I must confess to being puzzled last week by an American Banker article that claimed that Federal banking regulators were looking to send out cease and desist letters to serviers as a way to light a fire under banks who were dragging their feet at the now somewhat infamous so called settlement negotiations among 50 state attorneys general, various Federal regulators, the Department of Justice, and the major banks/servicers.
Now on the surface, this sounds sensible. The banks are not cooperating, so pull out a big gun and if needed, use it on them. But American Banker provided a link to the form of the cease and desist order and it looks remarkably weak. Its requirements are far less demanding than those set forth in the famed 27 page settlement draft that was presented by the AGs and the Federal authorities to the banks.
It’s important to stress that a threat of action that is weaker than what you are demanding in a settlement makes no sense in a negotiating context. It’s like offering to settle a lawsuit for $500,000 when the case only asks for $250,000 in damages. No one would accept the settlement, they’d either fight in court or accept a default judgment.
Now some of my correspondents were of the view that a cease and desist order was a serious matter, so this might create a frisson in the press if this comes to pass. But this is simply not a very serious cease and desist order. Adam Levitin, who replied by e-mail and then amplified his view in a post, confirmed my instincts:
The draft C&D order is a regulatory equivalent of a Potemkin Village….On the surface it looks like a very serious thing–C&D orders are an extraordinary regulatory response in the banking world, where a lot of regulation is done informally….But when one looks at the substance of the C&D order, one is struck by how empty it is. All sizzle, no steak.
The C&D order basically tells banks to set up lots of internal procedures and controls within the next few months and then to tell their regulators what they have done…. The result, I suspect, is that in a few months the bank regulators will declare that everything is fine.
(Even if the regulators think the internal controls are inadequate, it’s not clear what the consequence would be. My guess is that it just results in the bank regulator telling the bank to revise and resubmit.)
By far the most interesting bit in the draft C&D order is the bit requiring the banks to engage independent foreclosure review consultants to review “certain” foreclosures that took place in 2009-2010. There is no specification as to which foreclosures are to be reviewed or precisely what the standards for review are. But that’s all kind of irrelevant. Who do you think the banks are going to engage to do these reviews? Someone like me? Not a chance. They’re going to find firms that signal loud and clear that if they get the job, they won’t find anything wrong. It’s just recreating the auditor selection problem, but without even the possibility of liability for a crony audit.
Frankly, this sort of regulatory outsourcing is pretty astounding–the OCC has resident examiner teams at the major servicer banks. Shouldn’t they be the ones auditing the internal controls and performance, not a third-party compensated by the bank? (Oh wait, I forgot that the OCC is paid by the banks–it’s budget comes from chartering fees and assessments on the banks is regulates. Indeed, I was struck in some places by the linguistic similarities between the proposed C&D order and the banks’ counterproposal to the AGs. It’s impossible to know who was cribbing from whom, but the similar language is revealing.)
So here’s what’s going down. The bank regulators are going to provide cover for the banks by pretending to discipline them very hard, but not really doing anything. The public will see a stern C&D order, but there won’t be any action beyond that. It’s as if the regulators are saying so all the neighbors can hear, “Banky, you’ve been a bad boy! Come inside the house right now because I’m going to give you a spanking!” And then once the door to the house closes, the instead of a spanking, there’s a snuggle. But the neighbors are none the wiser. The result will be to make it look like the real cops (the AGs and CFPB) are engaged in an overzealous vendetta if they pursue further action.
The interesting part here is the question of who is behind this C&D order, assuming it goes ahead. Per the reading above, this looks designed to undermine the settlement negotiations. But the American Banker article claims that:
Frustrated by the lack of progress with a global settlement between the 50 state attorneys general and the top mortgage servicers, federal banking regulators are expected to move forward with their own enforcement actions against 14 servicers as early as next week.
That seems completely implausible. But the reports on which Federal agencies are actually supporting the negotiations have been inconsistent, and there is clearly a split among “banking regulators”, which raises the question as to who is behind this leak to American Banker.
The CSFB is clearly an active player in the settlement process, and we’ve been told that Sheila Bair is too, so at least those two “banking regulators” are trying to move the negotiations forward. The FTC and the DOJ were in on the session with the banks last week, as were “representatives of the Treasury” (which may be CSFB designees rather than permanent Treasury staffers). And the OCC has been reported to have gone rogue and is opposed to the talks.
If I were a betting person, I’d say this is an OCC rearguard action, which might even have quiet Treasury and Fed support, since they are also terribly bank friendly. But I’m open to reader views as to how to square this circle.