So now we know what it takes for the Federal Reserve to show an interest in rooting out fraud at a too-big-to-fail bank. The Fed must decide that the Fed itself has been defrauded.
Borrowers? Depositors? They can protect themselves. Heaven help a bailed-out bank unlucky enough to be discovered servicing some of the Fed’s junky mortgage bonds, though. Good cops know a victim when they see one. The Fed knows a victim when it is one.
The supposed perpetrator in this unfolding drama is Bank of America Corp. Its accusers are a group of mortgage-bond investors that include the Federal Reserve Bank of New York, Pacific Investment Management Co., and BlackRock Inc., about a third of which happens to be owned by Bank of America.
The bondholders, who are threatening litigation, want Bank of America to buy back untold numbers of soured home mortgages that its Countrywide unit packaged into the loan pools backing more than $47 billion of residential mortgage bonds. Some of those securities landed on the New York Fed’s balance sheet as part of the government’s 2008 rescues of Bear Stearns Cos. and American International Group Inc.
In a letter last week, the bondholders accused Countrywide of failing to service the loans properly, which they say exacerbated their losses. They said Countrywide covered up instances where mortgages that should have been disqualified were included in the loan pools anyway. The investors also accused Countrywide of padding its fees and engaging in a “fraudulent, unauthorized and deceptive effort to supplement its servicing income.”
Strong words, those are. So, where are the police?
If those allegations are true, it can’t be just this one group of bondholders getting fleeced. The fraud would have to be endemic, and probably industry-wide. The Justice Department should be locking up bankers. The Securities and Exchange Commission should be filing lawsuits for ripping off investors. The various banking regulators’ enforcement divisions should be cracking skulls. None of that is happening, of course. And there’s no sign yet that it will.
The Fed isn’t acting in its capacity as a regulator. It’s exercising its rights as an investor protecting its own pecuniary interests and, by extension, those of taxpayers. The two roles don’t mix well.
100 Cents on Dollar
Consider the argument the Fed was making a year ago when asked to explain why it didn’t demand concessions from any of AIG’s counterparties after the Fed bailed out the insurance company. Those would be the banks, such as Goldman Sachs Group Inc., that got paid 100 cents on the dollar for credit-default swaps AIG had sold them.
Demanding they accept less than that “would have been a misuse of our supervisory authority to further a private purpose in a commercial transaction,” the New York Fed’s general counsel, Thomas Baxter, told the Troubled Asset Relief Program’s inspector general in a November 2009 joint letter with the Federal Reserve Board’s general counsel, Scott Alvarez.
A New York Fed spokesman, Jack Gutt, declined to comment.
Perhaps the Fed could argue it had no legal grounds two years ago to seek concessions from AIG’s customers, but that its claims now against Bank of America are solid. Whatever the Fed’s logic, Bank of America says it will defend itself vigorously.
Most claims “don’t have the defects that people allege,” its chief executive officer, Brian Moynihan, said last week. As long as the facts remain unsettled, the Fed can’t pretend it isn’t throwing around its weight as a regulator, or that this isn’t a dispute over a commercial transaction.
It’s a classic Catch-22. If the Fed exercises its rights as an investor, it undermines its credibility as a supervisor. If it doesn’t, it’s abandoning its duty to minimize taxpayers’ losses. This shows why the Fed shouldn’t be allowed to hold mortgage-backed securities of this kind in the first place.
The Fed’s repurchase demands are a small feature of the larger bailout economy. It works something like this: The Treasury each quarter sends new bailout checks to Fannie Mae and Freddie Mac, which the government seized in 2008, to prevent the mortgage giants from falling into mandatory receivership. This ensures the solvency of the Fed, which holds about $1 trillion of mortgage bonds guaranteed by Fannie, Freddie and Ginnie Mae.
The Fed then can go and buy more securities with freshly printed money, which pushes mortgage-interest rates down and keeps housing prices up, propping up the banking industry. The steady payments to Fannie and Freddie also keep the Treasury from having to backstop their guarantees, for now.
This makes it possible for Fannie, Freddie and the Fed to send repurchase demands to Bank of America and other lenders, except they can’t ask for too much. If they do, the taxpayers might have to bail out the banks all over again.
Meanwhile, Fannie, Freddie and the Fed get to say they’re being good stewards of the people’s investments. The charade is part of a neatly circular confidence game. While we can hope this doesn’t end badly, chances are it will eventually.
This country can survive a bad economy. What it can’t live without is the rule of law. If the Fed’s claims are true, that a major bank intentionally defrauded the public on a massive scale, the government should prosecute everyone responsible.
Americans aren’t measuring the success of the bailouts only in dollars and cents. They’re evaluating them in terms of justice. The problem is there hasn’t been any.
(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)
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