Potemkin Regulation: Servicing Fraud Cease & Desist Orders
There appear to be forthcoming cease-and-desist orders on servicing fraud from some of the bank regulators, and the American Banker has a draft C&D order up.
The draft C&D order is a regulatory equivalent of a Potemkin Village. (In truth, the better analogy for bank regulation has the inmates running the asylum.) On the surface it looks like a very serious thing--C&D orders are an extraordinary regulatory response in the banking world, where a lot of regulation is done informally. They typically indicate a very serious problem. But when one looks at the substance of the C&D order, one is struck by how empty it is. All sizzle, no steak.
(Even if the regulators think the internal controls are inadequate, it's not clear what the consequence would be. My guess is that it just results in the bank regulator telling the bank to revise and resubmit.)
By far the most interesting bit in the draft C&D order is the bit requiring the banks to engage independent foreclosure review consultants to review "certain" foreclosures that took place in 2009-2010. There is no specification as to which foreclosures are to be reviewed or precisely what the standards for review are. But that's all kind of irrelevant. Who do you think the banks are going to engage to do these reviews? Someone like me? Not a chance. They're going to find firms that signal loud and clear that if they get the job, they won't find anything wrong. It's just recreating the auditor selection problem, but without even the possibility of liability for a crony audit.
Frankly, this sort of regulatory outsourcing is pretty astounding--the OCC has resident examiner teams at the major servicer banks. Shouldn't they be the ones auditing the internal controls and performance, not a third-party compensated by the bank? (Oh wait, I forgot that the OCC is paid by the banks--it's budget comes from chartering fees and assessments on the banks is regulates. Indeed, I was struck in some places by the linguistic similarities between the proposed C&D order and the banks' counterproposal to the AGs. It's impossible to know who was cribbing from whom, but the similar language is revealing.)
So here's what's going down. The bank regulators are going to provide cover for the banks by pretending to discipline them very hard, but not really doing anything. The public will see a stern C&D order, but there won't be any action beyond that. It's as if the regulators are saying so all the neighbors can hear, "Banky, you've been a bad boy! Come inside the house right now because I'm going to give you a spanking!" And then once the door to the house closes, the instead of a spanking, there's a snuggle. But the neighbors are none the wiser. The result will be to make it look like the real cops (the AGs and CFPB) are engaged in an overzealous vendetta if they pursue further action.
Don't buy it--this is Potemkin regulation, plain and simple. The C&D orders are a barely a slap on the wrist for the largest consumer financial fraud case in history. The CFPB estimates that servicers made at least $25B by failing to comply with the law. And that's with very conservative assumptions. The idea that requiring the internal controls that should already exist in any well-run financial institution is a sufficient penalty for fraud of this magnitude is chutzpah to a degree that one could not expect except from an agency like the OCC.