury Department assured everyone that (A) there was nothing unusual about the FDIC (or the OCC, the lead federal regulator of the banks, and another target of Geithner's previous F-bomb barrage) not communicating the pending seizure to Treasury, (B) no tax credits were "lost" when the bank went down, because they'll go to the acquirer of all of the failed banks, US Bank, and (C) blah, blah, blah, yadda-yadda-yadda.

My secret inside sources assure me that Sheila and her staff broke into a late-day giggle-fest behind closed doors over the picture of Geithner's empurpled face clouding with rage when he realized, late in the day, that he'd been goosed by his arch nemesis. They also assured me that Geithner responded with a veritable carpet F-bombing of all within earshot, causing a passing sparrow to fall dead from the sky. You have to give this bureaucratic "gotcha" to Sheila.

Another interesting tidbit was that the failed banks were fatally hit by the collapse of FNMA and FNMA, which rendered worthless $855 million in preferred stock owned by the banks. Those investments were considered gold not so many years ago, and banks thought of that preferred stock as a safe haven that yielded nice dividends. Although one expert criticized the "business plan" of the banks, it's hard to see how holding hundreds of millions of dollars in GSE preferred stock was anything other than a no-brainer until everything went to hell in a hand basket in a hurry. Who knew Fannie and Freddie were going to be as broke as Bernie Madoff? Other than know-it-all bloggers and anonymous commenters on the internet, that is.

A final interesting facet is that the regulators apparently stymied the holding company's attempt to raise $750 million in private equity. One analyst was quoted as saying that the FDIC wouldn't approve that infusion of capital because it might have had to come back and take over the bank anyway at a later date. Huh? As long as you don't let the bank use the new capital to grow its way out of the problem, my preference would have been to let the bank burn through the $750 million in private money before it ever got to the insurance fund. Then again, I'm merely a tool of private enterprise and not a free thinker with a big picture view like those in D.C.

Another Bank Fail Friday approaches. More fun is likely to ensue.

NOTE TO SELF: Even though you barely have time to bang out these daily screeds, do yourself and all the rest of the readers a favor: proofread BEFORE you post. Thank you.

The Man In The Mirror

2009-11-04T21:22:00-06:00

We have met the enemy, and he is us.
---Walt Kelly

A former client, Pat Dalrymple, who for many years was the president of a savings banks headquartered in Greenwood Village, Colorado (a suburb of Denver), and before that one located is Aspen, wrote an opinion piece that was published in yesterday's Glenwood Springs Independent (Glenwood Springs is located on the Western slope of Colorado, near where Pat resides) in which Pat takes a sober look at the causes of the mortgage meltdown and tells it like he sees it. He doesn't spare "greedy lenders and lax regulators." However, he also doesn't spare others involved in this mess, especially not greedy homeowners who, in many cases, were hip-deep in the middle of the wrong-doing.

It's a myth that the homeowners of America were the innocent victims of unscrupulous mortgage lenders. The bankers had a lot of help; the crisis was “Made in the USA”, and it was an American team effort.

His last bank operated primarily as a single family mortgage broker, originating and selling loans into the secondary market. In that capacity, he had a center ring seat to the entire circus. Unfortunately, the circus went bust and nobody ended up laughing.

While unsparing in his criticism of lenders ("It got so that, if a borrower had a pulse, a mortgage was available") and other participants, including investors, brokers, and appraisers, you can tell that he's especially irked by what he calls the myth of the innocent borrower. Those are the folks who are the object of much wailing and gnashing of teeth in certain quarters, along with calls for their wholesale rescue (also known as "systematic loan modifications") to ease the pain of these innocent bystanders. Pat has some perspective from his own former bank's sad experience that demonstrates that finding truly innocent borrowers in this debacle might be like trying to find a "clean and sober" spectator at Metallica concert.

In August 2007 our bank had some 81 problem loans. These were mortgages that the bank had to buy back because they were in default, or were actually in foreclosure. Of these, 44 were instances of outright borrower fraud, 51 percent. (Many of the rest involved appraiser, broker or title company fraud. As I said, this was a team effort.)

About this time I got a phone call from a lady who said that her attorney had advised her to call the FBI and her lender to inform them why her loan was in default. She said she'd attended a seminar at which she was enlisted in a scam to qualify for a mortgage to “save a poor person's house”. She would certify that she occupied the home, but she'd never have to move in or make a payment. Rent would be collected by the entity masterminding the scam, and payments would be made to the lender. She was somewhat bitter that she'd been defrauded. I said, “Well, ma'am, I guess you committed fraud, too”.

“I guess I did,” she said.

There are a million stories in the naked city of borrower fraud. This was one of them.

We're in the middle of this muddle and dispassionate perspectives are hard to come by. It will be of interest to many of us (if we live that long) to look back after the dust has settled and the blame game has abated, to see how much culpability for the meltdown is apportioned to which participants. Currently, I buy Pat's view: it was a team effort.

As for the "innocent bystanders," I'm reminded of a most excellent meditation on that theme by the late Warren Zevon. From a performance that aired on the BBC on Christmas Day, 1994, Warren utters the plaintive cry of all rats caught in a trap of their own making: "Send Lawyers, Guns and Money."

LOAN MODIFICATION GUIDELINES: BANK LIFELINE OR LICENSE TO LIE?

2009-11-03T21:36:00-06:00

The following is a guest post by John M. Walker, Jr., an attorney and business executive with over 30 years of experience in finance and real estate.

It’s been an interesting few days for those who follow commercial real estate and banking. Friday (October 30), Bloomberg quoted billionaire Wilbur L. Ross Jr. as saying that the U.S. is in the beginning of a “huge crash in commercial real estate.” He also said he’d use “extreme caution” before putting money in commercial real estate, and that, “All of the components of real estate value are going in the wrong direction simultaneously. Occupancy rates are going down. Rent rates are going down and the capitalization rate -- the return that investors are demanding to buy a property -- are going up.”

That same day, the Federal Reserve adopted a policy statement “supporting prudent commercial real estate (CRE) loan workouts,” which, according to the Fed’s press release, “provides guidance for examiners, and for financial institutions that are working with CRE borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties.”

The new loan modification guidelines prompted Henry Blodget to post a blog entitled “New Rules! Banks Can Lie About Commercial Real Estate Loans” on Sunday (November 1). Noting “there’s nothing wrong with encouraging modification,” Bloget expressed concern that with rents dropping, leases rolling into a declining rental rate market, and the possibility of interest rate increases, “the modifications will just kick the can down road. . . .In the meantime, moreover, we will be prolonging the illusion that the banks are healthy. The modified loans will still be classified as ‘performing’ and carried at par--even though the actual asset value is far lower.”

This all comes on the heels of an October 29^th letter from Barney Frank and Walt Minnick to the heads of the Fed, FDIC, OCC, NCUA, and OTS exhorting the regulators “to show some temperance in their regulation of traditional banks” and identifying examples of problem areas, including “’unofficial’ capital requirements” that restrict lending activity and the valuation of assets “down to current ‘market’ value” that “now are making the banks’ capital crunch artificially and unnecessarily worse.”

So, are the new guidelines a lifeline for the banks or a license for them to lie? The answer is neither – and both – and when looking at the likely impact on the banking crisis, it really doesn’t matter which.

The Fed’s press release says the policy statement “details risk-management practices for loan workouts that support prudent and pragmatic credit and business decisionmaking within the framework of financial accuracy, transparency, and timely loss recognition.” The policy statement itself says, “In addition, renewed or restructured loans to borrowers who have the ability to repay their debts according to reasonable modified terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the loan balance.”

And, there lies (pardon the pun) the rub. If the collateral is declining in value – and has declined to an amount that is less than the loan balance - what really is financially accurate, transparent, and timely recognition of loss? Rather than constituting a concrete step toward softening the coming CRE blow and relieving some of the continuing pressure on the banks, the guidelines likely just will lead to sharper “Is too . . .Is not” babble between the banks and their regulators as they argue over value in workouts.

Let’s look at why that’s likely the result. The general consensus seems to be that commercial real estate values have fallen 35% to 45%. Except where there is substantial credit behind a CRE loan beyond just the real estate collateral alone, these loans today are worth no more than the underlying collateral. I don’t expect these values to snap back anytime soon. A September 2009 McKinsey Global Institute report, Global capital markets: Entering a new era, states, “From 1980 through 2007, the world’s financial assets – including equities, private and public debt, and bank deposits – nearly quadrupled in size relative to global GDP,” after having grown at about the same pace as GDP for most of the 1^st eight decades of the 20^th century. One of the report’s conclusions is that it is “likely that total financial assets will grow more in line with GDP in coming years.” A similar outlook for future asset value growth is expressed in the November 2009 Investment Outlook by Bill Gross. Gross notes that for a period of time, economic growth, not paper wealth, was king – but that, beginning in the 1980s, “the cult of the markets, which included the development of financial derivatives and the increasing use of leverage, began to dominate.” This in turn “produced a persistent increase in asset prices vs. nominal GDP.” And, according to Gross, “our ‘paper asset’ economy has driven not only stock prices, but all asset prices higher than the economic growth required to justify them.” Gross also notes “there could be payback ahead as the leveraging turns into delevering and nominal GDP growth regains the winner’s platform.”

Now let’s stir in the massive maturity default risk facing the banks. Deutsche Bank, in its quarterly commercial real estate outlooks, has estimated that over $2 trillion in commercial real estate loans mature between now and 2013. According to Deutsche Bank’s outlooks, many of these loans likely do not qualify for a new loan large enough to pay off the existing debt.

Bloomberg, in an August 13, 2009 article (Next Bubble to Burst Is Banks' Big Loan Values), highlighted the conundrum faced by banks between the balance sheet value of their loans and what may be the loans’ estimated fair value, using Regions Financial Corp. as an example. On page 5 of Region’s 10Q for the period ending June 30, 2009, its loans (excluding leases and net of unearned income and its allowance for loan losses) were carried on its balance sheet at $90.85 billion. In note 11 on page 37 of the 10Q, the estimated fair value of those loans was shown as $68.05 billion, a negative difference of $22.8 billion that is greater than the $18.74 billion net worth reflected on Region’s balance sheet. Is it more financially accurate and transparent and does it reflect more timely loss recognition for the balance sheet loan portfolio value to be carried as $90.85 billion with a note reference to the estimated fair value of $68.05 billion, with the positive net worth of $18.74 billion; or is it more financially accurate and transparent, and does it reflect more timely loss recognition, to reverse the relative portfolio value positions and reflect the negative net worth?

What little I know about FAS 5, FAS 114, and FAS 157 could fit into the proverbial thimble. Varying degrees of managerial discretion and judgment are involved when recognizing impairment, measuring impairment, and measuring fair value – particularly when the “fair value” hierarchy and its 3 levels of inputs come into play. Level 1 inputs (quoted prices in active markets) generally are transparent. Level 2 inputs (not quoted prices, but “observable” inputs) and Level 3 inputs (“not observable”) involve managerial assumptions and are where the “mischief” can occur. Levels 2 and 3 can allow for what Warren Buffett has called “mark-to-model” or, in extreme cases, “mark-to-myth” accounting.

The CRE problem is real. We know serious de-leveraging has begun and will continue; but we don't know the extent of the de-leveraging nor do we know the timing of the de-leveraging period. I think that simply extending the term of troubled CRE loans in hopes of achieving higher occupancies, higher rents, and lower cap rates in the future will delay the inevitable losses – even more so if asset value future growth does track future GDP growth rates. Let’s assume a portfolio secured by collateral originally valued at $10 billion in 2007. At a 35% decrease in value today, that collateral now would be worth $6.5 billion. If GDP were to average 3.5% growth each year in the future and asset value growth were to track GDP growth, then it would take roughly 13 years for the collateral’s value to return to $10 billion. If you’re an optimist, though, it’ll only take about 3 years at a roughly 15.5 % annual growth rate.

Instead of providing the banks a lifeline or giving them license to lie, the guidelines only will give banks cover from under which to push back more strongly against (1) what has been reported as overzealous and heavy-handed examinations that both run counter to the pressure from Washington to “lend” and to “mitigate foreclosure,” and (2) what some have labeled as a “hidden” agenda to reduce the number of smaller or community banks in the U.S. (also known as “to small to save”). Activity is not achievement – while the Neros who oversee our banking system continue to fiddle by addressing only paper-like symptoms instead of the real disease affecting the banking system, that system continues its financial melt-down – unless your objective is to create a smaller banking system under greater government control by simultaneous pursuit of the twin policies of “too big to fail” and “too small to save.”

Much Too Little, Way Too Late

2009-11-02T21:14:00-06:00

Six months ago, knowledgeable observers were moaning about unreasonably arbitrary and harsh examinations of community banks by examiners who seemed eager to choke off bank credit at a time when it was desperately needed. Last week, Congressional leaders finally caught on to the problem.

Democratic representatives Barney Frank and Walt Minnick of the House Financial Services Committee sent a letter to the federal bank regulators that complained about "over-zealous regulatory actions" not based "on wrong-doing by community banks, but on changes in the economic environment and toughening regulatory standards."

While I question how much good such public pressure will do, it's at least some comfort that community bankers are getting across to some people with political power the fact that, as Barney Frank asserts, the regulatory gaps and other regulatory shortcomings that contributed to the current economic crisis "were largely within the non-bank lending market and Wall Street banks." It's frustrating when people who ought to know better hear the word "bank" and apply it with a broad brush. There are "banks" and, then, there are "banks."

The "few examples" listed by Frank and Winnick are representative of what we've been seeing. If this type of jawboning, together with the flexibility that the federal regulators are trying to give banks in dealing with problem real estate assets as represented by last Friday's "Guidance on Prudent Commercial Real Estate Loan Workouts" curbs some of the more arbitrary overkill by federal bank examiners, so much the better for community banks. They need all the help they can get at this point. Nevertheless, to a large extent this is Nero fiddling while Rome burns.

The real problem is that commercial real estate values are distressed, and, as we've been babbling about for awhile, and as Wilbur Ross again warned on Friday, those values are likely to get much, much worse. Parsing the nuances about arbitrary CAMELS ratings, troubled debt restructuring, and sources of bank funding are going to be the least of the problems that we'll have to deal with if we're in the beginning of "a huge crash of commercial real estate."

Wilbur Ross thinks another 400 to 500 banks might fail; Chris Whalen thinks maybe as many as 1,000 might bite the dust. Most of these failed banks will be community banks, the "too small to save" banks, as they have been thus far. Is the country ready to see a large portion of an industry that Frank and Winnick state "fills an important need" (lending to the small businesses that drive the economy) fail because a steamroller started by the Too Big To Fail and the unregulated lenders rolls over them? If so, lots of luck with priming the economic pump through bank lending. You think it's tough now for small businesses to get a loan? Watch what happens when the community banking industry's cut by 15% to 20% or more.

If the country's not ready to accept that result, then something creative ought to be proposed and debated. Where are our feckless leaders in leading us by talking about these tough issues, no matter how politically unpopular they might be? They're too busy issuing overly optimistic pablum on the Sunday morning talking head shows, like the recovery's going to be "a little choppy" and banks need to "take a chance again on the American economy."

Regulatory relief is nice, but it's not enough. Not by a long shot.

Regulators to Private Equity: Take It Elsewhere

2009-11-01T21:12:00-06:00

A couple of articles on Friday's The Deal.com focused on how difficult it is for "private equity" investor groups to help the FDIC address the needs of commercial banks and thrifts for more capital and to increase the pool of bidders for failed banks. The first article is an excellent discussion of the problems that private equity firms have encountered not merely in successfully bidding on failed bank transactions with the FDIC, but with getting approval from the Federal Reserve Board to purchase solvent banks.

"What does private equity even mean to them?" says one annoyed private equity investor focused on banks.

The regulators refuse to be nailed down on the definition of "private equity." What they'll tell you when you talk to them about it is that the definition is a lot like the late Justice Potter Stewart's definition of "pornography": "I can't define it but I know it when I see it."

The article's author, Vipal Monga, asserts that banks are increasingly turning to public equity markets, and that solvent bank "strategic buyers" are "gaining confidence" in their ability to absorb their weaker brethren. Therefore, the regulators don't need private equity investors. Personally, I think that the public equity window will not survive long into the new year, and that the solvent banks' "confidence" will also take a hit in 2010. The commercial real estate market is going to hit the skids on a fast toboggan into the toilet next year and commercial banks are going to feel the effects much more than they have already. That's a subject for another post, however.

I agree with the article's author's view that Chris Flowers' impudent crowing earlier this year annoyed the regulators mightily. One private equity investor told me that Flowers should have been whipped with a wet noodle until he begged for his Mama to make them stop. On the other hand, I think that the regulators got over it. I think that their real problem with private equity is a fundamental distrust that is visceral and, in my view, is based on the fact that regulators are from Venus and private equity managers are from Mars. They come from completely different worlds. Regulators--especially within the FDIC and the Federal Reserve Board---think that "these Wall Street sharks" are not believable when they promise not to try to control the bank. The Fed is using the "common enterprise" doctrine to find "common control" and "interdependent courses of parallel action" across all kinds of structures where, previously, wise men feared to tread. A D.C.-based lawyer who has talked recently to responsible people at the Fed about structuring a private equity deal informed me that he/she was told, "We can't say that you couldn't theoretically structure a private equity deal that we'd approve; however, we haven't yet seen such a structure and we don't anticipate that we will see such a structure in the future."

Is that plain enough? Does anyone need to read between the lines?

The "blind-equity pool" scheme that's discussed in the article might pass muster. Certainly, on the surface it seems to meet the formal objections of the regulators concerning control. On the other hand, an unidentified "banker" opines in the article that such a scheme "will end badly" once a few banks that are purchased by the blind pool head south. At this point, who knows? It can't end badly if it never begins.

Some investors are pursuing other schemes where private equity plays some part, but not the major part, of the ownership of the bank. Others are pursuing joint ventures with financial institutions, in which the institution ends up with a failed bank's deposits and branches and the private equity investors end up with the bad assets and a loss-sharing arrangement with the FDIC. The FDIC is encouraging such ventures. Still other private equity investors figure that as bank failures accelerate and existing strategic buyers reach capacity (or suffer setbacks as the commercial real estate markets continue to deteriorate), private equity's turn at the table will come. The latter investors are standing pat, playing a waiting game. I hope cobwebs don't grow on their heads and shoulders as they wait for a phone call that never comes.

The Fed's hostility toward private equity merited a separate article by Mr. Monga. The speculation of the source of the hostility within the Fed focused on governor Daniel Tarullo. I'd heard that previously, as well. Mr. Tarullo's biography indicates that he never held a non-government, non-academic job in his life, so perhaps he believes everyone on Wall Street is the blood brother (or sister) of Gordon Gekko. Certainly, this can't be a case of familiarity breeding contempt. However, the article also points out that another "Dr. No" has been a fixture at the Fed for years. As one unnamed lawyer snidely observes, "It's not surprising they're making things difficult."..."They've been saying no forever."

"Forever" is a long, long time. As the crisis deepens and the need for buyers continues, we'll see how long this apparent wall remains standing. For the near term, at least, private equity seems to be running uphill.

Unintended Consequences And Potshots From The Peanut Gallery

2009-10-29T21:23:00-05:00

It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.
---Teddy Roosevelt

A post today by John Carney at Clusterstock, and some of the comments to that post, reminded me of my preference to apply "Occam's Razor" to most of life's problems. Simply put (because I'm not bright enough to put it more complexly), Occam's Razor is a principle that states "when you have two competing theories that make exactly the same predictions, the simpler one is the better."

Carney's post discusses statements by the Federal Reserve Bank of New York's general counsel that when the Treasury Department stepped in last year to bail out AIG, the ability of negotiators to make counterparties of AIG (like Goldman Sachs, for instance) on credit default swaps take a "haircut" on what they were owed by AIG went the way of the Dodo bird. A Washington Post article elaborates.

New York Fed officials explained that the main reason creditors were willing for a time to accept less than full reimbursement was their fear of an AIG bankruptcy. The government's rescue of the company removed that threat and left the company with virtually no way to wrestle concessions from the banks.

"In its negotiations with its counterparties, AIG just didn't have the same bargaining power that it did with the Federal Reserve standing in the background," said Thomas C. Baxter, New York Fed's general counsel. "The only sensible outcome was to give them what they were legally entitled to."

Moreover, AIG's foreign creditors told the Fed that they were barred by their governments from accepting partial reimbursement unless AIG faced bankruptcy, because doing so would amount to giving a gift to a U.S. company, according to officials at the New York Fed. Because the law prohibits the central bank from favoring some banks over others, New York Fed officials said they had determined that all of the creditors, foreign and domestic, had to be paid in full. They also decided it would be improper for the Fed to use its power as the banks' regulator to pressure them into taking less money.

Baxter said that the New York Fed "engaged a couple of institutions as to whether they would contemplate a discussion of taking a couple of points less than what they were entitled to." But he said officials were also racing to prevent AIG's collapse and did not have time to get involved in protracted negotiations with each creditor.

Carney alleges that the Fed's bailout of AIG, rather than allowing AIG to go bankrupt, had the "unintended consequence" of giving the counterparties enough spine that they would settle for nothing less than 100 cents on the dollar, which AIG paid. This, according to Carney, will cost the US taxpayers much more than they would have from the AIG bailout if the US government had simply stepped out of the way and allowed AIG to file bankruptcy or, at the very least, not taken any action to bail out AIG until the crisis reached its eleventh hour, fifty-ninth minute and the screws were put to the counterparties to take less than par.

Some commenters disagree strongly with the underlying contention, arguing that the government bailouts of GM and Chrysler resulted in the government strong-arming secured and senior unsecured creditors to take much less than they'd have been entitled to under bankruptcy, and that the government could have chosen to do so in the case of AIG but chose not to do so for some undisclosed reason. Others argue a more nefarious plot, one in which Hank Paulson and Tim Geithner rewarded their Wall Street cronies with plenty of taxpayer dollars because that's what good old boys do for one another. Another commenter alleges that its premature to raise the issue because AIG might pay back its loans from the Treasury and no taxpayer will suffer a loss on AIG.

I'm not a big believer in the probability that the Treasury Department will get back its full investment in AIG, although I agree that it's too early to tell. On the other hand, I don't buy the theories about the deliberate diversion of taxpayer money into the hands of Wall Street "cronies" of Hank Paulson and Tim Geithner solely because the Wall Street firms are part of some nefarious cabal that involves government and financial "oligarchs." That smacks of a poorly written Robert Ludlum knockoff novel. Human beings simply aren't that smart.

When I look for explanations, I usually look for the simplest one available that still passes the smell test. In this case, it's that the Treasury Department decided that it had to save AIG come hell or high water and the rest of the consequences were "details." Carney's correct to cite the law of unintended consequences. I think these folks were running around like Chicken Little, convinced that the sky was falling and that they were the only ones with the money and the power to prevent it. Having been in the midst of such situations, I suspect that paying off counterparties at par was a "detail" that someone thought about for a minimal period of time, looked at what he or she thought was the "big picture" and overriding goal, and simply said "screw it; pay 'em all at par and let's get this thing done." That was about the depth of the thinking that went into that particular issue at the time.

Of course, that's just my opinion. I could be wrong. Not that being wrong would ever keep me from continuing to lob shells from the peanut gallery.

The Everyready Energizer Defendant

2009-10-28T21:40:00-05:00

Some might think that it's hard to believe that supervisory goodwill cases arising out of bank failures that occurred in the 1980s are still working their way through the federal court system, but those faithless readers of this blog know that what Arnold & Porter partner Edward Sisson called "dancing with the bear" takes a very long time. In fact, it takes as long as is necessary for the bear to get tired enough to finally stop dancing, and this bear's "got legs."

FinCri Advisor (free registration required) profiled a shareholder derivative action that has been huffing and puffing since 1993. It arose out of the FDIC's seizure of Meritor Savings Bank, which had been given favorable accounting treatment of "supervisory goodwill" when it bailed out the former FSLIC to the tune of $696 million by buying the broke Western Savings Fund Society.

A key part of the deal, however, was a Memorandum of Understanding that the FDIC gave Meritor allowing it to treat "the differences between the liabilities assumed and the total of the market value of the Western assets, less reserves" as goodwill and amortized on a straight-line basis for up to 15 years.

Without that understanding, the merged bank would not have had enough capital to meet regulatory requirements.

To make a long story short, the regulators broke their word, refused to recognize the "supervisory goodwill" as capital, ordered Meritor to raise its capital levels, and seized it when it couldn't do so. A principal shareholder sued the government and won, to the tune of $276 million. The government appealed and argued that the FDIC was a "non-appropriated funds instrumentality (NAFI)," and, as such, should have been sued in federal district court, rather than the Federal Claims Court. A majority of a three-judge panel of the U.S. Court of Appeals for the Federal Circuit disagreed, and said that the FDIC is backed by the full faith and credit of the United States and, therefore, is not a NAFI, and that a lawsuit in the Federal Claims Court was proper.

Much of the discussion in the FinCri Advisor article focused on how the Department of Justice was shooting the FDIC behind the left ear. Rather than be paid out of the larger pot of funds appropriated by the federal government, if the argument presented by the Justice Department had prevailed, all of the judgment would have to be paid from the Deposit Insurance Fund, meaning that FDIC-insured banks might very well be stuck with the tab (through the assessments they pay to fund the DIF). More important, prejudgment interest, available in federal district court suits but not in the Federal Claims Court, might have elevated that $276 million award to $ 1 billion.

The FDIC is "operating in a manner that is against their own interests," says Thomas Buchanan, the partner in charge of litigation at Winston & Strawn in Washington, D.C., who represented the plaintiffs. "I don't think they thought it through."

Ya' think?

One of the most interesting lessons of all this is one discussed by Arnold & Porter attorney Michael Johnson, toward the end of the article.

But he cautions private parties now contracting with the government to be careful. When the crisis ends, he says, politics can come into play and "hindsight can make the deals look a little different. Government is uniquely situated to alter the terms of the deals everyone thought were good at the time. Hopefully the lesson learned here is that the government does need to keep its promises. If it chooses not to, there are consequences," he says. "Another lesson for the private parties is the wheels of justice can turn a little slowly."

That's a point I've been hammering home to banks who thought about taking TARP money (and some community banks who are still toying with that idea). Some ignored the warnings, took the TARP, and many are now having second thoughts. No small part of those second thoughts have been caused by the manner in which Congress enacted legislation after the deals were consummated that changed some of the deal terms. Those banks can't say they weren't warned, but some of the bank executives still shake their heads and ask whether the government is deliberately trying to screw up or if this is just pure incompetence. It's the latter, mixed up with cold political demagogy, in my view.

It's also a point that those who enter into "loss-sharing" and other types of agreements with the FDIC as part of the resolution of failed banks would be wise to ponder. Those agreements can be breached overnight by folks with (as a former client once put it to me) the ethical principles of an Iranian rug merchant. If a breach occurs, you may have a right to sue the government for that breach, but you may be "dancing with the bear" for 16 years or more before you see a nickel.

The government will next likely ask for a full hearing before the appeals court.

And on and on it goes...

Bad Actors For Bad Times

2009-10-27T21:36:00-05:00

Bad times for banks are also bad times for their customers. Now that the body count of dead banks has zipped past 100 (with a bullet), vermin are crawling out of the sewers to take advantage of the bad news. The FDIC issued a warning yesterday of a fraudulent e-mail that purports to be from the FDIC, states that the customer's bank has failed, and attempts to get the recipient to divulge account information so that the crooks can loot the customer's account. Beware of bottom feeders.

Another charming result of the current economic woes is one highlighted by Alain Sherter at BNet: rough tactics by collection agencies.

Complaints about debt collection rose 34 percent from 2004 to 2008, according to a new FTC report.

The agency last year received roughly 79,000 complaints regarding those third-party debt collection services everyone loves so much. That amounted to nearly one-fifth of all consumer complaints to the FTC.

The most common complaints about debt collectors involved, in order of prevalence: (1) misrepresentation of the amount or legal status of a debt; (2) excessive telephone calls; (3) telephone calls from collectors looking for other individuals; (4) use of obscene, profane or abusive language; and (5) threatening to sue if payment was not made.

While it's always risky (although often fun) to make broad generalizations about any group, I think I'll make one: too many debt collectors are scum, and the scum are tarring the segment of the business that tries to operate within the limits of the law. A recent run-in with a national bill collection firm on behalf of a pro bono client makes me lose that warm and fuzzy feeling I used to get whenever the term "debt collector" was uttered. Some of these losers deliberately flaunt the Fair Debt Collections Practices Act and seem to believe that paying civil fines for violating it (and its state counterparts) are simply a cost of doing business. They should be slapped down and slapped down hard.