by Sheila Bair
Everyone, including the OCC, gave lip service to supporting the SPOC, but when it came down to negotiating the language of the orders we would give the banks, the OCC refused to require that a single person be identified and named. It wanted to give the banks flexibility to have a team of people serve as the single point of contact, which, of course, defeated the whole purpose. In contrast, the Fed’s orders did require that servicers designate an individual employee to work with a borrower.
The OCC also failed to put any hard metrics into its orders. Early in the process, we had suggested that it make the banks develop quantitative objectives so that we would have some way to measure improvement. For instance, based on our loss-share reviews, we knew that one of the servicers218 it regulated had only about forty-four staff handling nearly 60,000 active loan files, or about 1,200 files per employee. Again the OCC refused, preferring instead to put vague standards into its enforcement orders. To this day, the OCC has failed to present any hard data that the servicers have significantly improved their operations with more staff, faster loan mod decisions, and fewer instances of lost paperwork and other processing errors. Whatever progress has been made has been due to the initiative of HAMP officials to publicly grade servicers, not anything required by the OCC.
Another problem was that the OCC treated all of the servicers the same even though the reviews showed variations in the quality of servicing operations. To be sure, all of the servicers had weaknesses, but the difference between, say, Wells’ servicing operation and that of Bank of America, was the difference between night and day, as documented by published reports. But again, as was the case with the bailouts, all the banks were lumped together.
Most problematic was the way the OCC proposed to handle the lookbacks—that is, the process the banks were supposed to use to retroactively review the individual files of people who had already lost their homes to make sure that servicing errors had not resulted in wrongful foreclosures. The OCC had fought our claims commission proposal based on the argument that all borrowers should have their records reviewed, not just those who came forward with a claim.
However, when it came to setting up the parameters of the lookbacks, the OCC decided to let the banks use their well-paid consultants to do it and also told the banks that they needed only to sample files! As previously mentioned, we had found significant error rates in loan mod denials in reviewing loss-share servicing records, so we suggested that they needed to conduct a 100 percent review, at least for borrowers who had applied for a modification and been turned down. Based on my bad experience in using bank consultants for the review of Citi’s management, I did not think consultants could be completely trusted to conduct an independent review of foreclosure files. They relied heavily on the banks for their consulting business; why would they conduct a thorough review that could end up costing the banks a lot of money to compensate past victims? To keep the process honest, I suggested that the OCC, Fed, and FDIC jointly review and validate the consultants’ work. Finally, I suggested that an independent hotline be set up to receive consumer claims and offered the considerable resources of the FDIC to operate it. (The FDIC has a highly regarded consumer call-in center with an excellent response time. I would occasionally test it by making an online inquiry, using my married name and my home email address. Within twenty-four hours, I always had a response.)
But time was running out on my tenure at the FDIC, and Walsh knew he could wait me out. In April, the orders were issued. They were vague and general. I issued a separate statement219 explaining the FDIC’s limited role in the process and saying that the orders were only a first step. In early June220, I sent an email to Walsh and Tarullo pleading for a 100 percent review of denied loan mod applications, borrowers’ claims, and all loans to military personnel, who have special protections against foreclosure while they are on active duty. “[S]ampling alone will not ensure that all harmed borrowers are identified,” I argued. I also pleaded for an interagency review process to validate the consultants’ work. My pleas mostly fell on deaf ears. At the end of June221, the OCC issued additional guidance to banks on complying with the orders. The guidance offered little new in terms of the specific remedial steps that banks were supposed to take. For the lookback, the OCC required 100 percent review for service members and those who came forward with a claim but expressly permitted sampling for everyone else. And instead of interagency oversight of the consultants, the OCC alone would be responsible for ensuring the independence of its work. The guidance provided no real clarity as to what the consultants were looking for and what would constitute financial harm.
In December 2011, in the face of mounting congressional pressure and criticism, Julie Williams finally provided a list of twenty-two servicer errors that the OCC felt could result in financial harm to borrowers in testimony before the Senate Banking Committee. However, Ms. Williams’s testimony also made clear that the consultants would decide the amount and type of compensation that banks would have to pay. She indicated that the OCC was “considering guidance222 that will clarify expectations as to the amount and type of compensation recommended for certain categories of harm. Any such baseline expectations would not, however, override the independent judgment of the independent consultants.”
The banks have now hired consultants to conduct the lookbacks. They are relying primarily on a mass direct-mail campaign to identify harmed borrowers. The onus will be on borrowers to come forward to file claims with consultants, who are being paid by the banks and have long-standing consulting relationships with the industry. The whole effort is a ruse and a waste of time and money, in my view. My guess is that the consultants will make big profits while ultimately finding that very few borrowers, if any, were financially harmed. But I know that many of the borrowers could have made payments if they had been given the modifications for which they qualified. Will they be compensated? I would like to be proven wrong, but my guess is that the consultants are going to make a lot more money out of this than the borrowers are.
Bank consultants can play an important, valuable role in providing confidential technical advice to banks on regulatory compliance matters, similar to the way you might hire an accountant or tax lawyer to make sure you comply with the tax rules. But even the best of them will be hopelessly conflicted in trying to judge whether a harmed borrower should receive compensation from the same bank that pays their consulting bills. Even if they can rise above the very real conflicts the process presents, the perception of bias will remain. It has put both the banks and the consultants into a hopeless position.
And what happened to the global settlement talks from which we were excluded? In November 2011, four months after I left office, I received a call from Shaun Donovan, asking me if I would be interested in serving as the monitor for the global settlement—the person who would be responsible for making sure the banks complied with the settlement once it was reached. I wanted to help Shaun, but I had a number of preexisting contractual commitments, including one to write this book. Of all the senior officials in the Obama administration, next to the president, I think he cared the most about trying to resolve the foreclosure mess in a way that would help borrowers and be fair to all parties. But my sense is that he never got the support he needed from Tim and the OCC. If they had put pressure on the big banks to reach a settlement, the banks would have been more willing to agree to meaningful reforms and financial redress. But without a clear signal from their two chief protectors, Geithner and Walsh, they were reluctant to give much.
On February 9, 2012, the administration finally announced a $25 billion settlement. The banks didn’t give much, but neither did the state AGs. Though the banks received relief from state AG suits related to mortgage-processing errors, they still face substantial litigation risk from borrowers and mortgage-backed investors, as well as state AG suits based on fraud and illegal discrimination. But the big banks had to pay only $5 billion in cash, some of which will support the operations of budget-constrained sta
te AG offices. The other $20 billion will be devoted to principal write-downs and refinancings. The banks were likely to do that much principal reduction anyway, and it is a drop in the bucket given that home owners in the aggregate owe about $700 billion more than their homes are worth. Like most of this administration’s initiatives, the settlement will help on the margin, but litigation and troubled mortgages will continue to drag down the economic recovery.
And as the banks escaped forceful government action to correct and remediate servicing errors, many were also allowed to pay increased dividends. The Fed did consult with us when reviewing the dividend increase applications. It agreed with us and did not approve BofA’s application to increase dividends (even though BofA’s CEO had inexplicably stated publicly that it would be approved) and kept Citi’s dividend to a token penny. We acquiesced in its decision to approve the healthier banks’ applications, though we objected to some of its decisions to allow weaker regional banks to increase shareholder payouts. As further losses from the troubled housing market and litigation still loom large on all the major banks’ balance sheets, I wish that the Fed had held off on any dividend increases, but at least it worked with us and said no to BofA and Citi. In contrast, the OCC made some efforts to consult us but ignored our objections by letting Citibank pay a whopping $3 billion to its holding company. The Fed did not let223 the holding company pay the money to shareholders, but nonetheless, it is no longer available to protect Citigroup’s bank (and the FDIC).
CHAPTER 22
The Return to Basel
Europe was to pay dearly for its ill-advised implementation of Basel II and failure to impose a leverage ratio. Its thinly capitalized banks had little capability to absorb losses when the 2008 crisis hit and government bailouts were required of a number of insolvent or near-insolvent major European financial institutions. What’s more, European banks had invested heavily in higher yielding debt issued by weak sovereign nations such as Greece, Portugal, Spain, and Italy because Basel II treated those investments as having low or zero risk. This helped give rise to a new problem—the sovereign debt crisis—which continues to plague Europe and is now spilling over into the broader global economy.
European taxpayers were outraged, and the European central bank heads, as well as the banking regulators, were feeling even more heat than we were in the United States to crack down on large financial institutions. And as the political climate changed, so did the willingness of the Basel Committee to achieve more meaningful reform. Basel Committee Chairman Nout Welling and Stefan Walter, who led the Basel Committee’s technical staff, seized the opportunity by pushing a new Basel III framework. Throughout 2009 and 2010, under their leadership, we worked diligently on coming up with new, stronger capital standards. The work was reinforced224 when, in September 2009, the finance ministers of all the G20 countries issued a directive to regulators and central bank heads to develop a comprehensive set of financial reforms, including stronger capital requirements, by the end of 2010.
Basel III had many components, but its most important work focused on raising both the quality and quantity of capital held by large, internationally active banks. To my great satisfaction, an international leverage ratio was on the table and garnering increasing support among committee members. In addition, there was strong consensus to raise the amount of high-quality capital banks had to hold. During the crisis, we discovered that the only type of capital that the market had confidence in was the traditional kind: that raised through issuance of common stock or built up through retained earnings, also known as tangible common equity (TCE). Market analysts essentially ignored trust-preferred securities and other types of hybrid debt instruments when determining whether a bank was solvent. But under Basel II, banks were required to keep that kind of TCE at only a paltry 2 percent of assets.
The main challenge of the Basel Committee leadership was to raise the amount of TCE held by banks. But what should be the new requirement? Two percent was laughably low. Nout and Stefan were also proposing to have an additional amount above the new minimum, called a “capital conservation buffer,” that banks could draw from during periods of economic distress. The idea behind the buffer was to act like a rainy-day fund for banks during economic downturns. When the economy entered a down cycle, regulators would let banks dip into the extra capital to support their lending activities, just as families dip into their savings when they face a job loss or pay reduction. However, once the banks dipped into their buffers, they would have to restrict dividends and bonus payments to conserve capital. During the crisis, regulators were caught flat-footed as even the weakest banks kept paying dividends and big executive bonuses, when they should have been retaining earnings to conserve capital and support lending. With the new capital buffer, the Basel Committee leadership wanted to create automatic restraints on dividends and bonuses for any bank once its capital level fell below the buffer.
The buffer was a clever idea, the product of research conducted by the Dutch Central Bank and refined by Nout and the Basel Committee staff. There was general consensus around the framework but wide disagreement over what the new capital minimums and buffers should be. Even though the Treasury Department was not a member of the Basel Committee (it is made up of only bank regulators and central bank heads), in the spring of 2010, Tim began calling us all to meetings at the Treasury to formulate the U.S. position. Ben and Dan Tarullo, the Fed’s point person on bank supervision, dutifully attended the meetings, as did I, Bill Dudley, John Dugan, and later John Walsh.
I could tell that Ben and Dan were uncomfortable with the meetings. The Fed, not the Treasury, headed the U.S. delegation to the Basel Committee and had the statutory authority to set bank holding company capital standards, in consultation with us and the OCC. Moreover, it wasn’t clear whether Tim was trying to build consensus among the U.S. regulators or trying to stir the pot. At each meeting, he would try to elicit our views on what the new standards should be, but he was very cagey when it came to expressing his own views. In his public pronouncements225, he had been talking a very good game, calling for significantly higher capital standards (without specifying a number) and even endorsing our proposal for an international leverage ratio.
Ideally, bank capital should be high enough to keep the banks solvent and lending even during a downturn. The Fed staff produced a good analysis showing that a bank’s tangible-common-equity ratio needed to be in the 8 to 10 percent range to achieve that objective, based on historical loss rates from the 2008 and previous crises. The Basel Committee staff conducted a similar analysis showing the range to be 7 to 11 percent. Never bashful, we opened by suggesting that the new TCE requirement (including the buffer) be at least 10 percent. George French of our staff presented an analysis showing that the big banks, in aggregate, could achieve a 10 percent tangible-common-equity standard over a period of five years simply by retaining half their earnings, meaning that they would have to cut back on dividends. For the two weakest banks, Citi and BofA, the time horizon was longer, and they would have to retain most of their earnings. But even they were capable of achieving 10 percent with a long enough transition period.
As usual, we were out there with the highest number. The Fed came back suggesting that 8 percent would be sufficient but that in addition the Basel Committee should impose some type of surcharge on the very largest banks. After further discussions, we agreed to 8 percent as the baseline, with the understanding that the United States would be united in pushing for a surcharge on the largest institutions—so-called systemically important financial institutions, or SIFIs—to bring their requirement up to 10 percent, the FDIC’s preferred number. As we were meeting with Treasury, we were having parallel discussions with Nout and Stefan, who were in a major battle with the industry. For reasons I never fully understood, the Basel Committee routinely met privately with international bankers to solicit their feedback on ideas for reform. That was frequently done through the auspices of the Institute of International Finance, heade
d by Charles Dallara. I did not object to getting technical input from the bankers—that was essential—but I wondered why the public comment process was not sufficient for that purpose.
In any event, Nout agreed to hold one of those industry meetings in Frankfurt on June 1, in conjunction with a Basel Committee staff meeting taking place at the same time. I sent my deputy, Jason Cave. He reported back226 that the industry was pretty much opposing everything we were trying to do. Nout had refused to give ground, saying only that there would be an ample transition period for the banks to raise capital. He had also strongly defended the leverage ratio and was pushing back hard on the idea that the stronger standards would hurt the economic recovery. The IIF had already circulated227 a draft report, which it made public the following week, shamelessly suggesting that constraining big banks’ leverage would reduce global output by more than 3 percent. More responsible studies released later by the Basel Committee staff, as well as a number of academics, show that the costs to economic output from higher capital standards are negligible and more than outweighed by the benefits of a more stable financial system.
Nout and Stefan were also struggling with the French, Germans, and Japanese. Throughout all of the postcrisis Basel discussions, it seemed that the lineup was the same. The United States, the United Kingdom, Canada, Switzerland, the Netherlands, Sweden, and most other Basel Committee members advocated, or at least were willing to support, higher standards; Germany, France, and Japan would resist.