Thursday, October 28, 2010

Time to Fire-up the Dodd-Frank Orderly Liquidation Authority

Even before the lawlessness of the banks caused the mortgage morass, the megabank sector seemed inadequately capitalized. In late August of this year, I summarized the problems facing the banking industry:

"bank capital remains under siege. European debt could explode at any moment and the bailout of last spring appears inadequate. Student loans will inexorably erode bank capital because of the dearth of job opportunities for graduates. The residential real estate market continues to meltdown, with the commercial real estate market now inflicting comparable losses on the financial sector. One trillion dollars of consumer debt suffers from serious delinquency. Consumer deleveraging will continue to suppress demand for quite some time. This will continue to mean employment problems that will lead to more losses on debt."

Things have not improved lately. The latest Case-Shiller index on home prices continues to decline and sales are stagnant at best. Economist Robert Shiller sounds more bearish than ever regarding the real estate market.

So, tack on the mortgage morass, and its time to face up to another looming spate of bank insolvencies on Wall Street. Consider the litigation costs if the banks need to litigate for equitable (assuming the banks can show clean hands) mortgages (which may be discharged in bankruptcy); litigate to enforce notes they do not hold (also dischargable in bankruptcy); and litigate all defenses borrowers may have against the original lenders (because you cannot be a holder in due course for a note you do not hold). Then the banks need to seek monetary recovery against highly distressed property with clouded title and highly distressed borrowers that probably can enter bankruptcy. It is entirely possible that the costs of recovery exceed the recovery on many thousands of mortgages.

We need to get our minds around the concept that many billions of dollars worth of mortgage backed securities could prove worthless. Professors Katherine Porter and Christopher Peterson each wrote outstanding law review articles that together lead to that logical conclusion, which I have previously highlighted.

Economist Simon Johnson hit the bull's eye with this post
. We need to determine whether the losses are containable (in the $120 billion range on put back exposure alone) as mainstream financial analysts claim, or whether they are far more legally problematic, as others suggest. If, as I strongly suspect, many of our large banks are insolvent we should immediately place them in receivership under the Dodd-Frank Orderly Liquidation Authority.

Under section 203 of the Dodd-Frank Act if a systemically risky megabank is insolvent then the Secretary of the Treasury (along with 2/3 votes of the Fed and the FDIC) may appoint the FDIC as receiver of the firm.

Section 210 authorizes the sale of assets of the firm--meaning the FDIC can sell off all the operating divisions of the firm separately--i.e., break the firm up. This section also empowers the FDIC to takeover all the powers of senior managers--i.e., prior management is terminated. Section 210(f) provides for the liability of directors and officers for gross negligence plus any other claims (like the duty of ordinary care applicable to agents such as senior managers) that the FDIC holds as it steps into the shoes of failed firm.

Dodd-Frank certainly is not perfect. And, the above summary is necessarily incomplete. Nevertheless, the government now has explicit power to put insolvent megabanks into receivership, break them up, terminate managers, and investigate and pursue civil claims against reckless (or even negligent) managers.

In addition, once the FDIC is in control of the firm the burden of CEO primacy is lifted and the FDIC can direct the firm to negotiate sensible loan modifications with borrowers. This would stop the foreclosure fraud madness in its tracks and create loan modifications that can be duly recorded in the recorder of deeds office to restore certainty in our system of property rights.

My working hypothesis is the great and irrational resistance to loan modifications now holding sway in the banks is mostly about senior manager bonuses--massive loan write-downs mean losses now for the banks and no bonuses for the CEO and other senior managers. It is the corollary to hoarding capital.

So again, if we follow the law then solutions are available. If we do not follow the law, and instead allow the reckless bankers to maintain control of the financial sector, the most likely out come seems to me to be this scenario--a long and protracted period of economic pain and misery.


  1. Foreclosure Frauds, the Fox in Charge, Elephants hiding in Plain Sight, and Victims

    Mortgage lenders cannot be trusted to correct foreclosure wrongs, no more than an addict can be trusted to self-reform; and lenders aren't required to know laws –attorneys are!

    Also, people who scowl at "deadbeats" don't know everyone's situation. NOT all defaulted owners obtained ill-affordable mortgages. Scores of defaults arose from divorce, medical bills,'outsourced' jobs, etc. And some elderly people were tricked into usurious "home repair" refinancing.

    Understandably, it seems that defaulted owners seek to ‘beat the system’ –a small amount of them do. But people I relate to aren't seeking to get a 'free' home, they're willing to pay rent.

    Still, why / how should owners be blamed for refusing to cooperate with erroneous and fraudulent confiscation of their homes? Who can blame people for not wanting to be homeless if there is a LAWFUL method to avoid it?

    Also, compare blighted neighborhoods and foreclosure deed conveyances to non-existent mortgage lenders; bankruptcy "Lift Stay" motions that "lack standing," and names on "proof of claims" different from 'lift stays' "movers"; and illegal property deeds. If homeowners 'move out', scoffers will welcome void and blight –and rats and vagrants eventually will come and go. [AND foreclosure "white collar" elephants hide in plain sight] *Foreclosure Frauds, Wells Fargo -the Fox in Charge, and Victimization @

  2. I agree with Robert Shillers unfortunate outlook on the housing market. Having dealt with multiple lenders who are now no longer in business, I have seen how the government plan of selling off defunked notes to hungry private firms for pennies on the dollar, creates a situation where there is no incentive for the firm to uphold the integrity of the prices. The low amounts at which these notes are being bought, afford private companies the luxury of selling lower than they should and still making huge profits while pummelling the area pricing on many sectors of the market.

    Once the absorbtion rate has stabilized and the mass of unsold inventory has equalized, we should see prices starting to rise so long as the private firms are still able to hold onto investments and reach maximum profits.