How far does corruption with banking regulators reach?

There are regulatory agencies with good reputations, and then there are agencies with bad reputations. There are bad ideas, and then there are criminally bad ideas. That's why it is so disturbing to see a regulatory agency with a good reputation like the FDIC propose a criminally bad idea.

(AP) — Regulators may borrow billions from big banks to shore up the dwindling fund that insures regular deposit accounts.
The loans would go to the fund maintained by the Federal Deposit Insurance Corp. that insure depositors when banks fail, said industry and government officials familiar with the FDIC board's thinking, who requested anonymity because the plans are still evolving.

The FDIC's fund has fallen to 0.22% of insured deposits, far below the Congressionally mandated level of 1.15%. For whatever reason, the FDIC is looking to avoid another taxpayer bailout, but their solution would compromise the integrity of the FDIC.

It's hard to count the number of ways that this idea fails, so I'll just touch on the most obvious ones.

1) Where would this money come from? Why from the same big banks that the taxpayer just bailed out. So while the taxpayer bought toxic assets at face value that private investors wouldn't touch except at a steep discount, the banks will now loan that money back to the interest.

2) Of course the banks support this idea. Instead of paying a fee to insure themselves (like you and I would), they get to loan money to the FDIC and collect interest on it. It's another taxpayer bailout.

3) Speaking of insurance, this loan from the banks would amount to self-insurance.

Writing insurance on yourself is a highly-lucrative business, especially when you can charge interest to the supposed insurer who you are supporting!
Insurance is supposed to work the other way around - you are supposed to pay into a pool to cover the risk of loss that some people in the pool might suffer.
Who would have thought that a government agency would actually contemplate paying the insured party for the coverage on their own risk?
In a world where we had a rule of law this would be identified instantly as what it is: rank, outrageous fraud.

4) And then there is the worst part of this proposal - the conflict of interest. Can we really expect the FDIC to effectively regulate the banks that have loaned them money so that they can do their job? Of course not. It's the same conflict of interest that got pushed the rating agencies into putting AAA ratings on subprime loans. It has the appearance of collusion.

The FDIC has a number of problems, some of which were demonstrated with the IndyMac failure that cost taxpayers $10.7 Billion. The FDIC correctly identified problems with IndyMac's business model back in 2002, yet failed to act. However, collusion with the banking industry is totally new territory for the FDIC.

On the other hand, collusion is very familiar territory for the SEC.

Judge Rakoff, Merrill Lynch, and the SEC

Our story starts on December 8, 2008, shortly before Merrill Lynch was taken over by Bank of America. Bank of America shareholders had already approved the merger. Merrill gave out $3.62 Billion worth of bonuses, or 22 times the size of the AIG's bonuses that caused such a stir. 36.3% of the money came from TARP funds and only employees making over $300,000 were eligible for the bonuses. Merrill's Compensation Committee determined executive bonuses before the disastrous Q4 earnings had been determined.
This was a departure from normal company practices. Bank of America was aware of Merrill's intentions to award huge executive bonuses, but failed to tell its own shareholders prior to the vote. In fact, on August 3 they had released a proxy statement that Merrill wouldn’t pay year-end bonuses before the takeover without consent.

Eventually the SEC was shamed into action. After months of investigation the SEC decided that it had built its case and approached Bank of America with a settlement offer that basically amounted to a slap on the wrist.
But then something amazing and unprecedented happened: the sitting judge, Jed Rakoff, demanded accountability and disclosure.

The judge wondered immediately why, given the “serious questions” raised in its complaint, the SEC wasn’t going after more facts. If BofA and Merrill conspired to lie to shareholders about bonuses that had been agreed to when the merger was signed, then why isn’t the SEC trying to figure out who is responsible? “Was it some sort of ghost? Who made the decision not to disclose [the bonuses]?” said Rakoff.

Judge Rakoff called the settlement a "contrivance", which allowed the SEC to appear to be a regulator, but doing nothing substantially. The SEC was only asking for a $33 million fine and didn't seek to punish any executives, or even to release their names. At least one Merrill executive got a bonus larger than $33 million.
The SEC responded to Judge Rakoff with what amounts to a "the dog ate my homework".

The SEC, in a court filing on Monday, said BofA’s alleged failure to disclose bonuses paid to Merrill Lynch employees before the companies merged was largely the work of attorneys who advised the banks. The regulator said it was constrained by the fact that the bank had not waived attorney-client privilege.

Judge Rakoff wisely rejected this pathetic excuse and instead dug his heels in further.

Responding swiftly, the judge questioned why the S.E.C. did not insist that Bank of America waive attorney-client privilege before striking a $33 million settlement. He also questioned whether bank executives — or the outside lawyers — should be charged in the case.
“If the company does not waive the privilege,” the judge wrote in his order, “the culpability of both the corporate officer and the company counsel will remain beyond scrutiny. This seems so at war with common sense.” The judge added that the filings Monday by the S.E.C. and Bank of America raised more questions than they answered, and set a deadline of Sept. 9 for both parties to come back with fuller explanations of who should be held accountable for the bonus disclosure decision.

So this is where we continue to stand: a federal judge preventing bank regulators from avoiding doing their job, and a major TARP bank refusing to disclose information about criminal fraud.

Faced with the embarrassment that would be caused by withdrawing the lawsuit, and thus cause people to question the existence of the agency, the SEC has been forced to look tough and take the case to court.

That doesn't necessarily mean a trial will occur. Even as it prepares, the agency could still appeal Rakoff's order to the U.S. Court of Appeals for the 2nd Circuit. The SEC on Monday left this option open.

Will the SEC start doing their job effectively? That seems highly unlikely. Remember these are the same people who failed to investigate Bernie Madoff despite receiving six "substantive complaints that raised significant red flags" about Madoff's operations.

Providing further embarrassment for the SEC, Massachusetts Secretary of State William Galvin on Wednesday released a transcript of a 2005 telephone call during which Madoff coached a potential witness about fooling federal regulators, saying "you don't have to be too brilliant" to get away with it.

Last week New York Attorney General Andrew Cuomo jumped into the SEC/BofA saga. Cuomo subpoenaed five Bank of America board members concerning the merger with Merrill. However, Cuomo isn't limiting his investigation to just the executive bonuses issue. The shotgun marriage between Bank of America and Merrill Lynch has the Federal Reserve's fingerprints all over it.

Federal Reserve Chairman Ben Bernanke and then-Treasury Department chief Henry Paulson pressured Bank of America Corp. to not discuss its increasingly troubled plan to buy Merrill Lynch & Co. -- a deal that later triggered a government bailout of BofA -- according to testimony by Kenneth Lewis, the bank's chief executive.
Mr. Lewis, testifying under oath before New York's attorney general in February, told prosecutors that he believed Messrs. Paulson and Bernanke were instructing him to keep silent about deepening financial difficulties at Merrill, the struggling brokerage giant.

Why would the Fed want these bank executives to keep quiet? A safe guess would be that they didn't want the Bank of America shareholders to get spooked and kill the deal. Thus we see that Judge Rakoff might have opened a huge can of worms that leads to some of the most powerful people in Washington, including the Treasury.

Our Savior - The Guys Who Created This Mess

The keystone of Obama's proposed banking regulations is to strengthen the power of the Federal Reserve. They would be the ones in charge of detecting and dealing with "systemic risk".
There are several problems with that idea. First of all, these guys couldn't detect the housing bubble even at its peak.

Ben S. Bernanke does not think the national housing boom is a bubble that is about to burst, he indicated to Congress last week, just a few days before President Bush nominated him to become the next chairman of the Federal Reserve.

Secondly, it is the easy money policies of the Fed that allowed the credit bubble to exist in the first place. To give them more power is just another example of rewarding failure.

Also, the Fed has been conducting enormous bailouts of Wall Street, putting the taxpayer at risk, without consulting with Congress beforehand. These include controversial bailouts of Bear Stearns and AIG.

Much like the SEC and Bank of America, the Fed has refused to disclose information that the public deserves to know.
With no government body acting in the interests of the citizens of this country, a private body, Bloomberg News, filed a FOIA lawsuit to force the Federal Reserve to disclose details of its Wall Street bailouts. On August 25, a federal court ruled in Bloomberg's favor.
So far the Fed has not acted. They have until the end of the month to appeal.

Because of the Fed's attitude that it can give out trillions of dollars of taxpayer dollars without any oversight whatsoever, Congress has pushed back on the Obama Administration.
Bills to audit the Fed for the first time ever, HR 1207 and S 604, are getting traction in both houses of Congress.

The Obama Administration has since realized that they hadn't done their due diligence, and requested a public review of the central bank's structure. The Federal Reserve flat out turned down Obama's request.

(Bloomberg) -- The Federal Reserve Board has rejected a request by U.S. Treasury Secretary Timothy Geithner for a public review of the central bank’s structure and governance, three people familiar with the matter said.
The Obama administration proposed on June 17 a financial- regulatory overhaul including a “comprehensive review” of the Fed’s “ability to accomplish its existing and proposed functions” and the role of its regional banks. The Fed was to lead the study and enlist the Treasury and “a wide range of external experts.”

The hubris of the Federal Reserve is beyond tolerance, although it shouldn't surprise much. After all, the Federal Reserve membership and governance is largely made up of current and former Wall Street bankers, and we've seen just how arrogant they can be.

All the current proposals by the Obama Administration and before Congress for regulating the banking industry involve giving the regulators more power and streamlining the process.
This ignores the most obvious observation that the regulators aren't enforcing the current laws anyway. So why would giving them more power change anything?

Does that mean that there is no good solution? On the contrary, there is an easy solution that is proven to be effective. The problem is that absolutely no one in Washington is considering it: roll back the financial deregulation.

I'm not just talking about the Gramm-Leach-Bliley Act of 1999. We also need to roll back the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, and the Depository Institution Deregulation and Monetary Control Act of 1980.
If we did all of that we would fix the Too-Big-To-Fail problem, the predatory lending problem, the usury rates that banks charge, and even tackle the out of control derivatives products. We would even break the control that Wall Street has over our politicians.
Could it happen? The status quo would never let it happen without a fight. It won't happen unless the people of this country take to the streets and force it to happen. The people of this country can take back this economy and this democracy, but they have to want to.



if Congress would do it's job

It seems to me the problem is the same as usual problem, Congress is corrupt and listens to corporate lobbyists.

Even when you have good Rep's trying very hard even an entire committee is "getting it", they can't get the entire Congress to act in concert and pass reforms.

I don't know if you saw the Fed taking on executive pay, but this is a weird thing here. I'm totally against the Fed getting even more power, considering their track record...
but at the same time, seemingly you cannot jack through Congress on executive pay, whereas the Fed can do end run's on the government.

What a friggin' mess and I agree with you as well as Bernie Sanders, Dorgan, others piping up on this...if these institutions are too big to fail they are too big to exist and they should roll back GLB of 1999.

I stumbled upon this case.

I was reading this article on Why Banks Are Failing? The articles mentions this example:

In 2008, ANB Financial N.A., Rogers, Ark., failed. (See Public data show that in less than a two-year period, ANB went from being a mid-sized community bank with $600 million in total assets to a $2.2 billion institution. The bank's balance sheet showed that most of the growth into the risky construction and land development (CLD) loan segment was funded through brokered deposits.

On the surface, ANB's loan pricing of the construction and land development loans appeared favorable. Loans were often priced 300 basis points above typical real estate rates. While 300 basis points seemed opportunistic at the time, the rate charged was insufficient for the risk being assumed. A substantially higher premium, perhaps an unimaginable risk premium, would have been necessary to compensate for the lower quality asset.

Wow, $600 million to $2.2 billion and talk about underestimating risk. The main regulator of ANB was the Office of the Comptroller of the Currency (OCC).

It would be interesting and maybe I will start it on google spreadsheet is list all of the failed banks and list their main regulators. - Financial Information for the Rest of Us.

The Ultimate Timeline

Nomi Prins published an outstanding timeline some months (or perhaps a year ago) in Mother Jones detailing how the Bush Administration had worked through the O.C.C. and, utilizing a recondite section of the National Bank Act of 1863, had insured that various state governments didn't interfere with predatory lending of the banksters.

They were backed up by Standard & Poor, who threatened to lower the bond ratings of the state and local governments.

Remember, those organized crime outfits we hear about are actually no more than the local, small-time ethnic "mom & pop" shops --- it's those banksters who are the biggest and most organized of them all, and have the clout to underwrite the publishing of all those stealth cleanser books (e.g., Tett's Fool's Gold, etc.).

Here is another case: New Frontier

ANB and New Frontier have something in common. Their enormous growth has been traced to an explosion of "brokered deposits".

Here is some background on New Frontier

New Frontier grew to $2 billion in assets when it failed in April from $795 million at the end of 2005. The bank used its swelling deposit base to increase lending to developers and dairy farmers in states as far away as Texas and Florida. It also made loans in Greeley, a city 60 miles north of Denver with a population of about 90,000 whose largest employer is meatpacker JBS USA, a subsidiary of JBS SA, the world’s largest beef producer.

It was regulated by Colorado's state bank regulator.

A "brokered deposits" are:

Bank deposits solicited by a third-party broker. Usually but not always deposits for some amount slightly below $100,000 so that all interest as well as principal is covered by deposit insurance. Brokers are typically paid a fee by the depository bank.

This are very transitory accounts - meaning that the account holders are typically searching for the best rate possible for deposit account and will move their business elsewhere if they find it. This coupled with more risk taking in terms of lending makes for a very volatile situation. - Financial Information for the Rest of Us.

fox in the hen house

This is pretty damn outrageous. Thanks for writing this. I doubt I would have known or realized otherwise.

A possible motivation of the FDIC

I was pointed towards this article.

Any new government borrowing brings the outstanding U.S. government debt closer to the $12.1 trillion limit. Tapping the FDIC’s line of credit or borrowing through the Federal Financing Bank or from private banks also would have implications for the debt limit, Treasury spokesman Andrew Williams said in an interview.

The Treasury is pretending that we don't have a deficit problem, so the FDIC has to make due until the cap is lifted.