FDIC and SEC: Suing banks over offenses government ignored.

Commentary about business and finance.
March 29 2011 5:22 PM

Left Hand, Meet Right Hand

The government sues bankers over offenses government regulators once ignored.

(Continued from Page 1)

While the evidence of the government's complicity is infuriating, it may not hurt the FDIC's case, legally speaking. Indeed, a legal source says that at trial, the FDIC will argue that the OTS's actions (or rather, lack of actions) are irrelevant, and shouldn't be admitted as evidence, because the OTS had no legal obligation to force WaMu's executives to do anything. Of course, the defense lawyers will try mightily to get the jury to hear all about OTS's cluelessness.

In the meantime, the SEC, which is reportedly contemplating charges against former Fannie and Freddie executives, has its own left-hand/right-hand paradox. The SEC is said to be weighing whether to charge Fannie executives with classifying mortgage loans as "prime," or relatively safe, when they should have been put in a category that reflected more risk. The SEC is similarly pondering whether to charge Freddie executives with not fully warning investors about the risks associated with its subprime mortgage portfolio. But as the Wall Street Journal noted, such accusations put another government regulator in the line of fire. That agency was formerly known as the Office of Federal Housing Enterprise Oversight, or OFHEO; it has lately been renamed the Federal Housing Finance Agency. The Journal reported that this successor agency to OFHEO sent a letter to the SEC opposing the charges.

As the Journal pointed out, OFHEO's blessing of Fannie's financial filings was one reason a federal judge threw out some charges in a shareholder lawsuit against Fannie executives. Fannie, the judge said, "operated in a heavily regulated environment." Since the government takeover, the judge added, "no restatements of Fannie's financials have been ordered." Perhaps you could argue that the Fannie and Freddie executives misled OFHEO—but that is not an argument OFHEO has made, at least not publicly,  possibly because reporters were already writing about Fannie and Freddie's problems well before their collapse.

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Sources tell me that there was a general complicity on the part of federal regulators—not just OFHEO, but Treasury too—as the financial crisis got into full swing. The hope was that if regulators didn't force Fannie and Freddie to own up to just how bad the losses might be—they call this "regulatory forbearance"—then Fannie and Freddie would outrun their bad loans. Regulators were also reluctant to take a hard line because they knew it might force a government takeover, for which there was no political appetite.

Such left-hand/right-hand problems don't arise when the litigant resides in the private sector.  Earlier this month, the National Credit Union Association threatened to sue several investment banks unless they refunded more than $50 billion in mortgage-backed securities sold to five credit unions that subsequently collapsed. I have not been able to understand why federal regulators have been so reluctant to hold Wall Street accountable for its role in packaging up bad mortgages.  Could it be that failed firms make easier targets than the too-big-to-fail banks that now dominate our financial landscape?

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