As a follow up to our series* on how Bank of America and its supposed independent consultant Promontory Financial Group, colluded to make a mockery of a process designed to provide compensation to borrowers who had suffered abuses in foreclosures during 2009 and 2010, we thought we would offer a few suggestions as to how to forestall future fiascoes of this sort.
Recall that when the OCC set forth what was later called the Independent Foreclosure Reviews, it envisaged that the process would be carried out by independent consultants. However, that process is well known by those who care about the public interest, as opposed to the interest of banks, to be hopelessly corrupted when the party who is supposed to be subject to tough scrutiny is choosing the consultant and writing the checks. And that’s before you get to the wee problem that large banks are very lucrative clients. Even a party that was not retained by the bank might well want to use a consulting gig to cultivate a relationship with it.
This problematic practice is made worse by the special role that Promontory has carved out in the financial services industry. The firm operates as a shadow regulator.** Promontory’s founder and CEO Gene Ludwig was Comptroller of the Currency under Bill Clinton; it was then that installed its recently departed chief counsel, Julie Williams, who was firmly ensconced when the consent orders were being negotiated. Williams, having been deeply involved in designing a process that insiders estimate earned Promontory $1 billion in gross fees across three clients, then went from the OCC to Promontory. And, bringing the revolving door to a new level, a Promontory staffer, Amy Friend, took her place at the OCC.
So any suggested reforms don’t simply need to address the general problem that supposedly independent consultants will follow the money, and the money happens to reside at banks; they also need acknowledge the fact that the OCC is a hopelessly bank-friendly regulator. It isn’t just that it has deep ties to a private-sector firm that pushes hard to help banks get their way (its own site describes how it helps “preempt” and “mitigate the severity of” regulatory actions). It’s that there’s no good reason for the OCC to exist at all. Recall that at one stage, regulatory reform proposals included getting rid of the current apparatus and folding everything into the Fed. There was considerable backlash, party due to turf protection, partly due to fear of too much power being concentrated in an already too secretive and influential organization.
But the consolidation proposal has some merit. Too many regulators with overlapping mandates allows for regulator-shopping (as in characterizing or housing activities so as to get the most friendly regulator in charge). And the OCC has the worst incentives of any financial regulator. Unlike the SEC and the CFTC, it is not subject to Congressional budgetary appropriations and oversight. Unlike the Fed and the FDIC, it does not have to eat its own cooking. If a bank fails, the FDIC has not only to deal with the consequences, it actually has to now and again run banks. This creates a vigilance and an understanding of nitty-gritty bank operations that other bank overseers lack. The Fed has trading operations in the New York Fed (giving it some appreciation of trading businesses and current market conditions) and has to open up the discount window (and more recently, create an alphabet soup of special facilities) to keep sick financial firms from keeling over. The OCC has no one to serve but the banks, since it lives off fees from them. It lives to serve their interests, not the public interest, and suffers no adverse consequences when it gets things wrong.
We’ll sketch out some high level ideas; we welcome further reader input.
Reforming the Use of Contractors in Consent Orders and Other Regulatory Processes
It would be much better if regulators were staffed up to regulate rather than having to fob off their job onto contractors. But in lieu of that, some changes that would improve the current process include:
Much tougher rules on conflicts. Every conflict, not just at the firm level, but of its senior executives the leadership team on the engagement, and any subcontractors must be disclosed online to the public. Failure to disclose a conflict should subject the company to an automatic fine greater than the value of the engagement. Bringing in subcontractors without disclosure and clearing for conflicts should also lead to automatic, punitive fines.
Greater transparency. While the engagement letters for the foreclosure reviews were made public, the redactions were remarkable. There is no justification for not disclosing the past work that Promontory did for Bank of America, nor for failing to disclose the names and backgrounds of the senior members of its project team. Even more important, the financial terms should be made public.
Have the regulator clearly be the client. The regulator should engage the consultants, not the bank, and the banks should be required to pay for the cost of the engagement. Given how the banks failed to do anything to contain the massive fee feeding frenzy of the foreclosure reviews, it’s impossible to imagine that any regulator could do a worse job.
Close the revolving door. Call it a Julie Williams clause, that no one at a regulator involved in any way in a consent order can obtain employment at any consultant involved in providing services related to that consent order for two years after the end of the engagement.
Reforming the OCC
While it would be better to get rid of the OCC, it is more realistic to rein it in.
Subject the OCC to Congressional budgetary processes and oversight. The OCC needs to be made accountable to the public. Making it answer to Congress isn’t perfect, but it would be a step in the right direction
Give the OCC its own inspector general. Right now, the OCC is supervised by the Treasury IG, which Neil Barofsky has depicted as the weakest IG in the executive branch.
Eliminate the budget for international travel and fold any foreign oversight into other regulators. The London Whale was under the purview of the OCC. Need we say more? The risk supervision in JP Morgan’s Chief Investment Office was astonishingly lax, including the unheard of approach of having the risk managers report to the business unit, rather than an independent, corporate-wide risk management function. The very fact that the OCC waved that through alone should be cause for clipping its wings.
Install external directors that can oversee the OCC on an ongoing basis and vote on major policy measures. Perversely, given its track record, the Comptroller of the Currency is a Director of the FDIC. It would be preferable to have there be, say five directors of the OCC, with two appointees, plus the head of the FDIC and (say) the Vice Chairman of the Fed as directors, along with the comptroller. Obviously, an important governance step would be to determine what decisions could be made by the Comptroller alone and which needed to be approved by the full board.
Investigate What Went Wrong With the Foreclosure Review
Any reform effort would be much better informed with a proper investigation of why the foreclosure reviews went so horrifically awry. An investigation needs to start not with the hiring of the independent consultants, but the development of the consent orders themselves, and include what parties influenced the provisions of the consent orders. At a minimum, it’s critical to review the e-mails, meeting schedule, and phone log of Julie Williams and anyone else in the OCC who was involved in a major way in negotiating the consent orders and in the process of vetting independent consultants. It is also important to subject the sudden closure of the review to similar scrutiny. The key questions there involve the fact that the banks and the independent consultants clearly misrepresented the amount of borrower harm to the OCC. Query what penalties should result from that sort of misrepresentation.
* See Executive Summary, Part II, Part IIIA, Part IIIB, Part IV, Part IVB Part VA and Part VB. We have also contacted Promontory Financial Group with a list of these articles, indicating that were planning additional posts and asking for their comment. We did not get a reply.
** ProPublica called Promontory a “shadow OCC” yesterday. Naked Capitalism readers know that well already, since Matt Stoller first described Promontory as a shadow regulator in May 2012 and reiterated that point in June. We fleshed out his observation in our whistleblower series, including an entire post that described how Promontory became a shadow regulator on February 11.