Eliot Spitzer, former New York State attorney general, now governor, savages the Bush Administration in a Washington Post op-ed today (hat tip Mark Thoma). He discusses the measures taken by Federal banking regulators, namely the Office of the Comptroller of the Currency, to stymie state efforts to curb predatory lending.
While the article is largely accurate and highlights a largely unknown chapter in our credit mess, it is a tad misleading on a couple of points. Spitzer presents the OCC as an unimportant regulator, when starting with the Clinton Adminsitration, under Comptroller of the Currency Eugene Ludwig, the OCC has been playing a more active and influential role than in the past. Similarly, states have been in a long-running turf war with the federal government over banking regulation, and the states have lost most battles, as this case attests.
From the Washington Post:
Several years ago, state attorneys general and others involved in consumer protection began to notice a marked increase in a range of predatory lending practices by mortgage lenders. Some were misrepresenting the terms of loans, making loans without regard to consumers’ ability to repay, making loans with deceptive “teaser” rates that later ballooned astronomically, packing loans with undisclosed charges and fees, or even paying illegal kickbacks. These and other practices, we noticed, were having a devastating effect on home buyers. In addition, the widespread nature of these practices, if left unchecked, threatened our financial markets.
Even though predatory lending was becoming a national problem, the Bush administration looked the other way and did nothing to protect American homeowners. In fact, the government chose instead to align itself with the banks that were victimizing consumers.
Predatory lending was widely understood to present a looming national crisis. This threat was so clear that as New York attorney general, I joined with colleagues in the other 49 states in attempting to fill the void left by the federal government. Individually, and together, state attorneys general of both parties brought litigation or entered into settlements with many subprime lenders that were engaged in predatory lending practices. Several state legislatures, including New York’s, enacted laws aimed at curbing such practices.
What did the Bush administration do in response? Did it reverse course and decide to take action to halt this burgeoning scourge? As Americans are now painfully aware, with hundreds of thousands of homeowners facing foreclosure and our markets reeling, the answer is a resounding no.
Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye.
Let me explain: The administration accomplished this feat through an obscure federal agency called the Office of the Comptroller of the Currency (OCC). The OCC has been in existence since the Civil War. Its mission is to ensure the fiscal soundness of national banks. For 140 years, the OCC examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers.
In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government’s actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.
But the unanimous opposition of the 50 states did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation.
Throughout our battles with the OCC and the banks, the mantra of the banks and their defenders was that efforts to curb predatory lending would deny access to credit to the very consumers the states were trying to protect. But the curbs we sought on predatory and unfair lending would have in no way jeopardized access to the legitimate credit market for appropriately priced loans. Instead, they would have stopped the scourge of predatory lending practices that have resulted in countless thousands of consumers losing their homes and put our economy in a precarious position.
When history tells the story of the subprime lending crisis and recounts its devastating effects on the lives of so many innocent homeowners, the Bush administration will not be judged favorably. The tale is still unfolding, but when the dust settles, it will be judged as a willing accomplice to the lenders who went to any lengths in their quest for profits. So willing, in fact, that it used the power of the federal government in an unprecedented assault on state legislatures, as well as on state attorneys general and anyone else on the side of consumers.
One very underreported story in recent years has been the pattern of “Federalization of regulation” — every time a state tries to exercise its own authority to enforce a higher standard than the Bush administration approves of, they simply pre-empt it. We saw that most recently with the EPA’s efforts to shut down California’s greenhouse gas limits.
One wonders if anyone in the executive branch has considered how a Democratic administration might use the power they’ve been grabbing.
There’s some irony in that for those familiar with the history of the slogan “States’ Rights!”
Meanwhile, on the credit card side, the U.S, Supreme Court ruled in 1978 that a nationally chartered bank can export interest rates from the state where it is incorporated, based on the laws of that state, to any other state, regardless of the usury laws in effect there. 2 state legislatures, Delaware and N or S Dakota, have effectively been
the means by which banks have circumvented the other 48 states attempts to protect against predatory credit card lending.
You probably already know this, but in that case, Marquette vs. First Omaha Services Corp. the Supreme Court ruled that a national bank could charge the highest interest rate permitted in its home state to customers living anywhere in the United States, irrespective of any state interest rate caps. That was first used by credit card issuers (Citibank in South Dakota) and had the effect of gutting usury laws (the decision is considered to include not just national banks, but also federally chartered savings and loans, installment sale sellers, and chartered loan companies).
There have been other attempts by the states to assert authority over local banks; in recent years, these have been fought much harder by the OCC and/or the Fed. You are correct, the Supreme Court decision was a big loss.
He doth protest too much. He was well aware of what was going on, and investigated the situation but went suddenly silent until now. How convenient.
Spitzer probe threatens MBIA bond guarantees
May 2005 | Feature
Regulatory scrutiny of accounting practices at MBIA has put pressure on the monoline insurer’s triple-A rating, undermining its guarantees. Hardeep Dhillon reports
Investigations by New York
attorney general Eliot Spitzer and US regulator the Securities & Exchange Commission into market abuses by the insurance industry have focused firmly on two of the industry giants, AIG and MBIA Insurance. Accounting irregularities at the two firms have made April another worrying month for insurance sector spreads and sentiment towards ratings.
MBIA overstated profits by $54 million and was forced to restate seven years of results based on incorrect accounting for two insurance deals in 1998, spurring several class action lawsuits. More worryingly, the firm was hit with additional subpoenas from Spitzer and the Securities and Exchange Commission over and above those it received in late 2004. The investigations relate to MBIA’s accounting treatment of advisory fees; how it determines loss reserves and case reserves; purchasing credit default protection on itself; and documents relating to Channel Reinsurance, part-owned by MBIA.
Maintaining its triple-A rating is paramount to MBIA and, by extension, a large proportion of the market. The elite status is transferred to nearly all of the roughly 100,000 bond issues the firm guarantees. MBIA Insurance has been, and still is, rated at the highest level by Standard & Poor’s (since 1974), Moody’s (1984) and Fitch (1995).
The importance of the nine ‘A’s is not lost on MBIA. According to its 2004 report, the insurance giant firmly states that having the highest rating possible is “the keystone of our franchise”. John Hallacy, managing director of public finance, adds that MBIA’s “objective is to maintain that triple-A, and we’re not going to do anything to put that at risk”.
MBIA’s immense clout in the market is evidenced by the volumes of debt it guaranteed last year, a whopping $585.6 billion. Of this, $367.2 billion was municipal bonds, 18% of the market. MBIA also backed $218.4 billion in domestic and foreign structured finance deals, which include asset- and mortgage-backed securities, as well as foreign public finance bonds and collateralised debt obligations.
Though analysts say that any risk to MBIA’s financial strength is not thought to be immediate, they do warn that the prospect or threat of a downgrade, such as a change to a negative outlook, would be severely detrimental to the firm’s business. According to Deutsche Bank, MBIA has guaranteed 5% of all triple-A asset-backed bonds launched since 1999. If the company was cut to double-A plus, 80% of the securities MBIA insures would suffer a ratings cut, leaving a paltry 20% at triple-A.
“A downgrade would have significant repercussions in the structured credit market. Because MBIA guarantees so many triple-A tranches of asset-backed issues, a ratings downgrade would cause those bonds to widen sharply,” says Rob Haines, insurance analyst at CreditSights in New York.
The importance of the triple-A rating to MBIA’s business, adds Haines, makes the firm’s debt and equity vulnerable to any news that its ratings are at risk. This was borne out by MBIA’s bond market valuations weakening substantially on news of the accounting problems. Five-year credit default swaps were trading more like a triple-B credit last month, widening from 39/42 to wides of 100bp before resting at 80/85 on April 18. “Spreads have been pretty beaten up, but they have not just moved on MBIA-specific news; Spitzer’s investigations into AIG and others in the industry have also buffeted spreads,” says Arun Kumar, insurance analyst at JPMorgan.
Question marks over MBIA’s credit quality have been raised before (see Credit, March 2003, pp. 26–29), when US hedge fund Gotham Partners published a report on its website entitled Is MBIA triple-A?. The hedge fund claimed that MBIA was excessively leveraged and had incurred estimated losses of between $5.3 billion and $7.7 billion on its underwriting exposure to CDOs.
Sean Egan, managing director of Egan-Jones Ratings, says that MBIA’s new policy sales dropped from $568 million in 2003 to $220 million in 2004 because of reduced demand and increased competition. And Egan expects fines and curtailment of business lines on the back of the investigations. “MBIA and MBIA Insurance are not triple-A credits because of the slim capital and soft demand and margins. The level of cushion is not enough to sustain triple-A ratings,” he says.
Nonetheless, a host of others are not as critical of MBIA. One favourable voice is CreditSights’ Haines, who believes that fears have been overplayed and though the spotlight on the company has affected its valuations, this could provide investors with good trading ideas. “We expect spreads to materially tighten from current levels. Consequently, we believe MBIA represents one of the more attractive relative values in the insurance sector,” he says.
AIG has also come under regulatory pressure. The insurance company surprisingly delayed the filing of its 10-K until April 30 after allegations that it had used improper finite reinsurance contracts to inflate its net worth and smooth earnings figures.
On March 30, AIG management disclosed that a number of questionable transactions since 2000 would result in a decrease to AIG’s shareholder equity of $1.7 billion, triggering the resignation of Maurice ‘Hank’ Greenberg, the firm’s CEO for the last 38 years. Other concerns relate to bonuses being paid to AIG staff via subsidiary Starr International and questionable ties with other subsidiaries.
Confidence in AIG was not helped when a number of employees tried to remove documents from AIG’s Bermuda office at the start of April.
The rating agencies were quick to take action. Fitch led the charge against AIG on March 15 by removing the firm’s coveted triple-A crown, leaving the firm on AA+. Standard & Poor’s and Moody’s matched Fitch at the end of March, downgrading AIG to the same level. All three agencies left the company on review for downgrade.
Despite their speed of response, some have questioned the actions of the rating agencies. For Rafael Villarreal, insurance analyst at BNP Paribas in London a review for downgrade was reasonable but he believes it would have been better to wait until submission of the 10-K and all relevant information had been disclosed before taking rating actions. “The rating agencies have pulled the trigger before all the facts are known. This is not the right way to proceed,” he says.
Fitch has kept AIG on negative outlook since March 2003, an example of “poor rating management” for Villarreal, who believes that sitting on the fence with positive or negative outlooks for so long does not help investors at all. “Except on limited circumstances, unresolved outlooks and long lags in rating actions are useless to the market they serve,” he says.
Villarreal believes that investigations into AIG’s non-life insurance business will have little effect. The unit represents roughly 30% of operating profits and the adjustments will impact only a small proportion of that division. More importantly one cannot ignore the fact that AIG has been successfully writing profitable business across the globe for many years. The firm has $83 billion in shareholders’ funds, substantial income from a diversified business and strong business fundamentals, superior to all European insurance groups.
Haines at CreditSights is another strong advocate of AIG’s creditworthiness. “Although the loss to its triple-A rating is clearly a significant event for AIG, we do not expect the company to fall out of the double-A ratings bracket. The company’s capitalisation remains strong, its financial leverage is conservative and its coverage ratios remain solid,” he says.
National banks were not engaging in predatory lending to any significant degree. The major bad actors were lenders and brokers who were not regulated by the federal bank regulators, and were subject to the authority of state attorneys general. Spitzer’s falsehoods were soundly fisked by Comptroller John Dugan today. Preemption is a red herring, since national banks did not cause the predatory lending problems that Spitzer’s complaining about. Spitzer knows this. He’s simply an abject liar, who’s using this issue in an election year to boost Democrats and hurt Republicans.
And pray tell what is Countrywide? They have engaged is so many bad practices, including advertising fraud (bait and switch), calling customers a good two years+ before their mortgages reset to tell them inaccurately that a reset was imminent and they’d better refinance, changing deal terms, that it defies description.
Yes, the OCC’s record is far better than the Fed’s as far as taking OFHEO to heart is concerned. And Spitzer likes the limelight. But people in affordable housing say the states are far more pro active (as a whole) and pro consumer than the Feds, particularly as far as banks are concerned.
First anonymous: you have not been following very closely, have you? The Federal Reserve was given authority to regulate the non-depository lenders with the ’94 HOEPA Act, and refused to do it. So Countrywide (outside the bank), Ameriquest, OptionOne, New Century, et. al. were free to ply their trade with no regulation. And Bernanke was Alan’s chief deputy during those years. One term Ben, that is all, helluva job.
New York State has a predatory lending law and was recently utilized by an attorney on Staten Island. The court found that the case involved predatory lending and has issued an order blocking the foreclosure:
Why doesn’t Spitzer provide the resources so everyone in New York facing foreclosure can take it to court in a similar manner.
It is quite interesting to watch the blame game but no one cared not first the Gov and his cohorts when the state coffers were stuffed with rising revenue. This whole discussion is patronizing to the very folks who were real estate mensa. Banks need tighter oversight for sure and the usurping of power by the Federal Gov is well documented across the board. Whatever you think of ROn Paul, he has a point.
I doubt if anyone gives a crap about The Department Of Labor makeover (By Bush Admin) and what The Pension Reform Acr did for SIFMA and the derivatives mafia, and why there is massive danger ahead! No one has cared yet…..why bother….