Federal bank regulators fought over turf with state agencies while
America's mortgage lending system grew increasingly unstable and then
fell apart.
When state investigators spotted questionable loan
practices, the feds rejected their help and informed the state that it
had no business looking into the affairs of federally chartered
institutions. Scott Jarvis, director of the Washington state Department
of Financial Institutions, said his files are full of letters from
federal bank regulators, bankers and other lenders politely telling his
office to take a hike.
In a typical case in late 2002, state bank examiners believed
National City Mortgage was violating the state's Consumer Loan Act by
charging extra fees on mortgages, said Kwadwo Boateng, the state's chief
bank examiner. When asked to explain the costly "discount loan fees,
underwriting fees, processing fees and marketing fees," National City
Mortgage sought intervention from federal regulators, records show.
The investigation was stopped by federal decree.
At the company's request, Julie Williams, general counsel of the
federal Office of the Comptroller of the Currency, wrote National City a
letter in January 2003 saying the state had no right to examine or even
visit its offices. Because National City's parent bank in Cleveland was
chartered with the OCC, the federal agency pre-empted the state's
authority. National City attached Williams' letter to a missive to the
state in February 2003, asking state investigators to stay away.
And here's the kicker. The federal agency didn't go after the
mortgage fee complaint because it had no authority to enforce state
consumer protection laws, Boateng said.
"We dropped the case," he said.
National City spokesman Todd Morgano said he wasn't aware of the
case, but "in general we fully cooperate with all of our regulators."
"Pre-emption is about the application of uniform, national and ...
rigorous standards," said Williams, who is also the first senior deputy
comptroller at the OCC. "It is not about getting out of rules and being
allowed to play in a more relaxed environment."
Williams increasingly pre-empted state regulatory actions starting in
2002, about the time subprime and nontraditional mortgage lending was
beginning an astounding climb, from $267 billion in originations
nationally to more than a trillion by 2005, according to Inside Mortgage
Finance, a tracking newsletter. Mortgages sold as pools on Wall Street
created a firestorm of irresponsible lending that peaked in 2006 and
smoldered afterward with widespread foreclosures and today's financial
instability.
The OCC's federal cousin -- the Office of Thrift Supervision --
wasn't far behind in the pre-emption effort. For example, Washington and
other states have been waging a battle with the OTS and State Farm Bank
over the state's right to license the bank's mortgage brokers and
originators.
"We don't need dual supervision," said State Farm Bank general
counsel Todd Haynes, who expressed a strong preference for the feds.
"They've done a fine job."
That's not the opinion of others, nor is it reflected in statistics
regarding enforcement actions that show almost nothing from the feds in
the area of consumer protection.
"National banks and their operating subsidiaries function without
meaningful law or enforcement," said Rep. Barney Frank, D-Mass., then
ranking member of the House Financial Services Committee, in a toughly
worded letter to federal Comptroller John Dugan three years ago. He said
that's because the feds have shoved aside state regulators without
filling the "regulatory void."
He pointed out that the comptroller's office lacked the ability to
enforce state consumer protection laws, yet repeatedly shielded national
banks from state investigations, as it did with National City. Both
federal agencies have imposed "visitorial" bans, meaning state
investigators can't even visit their chartered institutions for
interviews.
"What value is an applicable state consumer protection law if there
is no one to enforce it?" asked Frank, who is now chairman of the
committee.
Nothing has significantly changed since Frank wrote the letter to
Dugan, except for a U.S. Supreme Court decision last year that more
firmly barred the door to state investigators.
Other laws encourage concurrent federal and state investigations of
consumer violations regarding credit repair and telemarketing fraud,
said Joseph Vincent, state DFI general counsel.
Most big depository and lending institutions -- like Wells Fargo and
Washington Mutual -- are chartered by either the comptroller's office or
the thrift supervisor. Washington's Department of Financial
Institutions, as well as bank regulators in other states, charter or
license community banks, financing firms, credit unions and mortgage
brokers.Deciding who oversees you is mostly voluntary in the banking
world.
Banks are governed by a patchwork of federal and state laws, which
are notably weak at the federal level in the areas of predatory lending
and consumer protection, according to law professors, attorneys and
other experts. Some states, like North Carolina, New Jersey and New
York, have passed tougher predatory lending laws with provisions holding
Wall Street liable for financing bad loans. But the two federal agencies
in recent years have increasingly shielded their chartered banks, and by
extension Wall Street financiers, from states' laws.
Assistant state Attorney General David Huey, who has handled some of
the state's biggest predatory lending cases, wants Congress to empower
state regulators to investigate federally chartered banks. Federal and
state regulators should work closely together, he said, just as state
attorneys enforce the federal anti-trust Sherman Act.
Without that authority, Chuck Cross, former Washington state
regulator and currently vice president of the Conference of State Bank
Supervisors, and others said they watched federally chartered
institutions such as Washington Mutual founder in their own backyards,
while federal regulators did nothing to stop the bleeding.
Cross said he had an inside source at WaMu who told him he wouldn't
believe what was going on with its questionable underwriting activities.
Bill Longbrake, recently retired WaMu vice chairman, said the bank
reported to its stockholders problems with loans made by a subsidiary,
Long Beach Mortgage, but those problems were solved over time to the
satisfaction of the OTS.
Jarvis said the community banks under his office's supervision didn't
wade into the risky subprime and nontraditional lending waters the way
nationally chartered banks did. One of the largest, Sterling Savings
Bank in Spokane, didn't engage insubprime or nontraditional loans,
spokeswoman Jennifer Lutz said. Nor did Cascade Bank in Everett, bank
President and Chief Executive Officer Carol Nelson said.
Two-thirds of bank deposits in the state are regulated by the federal
regulators, Jarvis said.
Jarvis acknowledged that some mortgage brokers and other financial
institutions under his agency's watch participated in the risky lending
behind the current crisis.
But the numbers support his contention that the state was a better
guardian.
The federal OCC took about a dozen formal enforcement actions against
banks for "unfair and deceptive practices" in the current decade, agency
spokesman Robert Garsson said. The other federal agency, OTS, took about
half as many, in "the five to six range," OCC Chief Operating Officer
Scott Polakoff said. States, by contrast, took 3,694 enforcement actions
against mortgage lenders and brokers in 2006 alone, according to
congressional testimony.
The quality of local oversight varies from state to state, said
Longbrake, who was WaMu's liaison to regulators. Yet state regulators
are more innovative than the feds, he said. He encouraged them to work
together.
Pre-emption is a good practice, said Peter Wallison, co-director of
the American Enterprise Institute's market deregulation program.
Complying with 50 different sets of rules is expensive to banks and
consumers, he said.
But recent events show that predatory and reckless lending comes at a
cost to taxpayers, leading to the $700 billion federal bailout.
Congressional testimony, court records, interviews, academic papers
and news stories over the past decade reveal contrasting trends with
state and federal bank regulators. The states work together. The federal
agencies compete with each other, and with the states.
The feds were set up as rivals. Bank oversight is "the only place I
know of where regulated entities get to pick their regulators," said
Kathleen Keest, with the Center for Responsible Lending.
The two agencies exist on funds assessed from members, though the
president appoints their directors.
"They are competing with each other for the business," said Keest, a
charge officials at both agencies denied.
In what appears to be an enticement to state-chartered banks, the OTS
on its Web site boldly advertises its ability to pre-empt state laws and
regulators.
"Our examiners are very focused on predatory lending, and on
inappropriate lending," the OCC's chief operating officer Polakoff said.
To its credit, the OCC participated in a settlement in 2000 with
Providian National Bank forcing it to pay $300 million to consumers for
deceptive credit card practices. But according to publicity afterward,
the California state attorney general and the San Francisco district
attorney forced the issue.
Williams and Polakoff said they work behind the scenes, privately
counseling banks to change their lending practices without taking public
action. Washington's Jarvis said that's part of the problem, "when it
comes to protecting the public, we do a much better job."
Cross described feeling a chill reading what he called a "how to rip
people off" manual he obtained by subpoena from state-chartered First
Alliance Mortgage Company, a California company. It bluntly instructed
employees how to trap vulnerable customers in a room, distract them with
banter and stick them with outrageous fees and rates they couldn't
afford, he said.
The Washington Department of Financial Institutions forced First
Alliance to leave the state. Joining the effort were an Alameda County,
Calif., deputy prosecutor, state attorneys general around the country,
and the Federal Trade Commission, which operates separately from the
federal bank agencies. The company owners -- who declined to talk with
the Seattle P-I -- sought bankruptcy protection. They also paid $60
million to victims in a settlement.
As a result of the same investigation, Lehman Brothers also was found
liable in a federal lawsuit in California for knowingly financing the
First Alliance lending practices, a rare case where a Wall Street firm
was held liable for financing abusive loans.
Lehman filed for bankruptcy protection in mid-September, leading to
what has become the notorious sound bite from presidential candidate
John McCain, long a supporter of market deregulation, that "the
fundamentals of our economy are strong."
State investigators -- led by Washington -- produced other big
settlements with Household Finance for $484 million in 2002 and
Ameriquest for $325 million in 2006. Ameriquest was owned by
now-deceased Roland Arnall, a multimillion-dollar contributor to
President Bush's 2004 re-election campaign.
Earlier this week, Countrywide Financial Corp., recently acquired by
Bank of America, agreed to reduce loan payments and halt foreclosures,
at a cost of $8.7 billion nationwide. California, Illinois and Florida
led that multistate effort.
Cross said certain state regulators, all members of the Conference of
State Bank Supervisors, consult regularly to coordinate battles against
predatory lending. He cited Gov. Chris Gregoire as a leading participant
when she was attorney general, as well as her successor, Rob McKenna.
But the feds won the pre-emption war, unless Congress overturns the
whole system next year. Frank has indicated he might try.
The U.S. Supreme Court ruled in a split decision last year that the
OCC has absolute right to insist on exclusive oversight without states
intervening. The case involved Wachovia, a Charlotte, N.C.-based lender
that subsequently crumbled under an avalanche of subprime problems and
is now up for sale.
But Joe Vincent, general counsel for Washington's bank regulator,
said he doesn't care what the Supreme Court ruled. "It was wrong," he
said.
SECOND OF A TWO-PART SERIES
NO LIABILITY: Wall Street was shielded from
lawsuits that would have protected borrowers and halted a frenzy of
buying and selling that ultimately led to the current financial
meltdown.
Read the first part of the series at
seattlepi.com/382707.
http://seattlepi.nwsource.com/business/382860_mortgagecrisis11.html
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