Banking Law Prof Blog

Reworking Second Mortgages

Under the Home Affordable Modification Plan (HAMP), banks may begin working with Treasury to refinance second mortgages, including home equity loans, into a government-subsidized program.  This part of the HAMP could get up and running in August.

Texas lawyers will be wondering how this will work with the complicated Texas Home Equity Loan provisions embedded in the Texas Constitution which carry the possibility that a lender can have a lien on the homestead invalidated for failure to comply.

Reuters reports that JP Morgan, Wells Fargo, Bank of America, and Citigroup own $450 Billion in second mortgage loans.  Link to story:  http://www.bloomberg.com/apps/news?pid=20601087&sid=a5_CLxsTSQ14

(ag) July 11, 2009, in Home Equity Lending, Economy

FASB Combats Disclosure Overload

Really.  That's what the July 8, 2009, announcement from the Financial Accounting Standards Board (FASB) said.  Robert H.Herz, FASB Chairman discussed a new project to make financial statements more effective, coordinated, and less redundant. 

"Many constituents have expressed concerns about 'disclosure overload,' "  he said.  "While clear and robust disclosures are essential to informative and transparent financial reporting -- a critical component in maintaining investor confidence in the markets -- improving the way such disclosures are integrated can help decrease complexity."  He described the new FASB project as developing a "principles-based disclosure framework."

Wait a minute:  Weren't we talking about "principles based financial institution regulation" to replace standards based regulation just before the whole financial crisis blew up??

Link to FASB statement: http://www.fasb.org/cs/ContentServer?c=FASBContent_C&pagename=FASB%2FFASBContent_C%2FNewsPage&cid=1176156338441

(ag) July 9, 2009, in Economy, Regulatory Reform

When Agencies Combine: Lessons from the Federal Housing Finance Agency

It's been a year since GSE oversight was reconfigured.  Previously, the Department of Housing and Urban Development (HUD) was responsible for affordable housing goals for Fannie Mae and Freddie Mac, while Office of Federal Housing Enterprise Oversight was responsible for their safety and soundness.  Now the Federal Housing Finance Agency combines both functions.

So what lessons from this reorganization can transfer to the current discussion of financial institution regulatory reform?

1,  Some commentators believe that the separation of authority for safety and soundness from the housing mission of the GSEs exascerbated their problems because of a disconnect in information and a lack of coordinated oversight.  When we think about stripping the existing federal banking agencies of their consumer protection function and giving it to an entirely new, completely separate agency, we might want to think twice in light of the GSE experience.

2.  Others believe that the move to consolidate and strengthen regulation for Fannie Mae and Freddie Mac came too late.  The message here might be for Congress to move forward expeditiously with the current regulatory reform legislation.

Check out the July 8, 2009, American Banker article by Steven Sloan, "In Finance Agency's Birth, a Lesson for Obama Plan."

(ag) July 8, 2009, in Regulatory Reform, Federal Banking Agencies, Economy 

SEC, Corporate Governance, and Executive Compensation

The Securitis and Exchange Commission voted to propose two new rules relating to Executive Compensation.  Each proposed rule has a 60-day Comment Period following publication in the Federal Register.

1.  Proposed Rule requiring public companies receiving money from the Troubled Asset Relief Program (TARP) to provide a shareholder vote on executive pay in their proxy solicitations.

My Comment:  This is one clear reason why banks are repaying TARP money.  They don't want restrictions or disclosure requirements relating to executive compensation.

2.  Proposed Rule requiring new disclosures of executive compensation at public companies in their proxy statements regarding:

• The relationship of a company’s overall compensation policies to risk.
   
• The qualifications of directors, executive officers and nominees.
   
• Company leadership structure.
   
• Potential conflicts of interests of compensation consultants.

The proposed rule is meant to improve the reporting of annual stock and option awards to company executives and directors as well as to require quicker reporting of election results. The proxy rules would also be amended.

My Comment:  Past efforts by SEC to reduce executive compensation through disclosure have been spectacularly unsuccessful.  Where there's a will to circumvent or obfuscate disclosure rules (and there most certainly is), we have only to wait to be amazed at the inventiveness that will manifest itself.

Link to Press Release:  http://www.sec.gov/news/press/2009/2009-147.htm

(ag) July 8, 2009, in Executive Compensation, Corporate Governance

Resilience: Points to Ponder for Financial Regulatory Reform

In the July issue of the Texas Bar Journal, State Bar President Roland Johnson discusses Jamais Cascio's article, "Resilience:  If the Financial Crisis Has Taught Us Anything, It Is That Brittle Systems Can Fail Catastrophically."

My comments:  Key points in the article should reinforce our commitment to a dual banking system and to the proposition that monopolistic regulation is a recipe for disaster. 

Here's Johnson's summary of critical components of system resilience:

• "Diversity.  Not relying on a single kind of solution means not suffering froma single point of failure.
• Redundancy.  Back-up, back-up, back-up.  Never leave yourself with just one path of escape or rescue.
• Decentralization.  Centralized systems look strong, but when they fail, they fail catastrophically.
• Collaboration.  We're all in this together.  Take advantage of collaborative technologies, especially those offering shared communication and information.
• Transparency.  Don't hide your systems.  Transparency makes it easier to figure out where a problem may lie.  Share your plans and preparations, and listen when people point out flaws.
• Fail gracefully.  Failure happens, so make sure that a failure state won't make things worse than they are already.
• Flexibility.  Be ready to change your plans when they're not working the way you expected.  Don't count on things remaining stable.
• Foresight.  You can't predict the future, but you can hear its footsteps approaching.  Think and prepare."

More of my comments:  I would add Simplicity and Humility to this list.  Getting too complicated and thinking that you're smarter than anyone else almost always leads to trouble.  As we redesign our regulatory system, I hope we won't throw the baby out with the bathwater.  Let's look carefully at structures that have worked well in the past and not get so caught up in change that we design a new set of problems.  I hope Congress will listen to State regulators and keep their expertise.

Johnson makes an additional point:  "During any challenging time, we should surround ourselves not only with those who have fresh ideas, but also those who can say, 'This is not my first rodeo.'"

(ag) July 7, 2009, in Economy

The Cambridge University Chest - Better Than Keeping Your Money Under the Mattress

 

Having begun my career as a banking lawyer with FDIC's Washington, D.C. office, I have a keen interest in how banks originated and in how they assured the safety of their funds long before deposit insurance.  Another part of my past is a year spent at Cambridge University writing a thesis on European Community law and monetary policy.  So, I was doubly fascinated by the July 2009 calendar photo and text published by "Cambridge in America:"

"Before the days of banks, all the monies belonging to Cambridge were placed in the University Chest.  Until the fourteenth century, all of the University's books were housed in the chest as well, often as security against loans.  Though the University's money is now held in banks, the budget process is still known as the 'allocations from the Chest.'"

"The current Chest is in the Registrary's office and is 600 ears old.  The existing Chest replaced one burnt when participants in the Peasants' Revolt attacked the University in 1381.  Serious efforts were made to protect the contents of the new chest -- a total of seventeen locks were added to guarantee its security!"

--Source:  University Press Office.

(ag) July 7, 2009, in Deposit Insurance

Clark Abrahams and the Comprehensive Credit Assessment Framework (CCAF)

This week, I've been talking by e-mail with Clark Abrahams, long-time financial institutions compliance advisor and author of CREDIT RISK ASSESSMENT:  THE NEW LENDING SYSTEM (2009).  In his July 2, 2009, blog post, he discusses the proposed Consumer Financial Protection Agency ("CFPA").  He sees the administration's push for "plain vanilla" loan products as bringing with it the need for different means of evaluating a borrower's creditworthiness.  He is working on a Comprehensive Credit Assessment Framework ("CCAF"). 

Credit scores alone are an insufficient indicator of true risk.  Abrahams recognizes the need to include additional "alternative data to qualify borrowers who fall outside of the mainstream"  and to avoid the “one size fits all aspect of credit scoring by conditionally assessing each borrower and deciding what factors are most relevant in a particular situation and what, if any, secondary factors need to be considered in order to render a final decision and, if approved, appropriately price the loan."

Here are some more of his thoughts about evaluating loan applications in the current economic situation and soon-to-be-changing regulatory framework:

" Reading the news, it is obvious that folks like to come up with generalizations, or rationalizations, regarding just about anything.  Perhaps it is the human mind's desire to try to organize information and create rules around observed behavior.   

So, how does this idea relate to the financial crisis, new lending systems, and borrowers, lenders, and investors?  Well, in my travels and discussions with lenders, I have found that they like to generalize a good bit, and their policies reflect that tendency.  In this day and age, it is routine for people to get associated with a number – like their credit score for example.  But people are people, not numbers, and when we start treating people like numbers we end up in a rut like we have today. 

There has been far too much reliance put on credit scores, for starters.  In addition, when lenders decide to tighten or loosen credit standards, they adjust thresholds on individual credit factors in a fragmented fashion – e.g. lower the cap on debt-to-income ratio from 40 to 36 percent, or lowering of the loan-to-value ratio from 90 to 80 percent, or raise the minimum FICO score from 620 to 640, etc.  These sort of adjustments mow down a lot of qualified applicants along with the more marginal ones. 

So what would be a good way to manage risk and adjust credit standards?  The answer is adoption of a comprehensive framework that covers all of the bases at once.  So, what is a proper adjustment of the debt-to-income ratio if credit policy needs tightening?  The answer is: “That Depends!”  For some, the debt ratio does not need to be lowered.  For others it may need to be lowered more than for others.  Still, for others, it may actually make sense to raise it.  I am trying to get folks to imagine a world that avoids sweeping generalizations and treats people more like individuals."

--

My comments:

Long ago and far away -- let's say 30 years ago -- our remembrance is that lenders did sit across the desk from prospective borrowers from the same community, whom they saw every day in the grocery store, the feed store, and in church.  Just like in "It's a Wonderful Life," right?  Well, maybe. . .

Even if this were an accurate picture of lending in the past, we can't go back.  We live in a world of computer models and greater risk tolerance as well as greater consumer appetite for debt.  We've seen the result of carrying risk tolerance and high debt levels come crashing down around us.  We're still struggling to figure out what comes next. 

Objective lending criteria like credit scores make it easy for lenders who lack the skill to make subjective loan decisions.  And they avoid charges of impermissible discrimination.  If it's all quantifiable, it can't be discriminatory.  Can it?  

This is the tension.  How to more accurately evaluate each loan application, without tripping over fair lending laws. 

Other problems are inherent in the credit scores themselves.  Of course, their creators want to maintain the proprietary advantage of keeping confidential the information and algorithms that spit out the scores.  But as long as the scores remain a "black box," we will have trouble on this front.  More study and reform of the consumer credit rating agencies should be on our radar screen.

(ag) July 7, 2009, in Lending Issues

 

Banks and the Right of Setoff - Lehman Brothers Bankruptcy Illustrates a Potential Pitfall

Established law says that even after a bankruptcy petition is filed, a bank may have the right to offset amounts in an account owned by the debtor against loans the same debtor owes to the bank -- WITH APPROVAL OF THE BANKRUPTCY COURT IN RESPONSE TO THE CREDITOR'S MOTION FOR RELIEF FROM THE AUTOMATIC STAY. 

In addition to Bankruptcy Court approval, two other conditions must be met: 

1. The debt must be unconditionally fixed, due and owing before the debtor files the petition in bankruptcy; and 
2. At the time the bankruptcy petition is filed, the account and the debt to be offset must be in the same right and capacity.  (That means, for example, that the bank can't offset amounts in an account owned by X Corporation against a debt owed by Y Corporation even if Y Corporation is an affiliate of X).

So here's the problem in the Lehman Brothers Holdings, Inc, bankruptcy case: 

Lehman Brothers Holdings, Inc., owed a substantial sum to DnB NOR Band ASA (the "Bank").  The amount in question was denominated in Norwegian Kroner and not converted to dollars in the reported case, so let's just say there was a lot of money at stake. 

Before the bankruptcy filing by Lehman Brothers Holdings, Inc., a related but distinct corporate entity, Lehman Brothers Commercial Corporation, initiated a book transfer of funds to an account owned by Lehman Brothers Holdings, Inc.  The transfer of funds was initiated on Friday, three hours after the bank's cutoff time, which meant that the bank's account agreements provided that funds would be treated as transferred on the next business day which was Monday.  Before the transfer could be finalized around noon on Monday, Lehman Brothers Holdings, Inc., had filed a petition in bankruptcy. 

The issue facing the court was whether the transfer was deemed complete before the filing of the bankruptcy petition.  If the transfer was complete, the funds could be offset.  If not, the bank could not use offset to effect payment of the debt owed by Lehman Brothers Holdings because the funds were still owned by an entity other than Lehman Brothers Holdings at the moment the bankruptcy petition was filed.  

In this case, the delay in processing the transfer meant the bank was out of luck.  No offset was permitted because the deposit and the debt were not mutual (owned and owed in the same right and capacity) at the time the bankruptcy petition was filed.  Timing is everything!

In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

 

Link to background about Lehman Brothers Holdings bankruptcy:  http://www.bloomberg.com/apps/news?sid=awh5hRyXkvs4&pid=20601087

 

Link to case:  Download 08_13555 2

Thanks to Karen Neeley of the law firm Cox Smith in San Antonio and Austin, Texas, for mentioning this case in her client newsletter.   

(ag) July 6, 2009, in Lending Issues

Bank of America and Merrill Lynch - How Did a Private Deal Become a Public Bailout?

The U.S. House of Representatives Committee on Oversight and Governnment Reform is conducting a series of hearings to examine Bank of America's acquisition of Merrill Lynch, which started as an unasisted purchase, but subsequently required an extra $20 Billion in TARP funds to close the deal in the last days of the Bush administration.   B of A received a total of $45 Billion in TARP funds. 

On June 25, 2009, Federal Reserve Chairman Ben Bernanke presented his perspective on the transaction as it unfolded during the Fall of 2008.  Former Secretary of the Treasury Henry Paulson is scheduled to testify on July 16, 2009.  Bank of America CEO Kennneth Lewis testified on June 11, 2009, about the acquisition. 

Questions from the Committee include: 

• Why didn't Lewis tell shareholders the magnitude of problems and losses they would be picking up with Merrill at an earlier date and why wasn't the additional bailout funding disclosed earlier? 
• What kind of pressure did Bernanke and Paulson exert for Lewis to close the deal after it became apparent that losses in Merrill's portfolio were greater than initially estimated?
• In hindsight, how important was this transaction for a rapidly collapsing stock market and and increasingly troubled economy?

(ag) July 5, 2009, in Economy

Ideas for Teaching Banking Law When Everything Is Changing

Here's a discussion Cassandra Havard, Banking Law Professor at the University of Baltimore School of Law, would like to initiate.  She says:

"I'm writing to several banking law colleagues to ask how you've changed your syllabus since the financial crisis began. I'm tempted every semester to scrap the whole thing, but know that there are probably lots of innovative ideas of how to include the current events more.

One change I made last Fall was to have a hot topics newspaper discussion -- with each student presenting an article from the Sunday or Monday morning newspaper (my class met on Mondays). Our format was very similar to the news program Washington Journal on C-Span in the mornings, where the article is displayed on a document camera and highlighted in key places. I teach a seminar, which meets for three hours and the class is limited to 15 persons and I limit these discussion to the first 30 minutes of class."

-------

My comments from Texas Tech University School of Law:  I hope other banking law profs will share their ideas.  Here's what I do to keep the class fresh:

1.  Background is important.  Many people call every financial institution a "bank," with no distinction for non-depository mortgage lenders, investment banks, credit unions, or other types of charters with different powers and supervisors.  I use the textbook as a resource to put the business of banking in context, so that we can talk accurately about how banking evolved, who regulates what, and what the current powers and restrictions on each type of entity are.

2.  I invite Guest Speakers, including the General Counsels to the State Banking Department and the State Savings and Loan Department, banking lawyers from across the state, an investment banker from New York, and local bankers, to provide real world perspective.

3.  My course website includes links to each of the regulatory agencies, as well as Congressional committees, the State financial institution websites, and other sources.  We discuss current news items briefly almost every class day.  When developing issues are not covered in the textbook, I hand out packets that I prepare.  I suggest that students take a look at the Wall Street Journal online to follow the news.  This is a great class to be teaching now because everyone has questions and opinions.  I usually cap the class at 30-35, always with a waiting list.   

3.  In addition to a final exam to make sure we've covered the basics, I let each student choose a current topic, prepare a paper and make a group presentation (with powerpoint) to the whole class to share their research and gain public speaking confidence.  Following are some of the research topics I've assigned in recent years.  I provide some initial sources to get the students on the right track and I'm always impressed with their analysis and recommendations.  Of course, there's no problem finding new topics each year!

• Check 21:  Electronic Conversion and Check Truncation:  Why Does Wal*Mart Give Me My Check Back?  Why Don't I Get My Check Back in My Statement?  Will Paper Checks Become History?  Technology and the Changing Business of Banking
• Community Reinvestment Act:  What Is CRA?  Is It Serving the Purpose Congress Intended?  Why Are Banks Subject to CRA and Not Other Businesses?  Is This Fair?
• Financial Privacy Notices:  Why Do I Get All These Notices?  What Do They Mean?  Are They Accomplishing What Congress Intended?
• Federal Preemption:  When Can Federal Agency Interpretations Overcome State Law?
• FACTA:  What Is the FACT Act? Should Medical Information Be Used In Credit Decisions?  How will the affiliate marketing restrictions work?  What about requirements for "furnishers" of information to the Credit Reporting Agencies?  How will direct dispute resolution work?
• Financial Literacy:  What’s Available?  What’s Required or Recommended by the Federal Banking Agencies?  At the State Level?  Should credit counseling be mandatory before entering into a “high cost home loan”?  How can financial education address the problems in subprime lending?
• Sarbanes Oxley Section 404 Internal Controls:  What's the Impact for Large and Small Banks?
• Anti-Money Laundering:  Bank Secrecy Act and USA PATRIOT Act burden on banks after 9/11 - Is It Cost Effective?

• Loan Securitization – How did the originate-to-sell model for lending contribute to the subprime mortgage meltdown?  What role did securitization of subprime loans and the creation of complex derivatives play in the subprime mortgage crisis?  Who should we blame?  Borrowers?  Lenders?  Regulators?  Investors?

And a paper topic from my Fall 2007 Syllabus:  Subprime Lending and Predatory Lending – What’s the Difference?  What are the benefits and the pitfalls of subprime lending?  What are the ramifications for the U.S. economy and what are the global implications?

4.  Here's a compressed version of the basic topics I cover in a Banking Law course:

• Banking in the U.S. - Historical Development
• What Is A Bank?
• Money Supply and Payment Systems
• Regulation
• Charters - Types of Charters & How to Apply for a Charter
• Dual Banking System
• Bank Balance Sheet
• Loans as Assets and Lending Restrictions
• Investments as Assets and Investment Restrictions
• Deposits as Liabilities and Deposit Restrictions
• Capital Requirements
• Safety and Soundness
• Consumer Protection
• Activities Restrictions
• Geographic Restrictions
• Affiliates and Subsidiaries
• Enforcement
• Bank Failure

As a practicing banking lawyer for many years, I really enjoy this dynamic area of the law.  Getting the opportunity to teach the next generation of banking lawyers is great!  And frankly, I'm sure being a law professor for the last five years has been much less stressful than representing financial institutions through these economic times.  

AALS has a strong Financial Insitutions Section, which I encourage other banking law professors to join.  I'm always open to brainstorm about teaching and research in this area.  Just send me an e-mail!

(ag) July 3, 2009, in Banking Law
 

What Exactly Is a Dual Banking System?

One reader of this blog asks, "What exactly is a dual banking system?"  So here's the background:

In the U.S. today, we have two types of bank charters:  1.  Each State has the authority to charter and supervise banks within its borders through a State Banking Commissioner and State Banking Department (although states may consolidate regulation of banking with other industries such as insurance and name their supervisory department something different); and 2.  At the federal level, the Office of the Comptroller (OCC) has the authority to issue national bank charters and has exclusive supervisory authority (sometimes called "visitorial power") over national banks.

National banks trace their existence and powers to the National Bank Act of 1864.  The national bank charter was instituted as a means of raising funds for the Civil War.  State chartered banks were already in existence and continued on a parallel track with national banks. Many present-day legal disputes over the powers of national banks go back to the original language of the National Bank Act of 1864.  Of course, the National Bank Act has been amended repeatedly since then and the business of banking has evolved into many areas that could not have been foreseen in 1864.

FDIC statistics show that as of 3/31/09, there are 1,519 commercial banks (not thrifts or credit unions or other lending institutions but insured deposit-taking institutions with a bank charter) operating as national banks and 5,518 commercial banks operating as state-chartered banks.  The organizers of a bank can choose whether to operate under a state or national charter when the bank is formed and they can switch charters from state to national or national to state at any time (unless they are in poor financial condition and a charter change will not be approved). 

What factors influence choice of charter? 

• Those who choose a national charter often cite nationwide uniformity of regulation; thus most really large banks hold a national charter. 
• Those who choose a state charter are often smaller community banks that focus on a smaller geographic area and like the idea of going to the state capital to deal with a banking department that is smaller and more accessible, with decisions made on the basis of state-wide conditions.  However, there are also many smaller community banks holding national charters. 
• A comparison of charter fees, assessment fees, perceived expertise of examination staff, prior good or bad experience with the regulator, and perceived strictness of regulation may influence charter choice. 
• Because both national and state regulators are funded by fees and assessments paid by the banks they regulate, regulators in effect compete to get more and larger entities to choose their charter.  In the worst case, this can lead to a "captive" regulator who trades on "lax regulation" to gain in the turf war.  Commentators cite the former Federal Home Loan Bank Board that chartered federal savings and loan associations up until the S&L crisis of the 1980s as the poster child for a "captive" regulator that kowtowed to the industry it was supposed to regulate.  As a result, Congress dissolved this agency and created the Office of Thrift Supervision ("OTS"). 
• Nationwide banking operation, whether under a national or state charter, has brought convenience and lower cost financial products to consumers.  It is possible to operate a nationwide banking system under a charter from one state, with authorized branches in other states.  This does require complying with laws in each state of operation and increases the cost of compliance.  On the other hand, the costs of trying to evade state consumer protection have been quite high for consumers and the economy.  
• Over the past five years, the Office of the Comptroller of the Currency ("OCC"), the chartering authority for national banks, and the Office of Thrift Supervision ("OTS"), the chartering authority for federal thrifts, have responded to their industries by aggressively claiming that more and more state laws are preempted by the National Bank Act.  Former Comptroller of the Currency John D. Hawke openly marketed the national bank charter as a way to escape state consumer protection laws.  Subsequent Comptrollers have continued to pursue litigation to shield national banks from state laws.  
• Two recent Supreme Court decisions have addressed federal preemption. 
  •  In Watters v. Wachovia (2007), the Supreme Court allowed a mortgage lending corporation (not a depository institution but a state corporation) to exempt itself from state consumer protection law by becoming an operating subsidiary of a national bank.  Thus on one day, the entity was required to submit to registration requirements under Michigan law, but on the day after it was acquired as a subsidiary of a national bank doing exactly the same mortgage lending it had previously previously conducted in the State of Michigan, it placed itself beyond the reach of Michigan consumer protection law.  Although the OCC claimed exclusive "visitorial power" over subsidiaries of national banks to the same extent it possessed exclusive "visitorial power" over the banks themselves, the OCC never had the staff, the funding, or the schedule to go into operating subsidiaries to check on their lending practices as they did for banks themselves.  Wachovia (failed), Wells Fargo, Citibank (troubled), HSBC all had subprime mortgage lending subsidiaries that were exempt from state consumer protection laws.  One has to question why the OCC expended its resources fighting the State's efforts to enforce consumer protection laws instead using those resources to cooperate with the States to ensure consumer protection. 
  • In Cuomo v. Clearing House Association (2009), the Supreme Court found that the OCC had overstepped its legal authority in claiming that a State Attorney General could not sue a national bank for violations of valid state consumer protection and anti-discrimination laws.  The OCC had claimed that it was the only enforcer of consumer protection for national banks -- with the obvious problem that it was not equipped to do that job.  This month, the Supreme Court ruled that a State Attorney General can sue a national bank to enforce state consumer protection laws. 
  • The Obama administration's draft legislation presented to Congress this week (which I have outlined in a previous post) would reverse the Watters decision and allow States to pass and enforce consumer protection laws which are expressly not preempted by federal law, even when the State law sets a higher consumer protection standard than federal law, as long as the State law applies equally to State banks and National Banks (and subsidiaries).
  • The draft legislation would adopt the Cuomo decision, making it clear that State Attorneys General can sue national banks to enforce valid state consumer protection laws.  
• Some people as whether the State banking charter has any value today.  They may also ask why we do not have a single federal banking charter and a single national bank regulator.  Stated another way, why should we continue to have a "dual banking system," with the ability to choose either a State or a National Bank charter?  
  • Our nation is based on a balance between State and federal powers.  Americans have never wanted the federal government to overpower the ability of States to address issues particular to their citizens.
  • The Constitution's Tenth Amendment recognizes "federalism" and the state/federal balance by providing that powers not expressly granted to the federal government are reserved to the States and the people.
  • Congress and the Supreme Court have expressed reluctance to preempt state laws unless there is a strong reason to do so,
  • State banks have been described as "laboratories of innovation."  The State banks originated checking accounts, the first NOW accounts which paid interest, and interstate branching.  A State legislature can move more quickly than Congress to adopt new practices and products that apply to a more limited area.  If successful, the innovations can spread, and if not, they can be changed.
  • Having a single charter and a single regulator would create a monopoly, which is less efficient and less responsive that when we have a choice between state and federal regulation.  A single regulator can be coopted more easily by industry.  Absolute power corrupts.  There would be few checks on a single regulator's mistaken understanding of the economy or failure to regulate appropriately.  With the dual banking system, state regulators can catch issues that might be missed by a single federal regulator.
  • State and federal regulators have a long, successful track record of cooperating in bank examinations and regulations.  Cooperative pooling of resources leads to better oversight coverage.  Incorporating both State and national perspectives leads to a more comprehensive understanding of the economic costs and benefits involved in banking regulation.   

Link to FDIC's website for a very simplified timeline of banking from the 1700s to the 2000s:  http://www.fdic.gov/about/learn/learning/when/1700s.html

(ag) July 2, 2009, in Dual Banking, Federal Preemption 

Analyzing the Consumer Financial Protection Agency Act of 2009

      On June 30, 2009, the administration delivered to Congress legislation which provides details behind the broad Financial Regulatory Reform White Paper.  The draft “Consumer Financial Protection Agency Act of 2009” raises many critical issues, including:

 

•  Mission and Scope of Authority.   The CFPA’s broad mission is to protect consumers of all types of financial products and services.  This represents an effort to regulate unregulated financial institutions, to centralize consumer financial protection so as to minimize inconsistencies in regulation, and to address the reality that consumer protection issues have been marginalized by agencies with other responsibilities such as safety and soundness.

      A key concern here is whether consumer financial protection regulation can or should be compartmentalized.  Prudential regulation, which emphasizes financial solvency, must take account of the consumer protection performance of a financial institution to insure long-term viability.   Safety-and-soundness and consumer protection have long been regarded by the best bank regulators as complementary rather than contradictory.

A positive aspect of the proposal is the regulation of previously unregulated providers of financial products and services.  This is long overdue.  Had all mortgage brokers and lenders been subject to a level playing field of consumer protection oversight, many of the abuses leading to the subprime mortgage meltdown might have been controlled. 

      
• Composition of the new CFPA Board.  The five-member governing Board will include four public members appointed by the President and confirmed by the Senate as well as the Director of the National Bank Supervisor, another new agency combining the responsibilities of the Office of the Comptroller of the Currency (“OCC”) and the Office of Thrift Supervision (“OTS”).  One can question whether the new national bank regulator is given a disproportionate voice at CFPA, with only “consultation” to be provided by State regulators, the FDIC, and the Federal Reserve.

• Staffing.  Each of the existing federal bank regulatory agencies will transfer its current consumer protection division to the CFPA.  This proposal assures expertise and minimizes start-up time for the new agency.  The greatly expanded jurisdiction over new entities, products, and services will, however, require the new agency to recognize and allocate staff resources among at least three models for regulation.  I describe these as:  1.  “examination-driven” regulation, which is highly staff intensive because it is based on periodically scheduled on-site visitation;                     2.  “complaint-driven” regulation, which is less staff intensive and less comprehensive because it calls for regulatory attention only when triggered by a certain level of consumer complaints; and 3.  “report-driven” regulation,  like the current review of Home Mortgage Disclosure Act (“HMDA”) data by the Federal Reserve Board which analyzes information required to be submitted and produces a report lagging real time by almost two years. 

• Funding.  The Plan outlined in the White Paper calls for the CFPA to be “independent” of the industries it regulates.  As background, the existing federal banking agencies are funded, not through taxpayer monies but through charter fees and assessments raised from the entities they regulate.  This provides a perverse incentive for agencies to compete with each other to provide the most favorable, least restrictive regulation in order to increase the number and size of institutions they regulate.  “Captive” regulators have marketed their charters as a way to escape consumer protection statutes. 

Details provided in the draft legislation call for the agency to be funded through Congressional  appropriation, authorizing Congress to say how much the agency can spend; however, the legislation goes on to provide that the CFPA shall recover the amount of funds expended through collection of annual fees or assessments on covered entities.  Will continuing the practice of funding a regulatory agency from its regulated constituents result in “capture” of this new agency?

• Clarification of Federal Preemption.  The proposed legislation reestablishes balance between State and federal authority over consumer protection.  States are expressly permitted to enact and enforce consumer protection laws that are more stringent than federal laws.

The 2007 Supreme Court decision in Watters v. Wachovia would be overturned by making State consumer protection laws applicable to national banks and their operating subsidiaries to the same extent that they apply to state banks.  State consumer protection laws are declared not inconsistent with federal law and thus not preempted if they afford consumers greater protection than federal law, making federal consumer protection laws “the floor rather than the ceiling.” 

Industry representatives are sure to complain that the result will be fifty different state standards which will increase the costs of financial products and inhibit innovation.  These arguments must be judged in light of the high costs to all consumers and to our economy which resulted from aggressive preemption of state consumer protection laws.  Large nationwide financial institutions have the capability to research and coordinate legal requirements as they did prior to 2004 when the pace of federal preemption as a means of escaping state consumer protection laws accelerated.

The 2009 Supreme Court decision in Cuomo v. Clearing House Association is affirmed with language defining “visitorial powers” of the national bank regulator.  State attorneys general are expressly authorized to bring lawsuits to require national banks to produce records for investigations into violations of State consumer laws and to enforce any applicable federal or State law.

•  Establishment of a Victims Relief Fund.  Providing that civil money penalties will go into a fund available for restitution rather than into general revenue is a positive step. 

• Weighing Costs and Benefits of Regulation.  CFPA must, in the exercise of its rulemaking authority, consider potential benefits and costs to consumers and regulated entities.  Troubling language in the statute provides that CFPA may not declare a consumer financial product or service unlawful unless it “causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers and such substantial injury is not outweighed by countervailing benefits to consumers or to competition.”  Under this standard, “teaser rate” mortgages would not be unfair to consumers who could avoid injury by refusing the loan. 

 

(ag) July 1, 2009, in Congress, Economy, Federal Banking Regulators, Federal Preemption

Arthur Wilmarth Interview on Cuomo Decision

National Public Radio talked with George Washington University Law Professor Arthur Wilmarth yesterday.  He is a highly regarded proponent of the dual banking system and an opponent of aggressive federal preemption in the financial institutions arena, as well as a prolific author of Law Review articles in the banking law field. 

Link to interview:  http://www.npr.org/templates/story/story.php?storyId=106062165

(ag) June 30, 2009, in Federal Preemption/Dual Banking

Analysis of the Cuomo Opinion

Today, the U.S. Supreme Court delivered its opinion in Cuomo v. Clearing House Association, upholding the power of States to enforce their own non-preempted consumer protection laws by bringing suit against national banks and their affiliates.

This opinion was one of the very last to be published before the end of the Supreme Court’s 2008 term.  Justice Scalia authored the majority opinion, joined by Justices Stevens, Souter, Ginsburg, and Breyer.  Justice Thomas filed an opinion concurring and part and dissenting in part, joined by Chief Justice Roberts and Justice Alito.

The majority opinion finds that the Office of the Comptroller of the Currency (“OCC”), the chartering authority and federal regulator of national banks, promulgated a regulation and an interpretation of its regulation that do not comport with the National Bank Act and are, therefore, invalid. 

States do have the power to sue national banks for violation of state consumer protection laws.  

 The background of the case involved an investigation by the New York Attorney General, triggered by data indicating racial disparities in loans by national banks headquartered in New York made to white borrowers and loans the same banks granted to African-American borrowers.  Rather than respond to the Attorney General’s request for information that might explain these racial disparities, the national banks, including Wells Fargo, HSBC, J.P. Morgan Chase, and Citibank, and others that are members of the financial institution trade group, Clearing House Association, L.L.C., filed suit to block his investigation.  The OCC and the national banks agreed that state consumer protection and anti-discrimination laws in this case were valid and not preempted, but they said the State could not enforce its laws against national banks.  The OCC claimed that lawsuits against national banks were preempted because only the OCC had “visitorial power” over national banks and their operating subsidiaries.

The Supreme Court declared that the OCC’s regulation purporting to preempt State law enforcement is not a reasonable interpretation of the National Bank Act.  The majority opinion makes a distinction between “visitorial powers,” which the National Bank Act gives exclusively to the OCC, and the State’s power to enforce the law.  The majority opinion gives cursory acknowledgment to the Chevron Doctrine, under which courts defer to reasonable agency interpretations of statute, but goes on to say that “the presence of some uncertainty does not expand Chevron deference to cover virtually any interpretation of the National Bank Act.  We can discern the outer limits of the term “visitorial powers” even through the clouded lens of history.  [Visitorial powers] do not include, as the Comptroller’s expansive regulation would provide, ordinary enforcement of the law.”

Justice Scalia’s majority opinion recognizes that when a State sues a national bank, the normal rules governing litigation protect against overbearing.  The majority opinion did find that the State’s power to issue subpoenas under its own authority, rather than that of the court, is preempted.  As a result, the Attorney General’s letter request for information was preempted to the extent that it was a veiled threat to exercise subpoena power the Supreme Court declares preempted.  

The majority opinion turns on the term “visitorial powers” in the National Bank Act, coupled with the Supreme Court’s extensive analysis of the historical reach of “visitorial powers” and prior Supreme Court opinions, such as Guthrie v. Harkness, 299 U.S. 148 (1905) and First National Bank in St. Louis v. Missouri, 263 U.S. 640 (1924) , which upheld the right of a private citizen and the right of a State Attorney General, respectively, to bring suit against national banks to enforce State law.  The majority did not engage in a formal Chevron analysis and did not flatly say that the OCC’s interpretation was “unreasonable,” although that is the implication.  The Supreme Court says that “the presence of some uncertainty does not expand Chevron deference to cover virtually any interpretation of the National Bank Act.”   The majority opinion does not invoke the presumption against preemption and finds it “unnecessary to do so in giving force to the plain terms of the National Bank Act.”  On the other hand, the Court says, “Neither should the incursion that the Comptroller’s regulation makes upon traditional state powers be minimized.”  The majority opinion also notes that, “The consequences of the regulation also cast doubt upon its validity.”  It is reassuring to note that the Court does look at context and effect and does not merely rubberstamp an agency’s regulations.  The Court endorses cooperation between federal and state regulatory structures, saying, “This system echoes many other mixed state/federal regimes in which the Federal Government exercises general oversight while leaving state substantive law in place.”  

 The reach of Watters v. Wachovia, 550 U.S. 1 (2007), is strictly limited by Cuomo:  “The sole question was whether operating subsidiaries of national banks enjoyed the same immunity from state visitation.  The opinion addresses and answers no other question.”

Interestingly, Justice Ginsburg authored the Watters opinion, which upheld an OCC regulation invoked against a State banking commissioner attempting to enforce a state registration requirement against a state-chartered mortgage lender which became an operating subsidiary of a national bank to evade state consumer protection regulation.  Justices Breyer, Souter, Kennedy, and Alito joined the majority in the Watters case.  Justice Stevens filed a blistering dissent in Watters, joined by Justices Scalia and Chief Justice Roberts.  Justice Thomas took no part in the Watters case.

Justice Thomas’s dissenting opinion in Cuomo would have found the term “visitorial powers” ambiguous and allowed the OCC free rein to interpret that statutory term under the Chevron Doctrine.  The dissent relied on National Cable & Telecommunications Association v. Brand X Internet Services, 545 U.S. 967 (2005), for the proposition that:  “A court’s prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute and thus leaves no room for agency discretion.”  Justice Thomas thus dismissed Guthrie and St. Louis, discussed above.  Justice Thomas would not require a clear statement from Congress before allowing a federal agency to preempt state consumer law.

My analysis:  The Cuomo opinion must be read in light of the subprime lending crisis which has bloomed into a recession after the commencement of this case.  This case was brought for the express purpose of blocking State investigation into abusive lending.  Unchecked abuse is exactly what happens when a powerful federal agency crusades to enlarge its own jurisdiction and protect rather than regulate the industry it oversees.  Common sense has indicated for at least the last five years that the OCC has neither the staff nor the inclination to enforce consumer protection laws.  How could it not have been apparent to Congress and the courts that acquiescing in this agency’s aggressive efforts to prevent any other entity doing so would have disastrous results for consumers and for the economy?

As Congress now turns its attention to designing the optimal regulatory structure for financial institutions, one can hope that they will not ignore these lessons: 

• The dual banking structure, with equal standing for state and national charters, is an essential balancing component within our national economy.  
• State and federal agencies can and do cooperate in consumer protection and in bank regulation.  The long history of successful cooperative regulation should preclude any suggestion that the federal government should stand in the way of state consumer protection laws and enforcement. 
  
• No federal agency should be allowed to market a charter as a get-away-with-it-free card providing immunity from state consumer protection laws. 
  
• If the state/federal balance is restored, it will provide checks against any one agency or any one type of charter ignoring consequences for consumers and for the economy.
  

The Cuomo opinion reassures us that States can adopt and enforce consumer protection laws evenhandedly with respect to all financial institutions, regardless of charter.  Federal agency and financial institution resources that have, until now, been devoted to fighting consumer protection laws should now be invested in protecting consumers from financial abuse.

(ag) June 29, 2009, in Federal Preemption

Supreme Court Overturns OCC's Preemptive Regulation in Cuomo v. Clearing House Association

The U.S. Supreme Court released its opinion in Cuomo v. Clearing House Association this morning.  The good news for States and for consumer protection is that the decision invalidates an Office of the Comptroller of the Currency ("OCC") regulation to the extent it would have prohibited a State Attorney General from going to court to enforce valid state consumer protection and anti-discrimination statutes against national banks.

Finally, the Supreme Court has found that there is some "outer limit" to the OCC's preemptive authority, which has proceeded over the past 10 years to aggressively undercut the dual banking system and the power of the States to protect their own citizens from abusive lending practices.

Link to Supreme Court opinion:  http://www.supremecourtus.gov/opinions/08pdf/08-453.pdf

A more complete analysis of the Cuomo opinion and a comparison with Watters v. Wachovia will follow later today.

(ag) June 29, 2009, in Federal Preemption/Supreme Court