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Earlier this week, the Court of Appeals for the D.C. Circuit issued its much awaited opinion regarding the Securities and Exchange Commission's conflict minerals rule. The court ruled in the SEC's favor with respect to the challengers' Administrative Procedure Act and economic analysis claims and in the challengers' favor on their constitutional claim. The claim on which the challengers prevailed has attracted the most attention, but other parts of the opinion could also have important effects.


The Federal Deposit Insurance Corporation has produced valuable research on community banks, but more research is needed to address an issue of great concern for small banks--growing regulatory burdens. At the end of 2012, the FDIC released a helpful community banking study that explored the characteristics and practices of community banks. And yesterday, the agency issued a report on community bank charter attrition, which offers valuable insights into the nature and drivers of bank consolidation. The message of the most recent report is clear--despite years of consolidation activity, community banks are here to stay. That is good news, because the diversity of the U.S. financial system--including its large number of community banks--is critical to its ability to serve the nation's diverse financial needs. The study's optimistic assessment of the future, however, largely ignores one key issue--the effects of regulatory burdens on small banks.


Today, the momentum is growing for fundamentally restructuring the national residential mortgage market in the wake of the earlier collapse of the Federal National Mortgage Association (FNMA, or "Fannie Mae") and Federal Home Loan Mortgage Corporation (FHLMC, or "Freddie Mac). These two government-sponsored enterprises (GSEs)--so-called in recognition of their hybrid public/private nature--have long written large chunks of the residential home mortgage market, to the tune of trillions of dollars. The current legislative fixes now on the table include a bipartisan proposal from Tim Johnson and Mike Crapo, coupled with an earlier entry by Maxine Waters. The Johnson-Crapo proposal follows on earlier entries from Jeb Hensarling on the House side and Bob Corker on the Senate side. Each of these proposals seeks simultaneously to unwind the past and to redefine the future. To evaluate them requires understanding the historical linkage between past events and future prospects.

To begin, some background. In response to the brewing subprime mortgage crisis in 2008, Congress in late July of that year passed the Housing and Economic Recovery Act (HERA). That legislation, inter alia, created a new Federal Housing Finance Agency (FHFA), which on September 7, 2008 placed into a conservatorship both GSEs. These conservatorships were intended to keep both entities alive in order to facilitate their return to the private market. They were not receiverships whose object is the orderly liquidation of the two businesses. The basic plan called for an infusion of up to $200 billion in fresh cash into Fannie Mae and Freddie Mac under a Senior Preferred Stock Purchase Agreement (SPSPA) that gave the government warrants, exercisable at a nominal price, to acquire a 79.9 percent ownership stake in each enterprise. In exchange for that advance the senior preferred stock carried a 10 percent annual dividend payment, which went up to 12 percent if the GSEs delayed their dividend payments on the senior preferred.

The terms of that deal were radically altered in August 2012, when the United States, acting through the Treasury Department, imposed, through the Third Amendment to the 2008 SPSPA, a "net worth sweep" that entitled the government to 100 percent dividends on future earnings. That one bold stroke effectively made it impossible for the GSEs to repay their loans and rebuild their capital stock. Both the junior preferred stockholders and the common shareholders could under this agreement never receive a dime from either GSE, even after the entities returned to profitability. Assessing this gambit requires understanding two things: first, the relationship between the Third Amendment and the original 2008 SPSPA; and second, the relationship between the Third Amendment and efforts to revitalize the housing market. Both relationships are widely misunderstood today.


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Bidding Bye to the Bank
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The Wall Street Journal reported yesterday that senior JPMorgan executive, Michael Cavanagh, is leaving for private equity firm Carlyle. As the article explains, people are surprised, because Mr. Cavanagh was thought to be in the running for Mr. Dimon's job. No doubt the offer from Carlyle was enticing, but the Journal reported that there was also something he was running away from at JPMorgan--the prospect of winning the CEO job only to find that it consists primarily of dancing deftly with droves of regulators. So he will leave JPMorgan for the regulatory safe haven of private equity, where he'll be able to concentrate on lending instead of regulatory fights, at least until the regulators turn the brunt of their focus on private equity. Meanwhile, the bankers who stay behind will be too busy mastering the art of compliance to have time for their customers and business plans. As our recent small bank survey shows, this is not a uniquely big bank problem. Executives at small banks are also finding out that a job that used to be about making good loans is now about regulatory compliance.

CFTC's Aimless Budgeting
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In the wake of the financial crisis, the Commodity Futures Trading Commission convinced Congress to expand its mission and its powers. It is now working on a substantial budget increase to go with its increased authority. Congress should not hand more money over to the agency until the CFTC produces a reasonable plan for how it will spend the money and an explanation for its recent spending choices.

Letting Nonbanks Be Nonbanks
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Two recent speeches by financial regulators are the latest entries in an ongoing discussion about regulating nonbank financial institutions and financial stability. Decisions made in this area will have significant consequences for the health of our financial system.


Securities class actions often follow close on the heels of major announcements by public companies. These class actions have been portrayed as a shareholder's weapon against corporate wrongdoing, but too often that weapon inflicts harm on the very shareholders it is intended to protect.

Advice with Borders
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The Securities and Exchange Commission settled with Credit Suisse for providing financial services to U.S. clients without having registered with the SEC. The Swiss firm's efforts at winning American business were successful enough to generate more than 8,000 U.S. client accounts with more than $5 billion in assets. The firm took inadequate steps to ensure that it was in compliance with U.S. law and, even after deciding to stop offering cross-border advice, the firm took several years to close U.S. accounts. The settlement includes an admission of wrongdoing and a $196 million payment consisting of disgorgement of the firms' fees, plus interest and a $50 million penalty.

That kind of money suggests that clients were really harmed, but the complaint does not reveal any investor harm. Indeed, the delay in shutting the cross-border program down appears to have stemmed in part from reluctance of clients to part with their advisers. Contrast the Credit Suisse settlement with a settlement last year with a registered adviser that the SEC alleges stole more than $3 million from a police and firefighter pension fund to buy shopping malls. The settlement consisted only of requiring the adviser to repay the money it had allegedly stolen. A sophisticated global firm like Credit Suisse has the wherewithal to understand and comply with registration requirements, but the SEC's disproportionately large settlement in a case without discernible investor harm will dissuade other foreign firms from registering to serve U.S. investors. Such a result is not good for investors, who ought to be able to seek advice overseas.

Suing for Settling
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Advocacy group, Better Markets, filed suit in federal district court today to challenge the settlement between JPMorgan and the Department of Justice last November related to JPMorgan's crisis-era sales of residential mortgage-backed securities. The complaint alleges that the DOJ violated the law when it entered into a settlement that was shielded from judicial review and the details of which remain a mystery. As Better Markets paints it, the deal was negotiated by a politically connected bank with a department officials scrambling to show themselves tough on too big to fail institutions. The complaint suggests that the large settlement numbers served as a smoke screen to conceal DOJ's gentle slap on JPMorgan's brutish wrist. Better Markets, itself a confidant of regulators, likely overstates DOJ's deference in this matter, but correctly points out the settlement's troubling lack of transparency. When it was announced, I objected that the settlement's large dollar figures were not accompanied by any clear explanation of the violations being punished.

Striving for Justice
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Mark Cuban has not forgotten the agency he defeated in court. He has embarked on a plan to post Securities and Exchange Commission trial transcripts on his blog. SEC lawyers make mistakes just as everyone else does, so this project will undoubtedly bring some embarrassing moments to light and laughter. The first episode of candid courtroom commenced on a more serious note. Federal district court judge William S. Duffey, Jr. chides the SEC for "looking at a case late and finding an issue and evidence that they want to admit and trying to find a rationalization for it." As the judge explains, the SEC's objective should be for "a just result and not just for a result." The judge may have put his finger on the hardest part of an SEC enforcement attorney's job. There is an understandable thrill in making a wrongdoer pay for violating the law. Carrying out investigative and trial responsibilities in order simply to achieve a just result is much less satisfying. Justice may demand that a case get dropped or that a particular tactic for securing victory be avoided. The SEC and other government agencies must do their part by rewarding good lawyering even if it does not result in a checkmark in the government's win column.

 

 

 


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