Cease and Desist Orders as Regulatory Theater in Mortgage Settlement Negotiations

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.

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  1. Siggy

    The point of accomplishment here is the proposed C&D order itself and the fact of its publishment.

    It is theater or propaganda, however you might wish to style it.

    If it is successful, it will be a part of a campaign to avoid prosecution for what has been, and to a degree what is continuing, the perpetration of wilful fraud and the avoidance of due process in the matter of recording mortgage/deed of trust and note instruments as related to RMBS securitizations.

    As this all winds down we shall end up with several million clouded residential titles for which where will be no good course to cure.

    In the absence of prosecution, there will not be available an all encompassing cure and $20 billion is chump change relative to the economic damage that has been done.

  2. LillithMc

    My impression of Sheila Bair from FDIC last night on 60 Minutes was that she wanted a slush fund of 20 billion similar to the BP oil spill to use to buy off home owners trashed by the fraudulent lending and foreclosure processes. She said we have to stop the individual lawsuits or the economy will not recover. She seemed surprised and upset with the lawsuits. Proves the legal rights and interests of the homeowner was never part of the process.

    1. Externality

      The bankers wanted to hold hard assets (e.g., houses), not debt denominated in devaluing dollars. The lawsuits and contested foreclosures are making it harder for the banks to swap dollar-denominated debt for hard assets. The longer the foreclosure process goes on, the less the mortgages will be worth (in real terms).

      If, as some expect, the we see high inflation and a declining dollar, the bankers would be left holding devaluing paper, even if the homeowner pays the mortgage each month.

      If we see Weimar Republic-style hyperinflation, a days wage would be enough to pay off, in full, even a large mortgage. An article in Asia Times Online cogently argues that Bernanke’s strategy is identical to that of Rudolf von Havenstein, chairman of the Weimar Republic’s privately-owned central bank. http://www.atimes.com/atimes/Global_Economy/MC23Dj02.html If they are right, the banks would be left holding a mortgage worth less than a cup of coffee. A homeowner willing to forego a trip to Starbucks could pay off their mortgage in full, with change left over.

      1. positiveone

        You are absolutely right in that banks wanted to swap the bad loans for hard assets/land& property. I cannot believe regulators didn’t see that! I am having a hard time myself understanding how thousands of workers at these regulation agencies appear to have no specific job functions and really don’t regulate–they paper push? Scary! Doesn’t make you really comfortable that the needed supervision is happening at all. Keep writing, keep thinking, keep sharing..we can make a difference!

    2. Francois T

      “She said we have to stop the individual lawsuits or the economy will not recover.”

      Then she should know WTF she’s gotta do, no?

      If not, she has the right and the obligation to make room for those who do.

  3. readerOfTeaLeaves

    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.

    I don’t have enough information to make any sort of assessment. But I sincerely appreciate having this laid out as a Potemkin action. And phrases like ‘regulatory theatre’ need a much wider, more frequent usage IMVHO.

    At this point, I don’t have the smarts to figure out who is foisting this hornswoggle on the public, but it’s certainly a bracing breath of fresh air to get some pointers about its Potemkin nature.

  4. positiveone

    Who knows? All we have to do is keep writing to them, keep the facts flowing and not stop until we see real justice. What is real justice? I think we all agree it is bringing any mortgage from 2004-2008 to an adjusted balance to reflect the tax appraisers valuation. It means remediation for all who have had homes stolen in fraudulent foreclosures (that’s all of them). It means an end to securitization and return to basics in banking and investing–meaning only trade on real assets, on real company stock values, not on contracts–which is all that a mortgage is…a bi-lateral contract. We need to remember that banks have a think tether to ownership..only a mortgage and only if that mortgage has their name on it..Homeowners have: deeds, title insurance, equity stakeholdership, and in some states, homesteaded property rights. Banks should understand…nobody wins from having people living on the streets of America. People aren’t going to go out to dinner, shop, buy stuff, bank, or do anything while they are homeless. And everybody, everywhere needs to hold these bankers accountable, personally accountable for this fiasco. It must happen.

  5. positiveone

    And on the 60 Minutes episode..Sheila Bair looked nervous. She looked stressed beyond belief. I think the sale of the failed Wa-Mu to Chase in 2008, for literally pennies on the dollar, and the devaluing of Wa-Mu assets by Chase, and then Chase’s subsequent illegal foreclosure on millions of Wa-Mu’s failed loans (with no assignments for them)..has her nervous…and rightfully so. She was the head of the FDIC and allowed the sale of the $309billion dollar Wa-MU to sell to Chase for a mere $50,000,000. I am thinking she gets it now..really gets it and it must be blowing her mind that she was duped, cajoled, defrauded into cheating the government and taxpayers out the the real value of Wa-MU.

  6. Francois T

    Just receive an email saying “Re-Join Us”. It was for BO 2012 campaign.

    My 2 pages answer can be summarized as “In your dreams, sweet pea!”

  7. Stanley Putra

    Is the value of Wa=Mu’s assets conservative at $309 billion.
    This is why we have the US Congress. The house has 435 members and are the closest to the people being elected every two years. Spending Bills can only originate in the House of Rep. The Federal Reserve Act gives the power to coin money to a few people. The War Powers Act gives the power to declair war to the President. If we had a real Supreme Court it would rule that the Congress can’t delagate the powers the Constitution gives Congress. What the Congress is doing is passing admendments to the Constitution by vote. The Constitution can only be amended by State Ratification or the States can call for a Constitutional Convention. The American people have to understand an action either furthers a Free America as a Republic or it does not. PERIOD! Every Individual American has to realize what a great thing we have going here and it is our responsibility to pass this on to the next generation.

  8. A Further Comment

    Re: “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.”

    If that is the case… then, I say: genius. We should see a case like this. If the fiduciary must choose the least expensive path, let it be the path of litigation – that we may, as a country, finally SEE with our own 600,000,000 eyes what has been going on.

    As for C&Ds… Honest to God, no offense intended. It’s not the rarest thing, as this article implies. Mind you, It’s not something you want to do all the time – one does not want to appear as an over-reactor. But really, if you sign a contract for the buyer to take a certain action within the next three days – and they go on vacation… Day 4 = C&D> Bang, done. Why would you want to work w/ someone who has been partying for three days while a signed contract which could improved the status of the whole world is sitting right on their desks – ignored forever. C&D. Buh-bye. Sorry we met. Don’t call us, we won’t call you. Adios.

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