Holding banks to account for the financial crisis?

Author:Oonagh Anne McDonald
Position:Visiting Fellow, Institute of Banking and Investment, University of Leeds
Pages:45-69
SUMMARY

Purpose - The purpose of this paper is to examine the ways in which the USA has sought to hold the leading banks to account for the financial crisis and to asses the validity of the methods used. This is the first of two articles which looks at the basis of the Complaints against the banks and the settlements which led to the imposition of large fines on the banks. Design/methodology/approach ... (see full summary)

 
FREE EXCERPT
Holding banks to account for the
nancial crisis?
Oonagh Anne McDonald
Visiting Fellow, Institute of Banking and Investment,
University of Leeds, UK
Abstract
Purpose – The purpose of this paper is to examine the ways in which the USA has sought to hold the
leading banks to account for the nancial crisis and to asses the validity of the methods used. This is the
rst of two articles which looks at the basis of the Complaints against the banks and the settlements
which led to the imposition of large nes on the banks.
Design/methodology/approach – The paper rst provides an account of the government housing
policy from 1995 to 2008 and argues that the cases brought against the banks and then at the legal basis
of the charges. The methodology consists of a careful examination of the documentary evidence and an
analysis of the changes in the relevant laws used by the Department of Justice when bringing charges
against the banks.
Findings – The paper concludes that both the basis of the cases against the banks and the purpose of
large nes are open to question.
Research limitations/implications – Much of the information is available. However, as the major
cases against the large banks did not go the court, and the basis of the nes is a settlement between the
bank and the Department of Justice, each ne is supported by a relatively brief “Statement of the Facts”.
The evidence amassed by subpoenas issued by the Department of Justice is not tested in court.
Practical implications Much greater consideration must be given to more effective ways of
holding banks and especially senior executives to account.
Social implications – The imposition of large nes does not satisfy the public desire to see that
justice is done. Such nes imposed on the ban are not likely to change bank behaviour.
Originality/value – Its originality lies in setting out an account of government housing policy and its
role in the run-up to the nancial crisis. No one has carried out a careful analysis of the cases against the
large banks brought by the Department of Justice and, in the second article, by the Federal Housing
Finance Agency.
Keywords Banks, Department of Justice, Fines, Government housing policy, Legal basis for nes
Paper type Research paper
Introduction
This article examines the cases brought against the major banks by the Department of
Justice and sets them in the context of the government’s housing policy and the key role
played in the housing market by the two main government-sponsored enterprises
(GSEs) Fannie Mae and Freddie Mac. The argument outlined briey in this report is that
understanding the government’s housing policy and its impact on the housing market
makes it difcult to lay the blame for the nancial crisis on the banks alone.
The fundamental questions are: were the Complaints against the banks justied?
First, as a matter of law and, then, given the political pressures and the government
housing policies prevailing at the time, I argue that the legal basis of the Complaints is
not without question, both for complex reasons set out here and also because that the
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1359-0790.htm
Banks to
account for
the nancial
crisis?
45
Journalof Financial Crime
Vol.23 No. 1, 2016
pp.45-69
©Emerald Group Publishing Limited
1359-0790
DOI 10.1108/JFC-08-2015-0041
Complaints apparently neglected to refer to the laws and regulations applicable at the
time.
A signicant issue, but one which has rarely been addressed in the context of the
Complaints and the settlements is this: what is the purpose of the settlements? If it is to
hold those allegedly responsible for the behaviour of the banks which supposedly led to
the nancial crisis, then the settlements with the banks did not lead to the prosecution of
any cases charging important gures in the mortgage and nancial services industry. It
appears that this was not the purpose in bringing these cases against the banks: if not,
what was the purpose?
Part I: from policy to mandate to market practice
It is necessary to understand the historical context in which the Complaints against the
banks arose to assess their validity. Government intervention in the housing market in
the USA has a long history stretching back into the Roosevelt era of the New Deal as part
of which the government sought to get the housing market going again after the Great
Depression. The structure of the US housing market is quite different from European
markets. The government has more levers to inuence the operations of the market than
are available in other countries. Fannie Mae was created as part of that New Deal, but
Freddie Mac was a later addition, set up in 1970. Their status and function evolved over
time, and, by the mid-90s, they had become GSEs, shareholder-owned but subject to
government housing policies. They were “hybrid” institutions, prot-seeking, but
subject to their Charters, which were difcult to amend, or to take legal action against
them, control or limit their activities. Any changes in the regulatory framework and
their range of activities had to be agreed by Congress. A series of reform bills failed to
become the law during the 2000s. Congress set both the regulatory framework through
the Ofce of Federal Housing Oversight (OFHEO) and the range of their activities. In
addition, although their Charters stated specically that their bonds did not have the
backing of the “full faith and credit” of the USA, the markets believed that there was an
“implicit” guarantee.
Fannie and Freddie had a key role to play in the “affordable housing” policy which
President Clinton introduced as the “National Home Ownership Strategy” in 1995[1]. It
was designed to extend home ownership to minorities and those on low-to-moderate
income and very low incomes by “encouraging” banks to increase their lending to these
groups. Such groups could not meet the usual loan-to-value (LTVs), credit scores or
debt-to-income requirements which banks would normally recommend. Banks and
other lenders lowered their underwriting standards to meet the requirements of
government policy. The Clinton initiative was to create objective and performance-
based standards, which required regulators to rate banks according to their lending
records in low-to-moderate income neighbourhoods and to minorities. Each bank will be
rated in its assessment area on its willingness to meet its credit needs; its volume of
lending; its lending record to the most disadvantaged sections of the areas and to low
income individuals; and its use of innovative lending practices. Its focus is on the
origination of loans at any given time, not the number of outstanding loans. The scores
depended on the number of loans and banks received a score based on their evaluations
of “outstanding”, “satisfactory”, “needs to improve” or “substantially non-compliant”[2].
Examples of “innovative lending” practices were to be found in “Closing the Gap: A
Guide to Equal Opportunities Lending”[3].
JFC
23,1
46

To continue reading

REQUEST YOUR TRIAL