Stop Blaming Banks for All Your Troubles

HousingWire is kicking around the idea of doing a July feature on the global history of bank bailouts… Japan’s lost decade and the like. The view, though the idea is still on the drawing board, is to see if the Obama approach to bank bailouts will create a model of rescue going forward. The idea is still being researched. In the meantime, cases are being brought against banks left and right in the United States. Having just moved from the UK, this behavior feels relatively new, though not unexpected given the landscape of the crises here. A case against banks in Cleveland got tossed out, while class actions continue to be brought by pass-through investors against IndyMac and Morgan Stanley Capital. Now, for the record, I’m no big bank supporter, but these lawsuits are the last thing anyone needs. I feel investor grievance, I feel socio-economic upheaval, but let’s face it: The majority of these lawsuits are destined for failure. And here’s why. Actions against banks are going to be pre-empted by state laws, according to one attorney who is representing bank interests. In the Cleveland case, which is sure to be a successful model of argument going forward, the lawyers only need to explain that the banks represented in the case operated under applicable state and federal guidelines. The banks themselves obviously believed these products are robust enough to withstand some turbulence, for to argue to the contrary reasons that financial institutions are not adverse to the bust cycles that originate from pushing platforms that are knowingly doomed. The banks want nothing more than for securitizations to meet long-term maturity, for example. Therefore, isn’t the blame really in the hands of lax regulation of the current statutes, which are meant to curtail such impropriety? This is a particularly effective method considering the recent swap of character in the White House. Though banks need not soften judges by blaming Bush, as there remain other ways in which financial firms can prove a lack of culpability. In the case of pass-through certificate investors the cases seem even weaker.  One of HousingWire’s sources used to be an asset-backed securities analyst and is now bond trading over at… well I can’t say. At any rate, he is fond of asking “So, who put a gun to the investor’s head?” A lack of due diligence. Confidence in triple-A rating from credit rating agencies. A fundamental misunderstanding of risk. The onus on investors will be to prove their actions are the result of, essentially, someone else. Even if a judge believes a bank ‘made them do it,’ the bank can solidly counter that the risk appeared mitigated by the ratings. Ratings agencies, of course, defend that no one saw this coming.  For their part, they continue to “tighten criteria.” But this isn’t HousingWire‘s attempt to throw its hat into the blame game arena. Or to take sides. There’s been enough shouting in those corners. Rather, as one lawyer I spoke to this morning put it: “The government is really good at preventing the last crisis.”  The announced regulation of OTC derivatives is an example, considering credit default swaps as a form of credit enhancement no longer exists in the wake of the Lehman collapse. If such regulations do pass, the bad products will simply go by another name, just as ‘toxic’ is now ‘legacy.’ The situation is not unlike the current mortgage market in Italy. There, celebrities spent 2006 and 2007 promoting mortgage products on television — these same high loan-to-value type loans that no longer exist. Politicians are now shuffling regulation through with names such as the Tremonti and Bersani decrees, in an effort to appear proactive in sorted the whole mess out. But, the typical implementation scenarios are set-up to where the windows in which these programs will have a chance to make a difference is too small. By way of comparison, what’s the point of an $8,000 tax credit for first time buyers when the people who truly need homes are now foreclosed? Meaning there are not that many first time buyers on the bad side of a housing bubble, are there? An $8,000 rent credit would likely do more to stimulate macroeconomic conditions. But, right or wrong, this would be tremendously unpopular. So these actions are simply the results of populist posturing, at home as well as abroad. The only difference is, in Italy, no one is telling a judge that they blame the banks. Write to Jacob Gaffney. Disclosure: The author held no relevant investment positions when this story was published.