William K. Black on the law, in his own words. You decide.

[girl gone mad]

You don't have to let other people make your mind up for you.

William K. Black

Why Is Geithner Continuing Paulson's Policy of Violating the Law?
February 23, 2009. http://www.huffingtonpost.com/william-k-black/why-is-geithner-continuin_b_169234.html">The Huffington Post

Whatever happened to the law (Title 12, Sec. 1831o) mandating that banking regulators take "prompt corrective action" to resolve any troubled bank? The law mandates that the administration place troubled banks, well before they become insolvent, in receivership, appoint competent managers, and restrain senior executive compensation (i.e., no bonuses and no raises may be paid to them). The law does not provide that the taxpayers are to bail out troubled banks. Treasury Secretary Paulson and other senior Bush financial regulators flouted the law. (The Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) are both bureaus within Treasury.) The Bush administration wanted to cover up the depth of the financial crisis that its policies had caused.

Mr. Geithner, as President of the Federal Reserve Bank of New York since October 2003, was one of those senior regulators who failed to take any effective regulatory action to prevent the crisis, but instead covered up its depth. He was supposed to regulate many of the largest bank holding companies in the United States. Far too many of these institutions are now deeply insolvent because the banks they own are deeply insolvent. The law mandated that Geithner and his colleagues place troubled banks in receivership long before they became insolvent. Why are the banking regulators, particularly Treasury Secretary Geithner, continuing to disobey the law?

We need a Pecora investigation

We can understand now why the administration and so many committee chairs are virulently opposed to the single most essential step we need to take to diminish future crises -- a modern Pecora investigation. Pecora was the prosecutor hired by the Senate banking committee to investigate the misconduct that helped cause the Great Depression. You must vigilantly study past failures to learn causation and to enact remedies. If we were dealing with a crisis of airplane crashes and someone opposed studying the causes of the failures we would (correctly) label him a lunatic. Congress largely stopped conducting meaningful oversight hearings of financial regulation during the Bush administration. The results were horrific. It appears that only intense public pressure will suffice to overcome congressional and administration resistance to a Pecora investigation. I hope readers will add their voices to this call.

The financial cost of Paulson's and Geithner's flouting of the law

Paulson and Geithner's refusal to comply with the law has already cost the taxpayers scores of billions of dollars in unnecessary costs. Geithner indicated Friday, February 20 that he would continue to flout the law. If he is allowed to do so it will add hundreds of billions of dollars to the eventual cost to taxpayers. The amount of taxpayer money wasted due to Paulson and Geithner's violations of the prompt corrective action law will exceed the total present value cost of resolving the S&L debacle, $150 billion ($1993). The waste will take the form of the U.S. taxpayers subsidizing the officers, shareholders and subordinated debt holders of failed banks -- who are disproportionately wealthy, frequently profited from the accounting fraud that caused the banks to fail, and are often foreign. The prompt corrective action law was passed in large part to prevent such a subsidy.

The S&L debacle led to a new financial regulatory system premised on "prompt corrective action" (PCA). Future posts will explain more fully why this system failed, but it is remarkable that the system, the phrase, and the law have disappeared from the coverage of the banking crises. PCA's premise was that regulatory discretion led to cover-ups of failed banks and excessive losses to the taxpayers. The PCA solution was to require higher capital requirements and to mandate that the regulators take over troubled banks before they deteriorated to the point that the failure would impose a cost on the Federal Deposit Insurance Corporation (FDIC). PCA also recognized that failing bankers had perverse incentives to "live large" and cause larger losses to the FDIC and taxpayers. PCA's answer was to mandate that the regulators stop these abuses by, for example, strictly limiting executive compensation and forbidding payments on subordinated debt.

PCA's purpose is "to resolve... problems... at the least possible long-term cost to the [FDIC]." That means the least possible cost to taxpayers. Secretary Geithner's priority is protecting private shareholders:

We have a financial system that is run by private shareholders, managed by private institutions, and we'd like to do our best to preserve that system....

We have a law that says when banks are at or near insolvency private shareholders should be eliminated unless we can arrange a transaction that has no cost to the FDIC. Receiverships produce "private institutions." The FDIC manages the failed institution only long enough to get it in shape to be sold at the least cost to the taxpayers. Receiverships end unnecessary bailouts of private shareholders, reducing the cost to the FDIC, as the law requires. Receiverships place banks back in the hands of new shareholders. Geithner has so twisted the framing of this issue that he is warning that a cheaper, more effective means of resolving failed banks used under President Reagan is some alien form of socialism that President Obama must slay before it destroys capitalism. Geithner is channeling Rove when he conflates receiverships with "nationalization."

Secretaries Paulson and Geithner subverted the PCA law by allowing failed banks to engage in massive accounting fraud (which also means they are engaged in securities fraud). Treasury is telling the world that resolving the failed banks will require roughly $2 trillion dollars. That has to mean that the failed banks are insolvent by roughly $2 trillion. The failed banks, however, are reporting that they are not simply solvent, but "well capitalized." The regulators flout PCA by permitting this massive accounting and securities fraud. (Note that by countenancing this fraud they make it extremely difficult to ever prosecute these elite white-collar frauds.)

[geek tragedy]

1. Here's the actual law

(3) Conservatorship, receivership, or other action required
(A) In general
The appropriate Federal banking agency shall, not later than 90 days after an insured depository institution becomes critically undercapitalized—

(i) appoint a receiver (or, with the concurrence of the Corporation, a conservator) for the institution;

OR

(ii) take such other action as the agency determines, with the concurrence of the Corporation, would better achieve the purpose of this section, after documenting why the action would better achieve that purpose.

http://www.law.cornell.edu/uscode/uscode12/usc_sec_12_00001831---o000-.html

It says "or" which means they have a choice. I think Black is off here.

[girl gone mad]

3. If it isn't clear, then we have to rely on "intent".

What was the intent of this law?

I think it's fairly obvious.

[geek tragedy]

5. How is it not clear?

If I tell you you can have chocolate or vanilla, does that mean your obligated to have chocolate?

[girl gone mad]

7. You seem to be arguing that they had a choice to take other actions..

to resolve the troubled banks.

Well, they didn't do that, either. They've simply propped up the failed banks through various schemes. That's not a resolution.

[Emit]

29. It seems the other actions being taken right now include

assessing the situation, stabilizing the situation, trying to get enough toxic assets off the books to make the bank holding companies viable again, calling for more regulation for BHCs, etc.

As Bair explains below, "...the current bankruptcy framework available to resolve large complex non-bank financial entities and financial holding companies was not designed to protect the stability of the financial system..." ... "neither taking control of the banking subsidiary or a bankruptcy filing of the parent organization is currently a viable means of resolving a large, systemically important financial institution, such as a bank holding company. This has forced the government to improvise actions to address individual situations, making it difficult to address systemic problems in a coordinated manner and raising serious issues of fairness."

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation explains why this is such a complicated challenging issue:

The events that have unfolded over the past two years have been extraordinary. A series of economic shocks have produced the most challenging financial crisis since the Great Depression. The widespread economic damage has called into question the fundamental assumptions regarding financial institutions and their supervision that have directed our regulatory efforts for decades. The unprecedented size and complexity of many of today's financial institutions raise serious issues regarding whether they can be properly managed and effectively supervised through existing mechanisms and techniques. In addition, the significant growth of unsupervised financial activities outside the traditional banking system has hampered effective regulation.

Our current system has clearly failed in many instances to manage risk properly and to provide stability. U.S. regulators have broad powers to supervise financial institutions and markets and to limit many of the activities that undermined our financial system, but there are significant gaps, most notably regarding very large insurance companies and private equity funds. However, we must also acknowledge that many of the systemically significant entities that have needed federal assistance were already subject to extensive federal supervision. For various reasons, these powers were not used effectively and, as a consequence, supervision was not sufficiently proactive. Insufficient attention was paid to the adequacy of complex institutions' risk management capabilities. Too much reliance was placed on mathematical models to drive risk management decisions. Notwithstanding the lessons from Enron, off-balance sheet-vehicles were permitted beyond the reach of prudential regulation, including holding company capital requirements. Perhaps most importantly, failure to ensure that financial products were appropriate and sustainable for consumers has caused significant problems not only for those consumers but for the safety and soundness of financial institutions. Moreover, some parts of the current financial system, for example, over the counter derivatives, are by statute, mostly excluded from federal regulation.

In the face of the current crisis, regulatory gaps argue for some kind of comprehensive regulation or oversight of all systemically important financial firms. But, the failure to utilize existing authorities by regulators casts doubt on whether simply entrusting power in a single systemic risk regulator will sufficiently address the underlying causes of our past supervisory failures. We need to recognize that simply creating a new systemic risk regulator is a not a panacea. The most important challenge is to find ways to impose greater market discipline on systemically important institutions. The solution must involve, first and foremost, a legal mechanism for the orderly resolution of these institutions similar to that which exists for FDIC insured banks. In short, we need an end to too big to fail.

It is time to examine the more fundamental issue of whether there are economic benefits to institutions whose failure can result in systemic issues for the economy. Because of their concentration of economic power and interconnections through the financial system, the management and supervision of institutions of this size and complexity has proven to be problematic. Taxpayers have a right to question how extensive their exposure should be to such entities.

The problems of supervising large, complex financial institutions are compounded by the absence of procedures and structures to effectively resolve them in an orderly fashion when they end up in severe financial trouble. Unlike the clearly defined and proven statutory powers that exist for resolving insured depository institutions, the current bankruptcy framework available to resolve large complex non-bank financial entities and financial holding companies was not designed to protect the stability of the financial system. This is important because, in the current crisis, bank holding companies and large non-bank entities have come to depend on the banks within the organizations as a source of strength. Where previously the holding company served as a source of strength to the insured institution, these entities now often rely on a subsidiary depository institution for funding and liquidity, but carry on many systemically important activities outside of the bank that are managed at a holding company level or non-bank affiliate level.

While the depository institution could be resolved under existing authorities, the resolution would cause the holding company to fail and its activities would be unwound through the normal corporate bankruptcy process. Without a system that provides for the orderly resolution of activities outside of the depository institution, the failure of a systemically important holding company or non-bank financial entity will create additional instability as claims outside the depository institution become completely illiquid under the current system.

In the case of a bank holding company, the FDIC has the authority to take control of only the failing banking subsidiary, protecting the insured depositors. However, many of the essential services in other portions of the holding company are left outside of the FDIC's control, making it difficult to operate the bank and impossible to continue funding the organization's activities that are outside the bank. In such a situation, where the holding company structure includes many bank and non-bank subsidiaries, taking control of just the bank is not a practical solution.

If a bank holding company or non-bank financial holding company is forced into or chooses to enter bankruptcy for any reason, the following is likely to occur. In a Chapter 11 bankruptcy, there is an automatic stay on most creditor claims, with the exception of specified financial contracts (futures and options contracts and certain types of derivatives) that are subject to termination and netting provisions, creating illiquidity for the affected creditors. The consequences of a large financial firm filing for bankruptcy protection are aptly demonstrated by the Lehman Brothers experience. As a result, neither taking control of the banking subsidiary or a bankruptcy filing of the parent organization is currently a viable means of resolving a large, systemically important financial institution, such as a bank holding company. This has forced the government to improvise actions to address individual situations, making it difficult to address systemic problems in a coordinated manner and raising serious issues of fairness.

~snip~

http://www.fdic.gov/news/news/speeches/chairman/spmar0319.html

[girl gone mad]

36. This should have been done from the very beginning.

If the Feds really believed they didn't have the proper authority to do their jobs, they should have sought these powers at the start of the crisis rather than wasting months playing these perpetual bailout games.

I think this is nonsense. If the banks were truly insolvent, what choice would they have had but to work with the government via receivership? Bankruptcy would have been much less desirable. Instead of fulfilling their obligations to uphold the law and serve the public's best interest, our regulators acted at the behest of a group of corrupt and inept banking cartels.

[KittyWampus]

24. Well, the vanilla has proven toxic to society. And since that's the choice Obama & his

Administration have made, what does that say about them and their decision making?

They choose something that has proven poisonous and put those who INJECTED THE POISON to administer a remedy?

[truedelphi]

4. Sure they do have a choice. If there is reason to believe that

By leaving the bank in operation, some purpose has been served.

But in the case of AIG, we are leaving in place a corporation that not only has its onerous bonus system in place (as long as it is not in receivorship), but FAR WORSE also has in place contracts that spell out that the Credit Default Swap items must be paid off before monies taken in can be allocated to any other item.

So the Bailout Billions go in, and they go to those who bet agaisnt the Credit Default Swaps. Whereas if that contract was null and void, and AIG was in receivorship, then the monies could actually go to re-inflate some value into the SIV's or CDO's. Which of itself, would cause a good many of the Credit Default Swap bets to go away - you cannot ask to be paid out on your betting something loses, if it has been turned into a winner. (feel free to correct me if I am wrong.)

[Junkdrawer]

8. OK, what was the "other action" and where's the documentation....

why said action better achieved that purpose?

:shrug:

[rucky]

11. (ii) ..."better achieve the purpose, after documenting why..."

Can anybody point me to these documents?

[patriotvoice]

13. I would like to see the "documented" reason why the "action would better achieve"...

the purpose of "resolving problems of insured depository institutions at the least possible long-term loss to the Deposit Insurance Fund." USC 12/16/1831o/a/1

[KittyWampus]

23. Actually, Black is highlighting the Obama Administration's compulsion to obsess over that "or"

and the choice that clearly allows bad actors to continue existing and profit at taxpayer expense.

[The Straight Story]

28. LOL "or do whatever else you want" why not just put that instead of both?

The second option includes the first anyway in a sense :)

[truedelphi]

2. Will someone wake Obama up now please?

It was sort of fun, seeing how our wild enthusiasm could turn to sludge, when Obama mysteriously supported Paulson on Sixty Minutes in late Nov 2008.

"He's working hard, Hank is" or some such was Obama's comment.

And I thought - "Oh gawd, no! This sounds almost like "Good job there Brownie!"

And I keep thinking I am gonna wake up and there will be a big yellow PEEP sitting on my pillow telling me that it was just a test of faith, and no, dear, Obama could not possibly be playing into the interests of the lying banksters and fraudlent financiers.

But it isn't a bad dream. It is reality - and depending on who you listen to - it is 2.9 to 8.1 Trillion dolars of reality (The 2.9 trillion amount is from Democratic Senators questioning the wonderful Ms Warren - who heads the Oversight committee on the Bailout. She reported to the Senators that neither Geithner, nor any of the others she calls on for explanations, ever gets back to her. And the Senators report the same thing. Is this demoacrcry? Or democ-crrazy?

Please somebody get Obama out of the Voodoo people's clutches. And restore our economy.

[chimpymustgo]

12. These vultures are Obama's CHOICES. He's not in their clutches. Why can't people see this?

[empyreanisles]

16. And he chose them for a reason. I suspect he will be vindicated eventually.

Maybe you think the solution they come up with won't be "fair". But you better believe it will get us out of this mess.

These are exceptional situations we are in. Pragmatic, nimble approaches are what is needed. Not blind "justice" without a care for how things really work.

[truedelphi]

33. Exceptional situations mean we REALLY have to have measures that work

And far too many people who understand Basic Economics do not think the rabbit hole
Geithner wants us to go down will work:
http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=114x62603

[MarjorieG]

6. They keep talking banks, without addressing mixed service firms. Really different legal solution?

[KittyWampus]

22. Mixed Service Firms= Monopolies subject to Anti-Trust Laws or Racketeering/Conspiracy Laws

[xchrom]

9. something is terribly WRONG if we're basing this on 'or'.

like the people who wrote that that was a mistake?

or do certain duers think they 'know' better than geithner et al?

that was in there for a reason -- and not to benefit Th T ax Payer.

it's past time to stop giving these folks the benefit of the doubt -- early admin and all that -- they Know what they are doing.

[Pale Blue Dot]

10. Kick. nt

[troubleinwinter]

14. K & R !

[bvar22]

15. K&R

Thanks for posting this.
Yesterday, there was a pathetic kamikazi attempt to discredit William Black on DU.
How can any rational person still support Geithner and Summers?

[empyreanisles]

17. Wish there was a way to accelerate a topic's sink to the bottom.

Getting sick of ggm's Obama hate.

[NashVegas]

19. Please Explain How Discussion of a Specific Issue Equals "Obama Hate"

[empyreanisles]

21. Its intent is to discredit Geithener, and indirectly, Obama's decision making.

Nobody knows how this is going to turn out, so we need to STFU and let the strategy mature.

[TayTay]

25. It is precisely that thinking that led to the founding of America

The rest of America should have told those unhappy colonists in Americato STFU and let King George and the boys in Parliament work out the financial difficulties left over from the intercontinental wars with France and other European powers. These Americans should have bowed and scraped before the obviously superior gifts of their "betters" and quit exercising their alleged "right" to express displeasure in the actions of those who ruled over them.

Damn, good thing those colonists elected not to rock the boat and decided to quell all dissent. Now, pardon me, I'm late for my son's cricket match and I have nothing to serve for tea this afternoon.

[NashVegas]

26. Looters Are Stealing From Our Treasury

And they need to be jailed. If Geithner is assisting them, he needs to go.

[scarletwoman]

31. What? Is Obama the Pope? Is he infallible?

We don't need to let a strategy "mature" when it appears to be a very bad strategy to begin with. The correct thing to do in a democracy is to QUESTION our leaders ALWAYS.

sw

[spoony]

37. "we need to STFU" --You first.

[Pale Blue Dot]

20. Wow. Been here since March 17th and already sick of the "Obama hate".

Maybe if you presented some facts that refute the OP? Just a suggestion.

[leftofthedial]

18. Because Summers and Geithner are the inside men

in a financial coup.

The bankers apparently now (or maybe they always did) own the Executive and Legislative Branches outright.

[NashVegas]

27. The Looting Has to Stop

Jail the fraudsters.

Either the banks are solvent and being handed money from our national treasury for no real reason at all, or the banks are insolvent and need to be shut down.

Can't have it both ways.

[ljm2002]

30. What I find interesting...

...about the arguments that the government does not have the authority to put these holding companies into receivership, is this: the arguments are one-sided, and always work to the bank's (and bank holding company's) advantage.

Let me elaborate. Right now, people are saying that the law does not allow the government to take these entities into receivership because by golly, the law says banks, and these are holding companies. So there. And yet, on the other hand, AIG, which is neither a bank nor a thrift, was allowed to choose as its sole regulator, the Office of Thrift Supervision, an office that was singularly unprepared to wade through the intricacies of financial insurance and that was also completely understaffed. And they were allowed to do this because they had opened one, count 'em one, thrift in the U.S.

The way I see it is this: once these entities have been shown as engaging in massive fraud, someone in the government most assuredly does have the authority to take them over and take them down. However, there are many reasons our legislators -- and unfortunately, our executive branch -- are reluctant to do so, including: 1 - they are culpable in allowing all of this flim flam to go on over the years, from repealing Glass Steagall, to pocketing campaign funds, to turning away from obviously shady practices; 2 - they are scared witless that the whole system will collapse if the public ever truly understands what a sham these dealings are to begin with; 3 - they want to continue to hide behind the fiction that "it's all too complicated for you mere mortals to understand"; 4 - they don't want to go down with the ship, which is what would happen to lots of them if a real investigation were ever held. Not that I expect that to happen, for the reasons cited -- too many powerful people with too much interest in keeping it all hidden.

These people, all of them, are masters at using the letter of the law to play their little games. Things like saying to City Bank, sure, just change your name to Citi Banc, and all is well and you can forge ahead into the newly-allowed financial transactions, no problemo, because see by changing that letter, you're no longer a "Bank" in the eyes of the law, so it's all hunky dory. And these same people are all shocked and outraged when the little guys start to figure out what a sham it all is, and start to do things like exercising their own rights, such as when they start saying to the "Bancs", "Produce the note!" Because the law, in its infinite majesty, ... well you know the rest. It was forged by the rich and its intent is to protect the rich and the rest of us are supposed to sit by while the bright-boy hairsplitters argue over fine points but never do anything that might actually rock the boat.

That's how I see it.

[scarletwoman]

32. Great post! Well said!

It's quite clear to me that our political class is wholly subserviant to the Owner Class, and that is who our "leaders" serve.

The rest of us are simply herd animals who must be mollified on occasion in order to protect the power arrangements of Owner Class from any disruption.

sw

[girl gone mad]

35. Well stated.

I think it's clear what the spirit of this law is. The banks/bank holding companies/multinational financial conglomerates or however they want to structure themselves should have been properly supervised and regulated. When they became suddenly insolvent, the government had all of the leverage it needed to step in and act appropriately, in the best interest of the citizens. That didn't happen. Instead, the pillagers were handed more money with few strings attached. Management was left intact, bondholders were protected at the public's expense, certain counterparties were paid out in full (while others are being forced to take a haircut - why?). It hasn't been handled well, and hiding behind vagaries of the law is merely a ploy to provide cover and distract people from these shady dealings.

[Mari333]

34. k and r