Today’s topic du jour was the financial meltdown and bailout. Unlike yesterday, the three presentations on this topic complemented each other rather than plowing the same ground.
However, to properly address the topic, it is necessary t o start with yesterday’s lunch speaker. On Thursday, IWIRC sponsored Neil M. Barofsky, who is the Special Inspector General for the Troubled Asset Relief Program. His department is a combination of TARP cop (he has a badge but not a gun) and oversight panel.
Barofsky spoke about two different topics: how well TARP has accomplished its goals and efforts to keep TARP honest. I did not take good notes, so any inaccuracies are due to my memory and not to the speaker.
According to SIGTARP Barofsky, TARP was sold to the public on the basis that it would accomplish three goals: 1) avoid a financial meltdown; 2) protect jobs; and 3) keep people in their homes. In his opinion, TARP accomplished the first goal, but failed at the second and third. This has contributed to public perceptions that TARP was nothing more than a bailout of Wall Street rather than Main Street.
He also talked about his department’s efforts to keep TARP honest. He explained the concept that fraudsters go through three stages: they incur a loss; they use creative accounting to cover the hole; and 3) they look for a “whale” to plug the hole. In the case of the TARP program, this meant that financial institutions who had undisclosed losses would apply for government money to try to solve their problems while lying about their actual finances. He gave several examples of prosecutions for submitting false applications to TARP. He estimated that SIGTARP had saved the government $500 million in funds not paid out and had recovered over $100 million from bad guys.
The Banks Are Not Fixed
Friday opened with “Bailout and the Fallout,” featuring moderator William Derrough and panelists Damon A. Silvers, Deputy Chair of the Congressional Oversight Panel, and Matthew Feldman, who helped Treasury with the auto bankruptcies.
The panel spent quite a bit of their time talking about the events leading up to TARP. The story beings in early 2007 with the collapse of the subprime mortgage market. Two Bear Stearns hedge funds were seized by Merrill Lynch in June 2007. The year 2007 ended with Lehman Brothers reporting a profit.
In March 2008, JP Morgan Chase Bank acquired Bear Stearns for $2 a share with a federal guaranty attached. According to Silvers, this violated the rule that we don’t bail out stock brokerages. However, the government did not know what the consequences of not bailing out Bear Stearns would be. While much has been made of the pressure placed on JP Morgan Chase Bank to make the acquisition, even greater pressure was placed on the Board of Bear Stearns. They were told that they could accept $2 a share or they could explain their failure to do so to FBI agents and SEC personnel in the next room.
In September 2008, the government seized Fannie Mae and Freddie Mac. Their problem was that they had strict lending standards. However, they were competing with lenders who had no standards (i.e., no doc loans). To solve this problem, they began buying the junk that others were producing.
Over the period September 12-13, 2008, the Bush administration decided not to bail out Lehman Brothers. A decision was made to let a brokerage fail based on the belief that the damage to the economy could be contained. According to one of the panelists, it was an experiment to see what would happen if a major brokerage went over the cliff.
On September 14, 2008, Lehman Brothers filed for bankruptcy and Merrill Lynch sold itself to Bank of America.
On September 15, 2008, Timothy Geithner summoned JPMorgan and Goldman Sachs to a meeting. He informed them that they would bail out AIG with an $80 billion loan. He gave them a term sheet and left. At 2am the next morning, an attorney for the two called the Fed and said they would not do the deal. Undeterred, the Fed scratched out the names of JP Morgan and Goldman Sachs and wrote in the Federal Reserve Bank of New York. The Fed went so far as to employ the attorney who had drafted the term sheet on behalf of the private parties.
The conclusion was that in September 2008, the government, Republicans and Democrats alike, made a decision to take an activist role in avoiding a financial meltdown. That policy continued with the Obama administration.
In March 2009, the Obama administration made the decision to save Chrysler and GM. The government made a decision that a private equity firm would not have made for the reason that eliminating millions of jobs during a financial crisis was too great of a risk to take.
The take away was that TARP succeeded in calming the financial panic but failed to “fix” the banks.
The following is pretty close to a direct quote from Damon Silvers, which drew a sustained ovation. He was comparing the decision to “fix” the failing automakers with the financial sector:
Regulation Is Not Our Friend
The banks are not fixed. The corrupt nature of the way they are poisoning our
financial sector has not been fixed. We will eventually have to step in and fix
Friday’s lunch speaker was Fox Business Channel correspondent Charles Gasparino. His thesis was that the problem was not too little regulation, but too little trust in the market. The problem, in his view, was that the government intervenes to protect the market from the consequences of its bad decisions. Compounding the problem is that government regulators fail to recognize what is in front of them.
He said that regulation provides a sense of comfort that some all-knowing body is watching out for us. However, he said that regulation itself could have caused the financial crisis and that the recent Dodd-Frank financial reform legislation could lead to another financial crisis.
One problem he said was that regulators are always looking at the wrong stuff. The government investigated Bernard Madoff six times, but failed to verify any of his trades. Had they looked, they would have seen that they were non-existent and caught the fraud.
Gasparino also blamed a partnership between business and the government. He said that Wall Street was spared the pain of its mistakes time and time again. The Fed turned on the spigot in 1987, 1994 and 1998 to protect Wall Street. Lehmann Brothers was bailed out in 1994 and 1998. It survived until it took on so much risk that it nearly took down the financial system in 2008. Dick Fold, Chairman of Lehman Brothers believed that his firm would be bailed out up until the signed the bankruptcy petition. What if they hadn’t bailed them out, he asked. Would that have saved us from 2008? He also gave the example of Bear Stearns. In 1998, it was the company with the best risk controls. By 2008, it was the first to fail. His point was that the lesson Bear Stearns learned from the bailout of 1998 was that traders could receive the upside of risk taking while the government would protect them from the downside.
Gaparino claims that we put too much faith in regulation and not enough in the markets. Playing to the audience, he said that without all the bailouts, there would be more work for bankruptcy lawyers.
He also took aim at the Dodd-Frank financial reform bill. He argued that it enacts Too Big to Fail into law by allowing the government to take over (i.e. bailout) huge entities. He said that the bill’s problem was that it added more regulation when the system needed to be rebuilt from ground zero.
However, he did not criticize the decision to bail out AIG. He said that there was so much systemic risk built in by 2008 that the system could not have survived AIG going under. “When that toilet starts flushing, it takes everyone down.”
He had an interesting take on Glass-Steagall. His market-based solution was to allow combinations of banks and investment banks with the caveat that their deposits would not be insured. That way, they would have to pay more for deposits and the public would have to decide whether the increased return was worth the risk. He returned to his point that subsidizing risk is a bad idea. “They will gamble if you give them the incentive.”
Gasparino also suggested that bond rating agencies were worthless. They provided a false sense of security at the time that they were being pressured to give AAA ratings in order to generate fees. He suggested that investors should have been doing their own due diligence rather than relying on a third party.
He also suggested that political correctness may explain why business journalists didn’t point out the problems at Fannie Mae and Freddie Mac much earlier. He said that they were prodded by President Clinton’s Department of HUD to guarantee riskier loans, which led to a housing bubble. However, because giving working class people access to housing was deemed a worthy cause, the warning was not given.
I attended a breakout session on the foreclosure crisis led by Alane Beckett, Judge Susan Barrett, Dillon Jackson and former ABI President Ford Elsaesser. They sounded a similar theme of an industry in shambles. On the one hand, you have Jeffrey Steffen signing 10,000 affidavits a month (one every 78 seconds). On the other hand, you have paperwork that may be hopelessly lost. There used to be mortgage brokers in every strip mall. When the bubble burst, they went away, leaving file cabinets full of original documentation that had never been forwarded on. The original notes may now be in a landfill somewhere.
Lenders are reluctant to sign a lost note affidavit because it requires them to indemnify the title company; it also requires that they had the note in the first place (prompting one of the audience members to quip that was affidavits that got us into the problem in the first place).
The other side of the foreclosure crisis is that it gives homeowners false hope. One family broke back into their home after it was foreclosed and they were evicted in the belief that the foreclosure was bogus. The problems in the mortgage industry do not mean that everyone gets a free home. However, failure to correct the problem will result in thousands of pro se parties filing pleadings they downloaded from the internet and class actions being brought to “spank” lenders, but which primarily benefit the lawyers.
Ford Elsaesser offered a ten point program to fix the problem:
1. The mortgage companies must hire real lawyers.
2. The real lawyers must sign the pleadings themselves.
3. No affidavits unless drafted by an attorney who personally speaks to the witness.
4. Motions to lift stay should have to meet the pleading requirements of Iqbal. This should be enforced by local rules.
5. No robo-signing, including by Judges. In other words, judges should stop signing default orders on defective lift stay motions.
6. MERS should go away.
7. Prior to filing a motion to lift stay, the mortgage company should contact the debtor to try to work out a modification or short sale or deed in lieu. This would allow homeowners to stay in their homes when feasible.
8. If the debtor has vacated the property, the mortgage company should contact the trustee to offer to purchase the property free and clear of liens for a small amount. This would give them good title.
9. There should be a national pre-mediation program on foreclosures.
10. Title companies will need to develop a standard for insuring foreclosed homes.
All of these proposals would increase the costs to mortgage companies. However, his point was that Sears had to pay to comply with the law. “Bringing mortgages into compliance is simply a financial cost.”
Gaming Industry Bankruptcies
My take away from this panel was that secured creditors can’t receive a lien on all the debtor’s assets, giving unsecured creditors more leverage. Lenders can’t foreclose upon and operate gaming machines. They can’t take a lien on gaming licenses or liquor licenses. The money in the teller cages is subject to control of the casino regulators. What do they have a lien on? “A big room with beds upstairs.” The highly regulated nature of the gaming industry means that regulators can insist that trade creditors get paid.
The take away here is that the unique structure of chapter 9 is a compromise based on federalism. The federal government cannot exercise control over a municipality through the bankruptcy system. As a result, municipal bankruptcy must be authorized by state law. There can be no trustee, no creditors’ plan, no conversion to chapter 7 and no interference with the political or governmental powers of the municipality. Interestingly enough, there is also no requirement that counsel be formally retained or seek approval for their compensation.