Last Friday, right before a three-day weekend, the Federal Housing Finance Agency filed 17 lawsuits accusing a motley crew of some of the biggest financial institutions in the United States of fraudulently misrepresenting the value of mortgage-backed securities. Pick any one of the lawsuits, for example, the complaint against Merrill Lynch, and you will read language sure to get the heart pumping of any American still seething at the role Wall Street played in precipitating the Great Recession:
These securities were sold pursuant to registration statements, including prospectuses and prospectus supplements that formed part of those registration statements, which contained materially false or misleading statements and omissions. Defendants falsely represented that the underlying mortgage loans complied with certain underwriting guidelines and standards, including representations that significantly overstated the ability of the borrowers to repay their mortgage loans.
To most people who have followed the mortgage crisis closely from the beginning, the FHFA would seem to have a slam-dunk case. As Felix Salmon pithily summarizes: "These banks lied to investors when they put together mortgage securitizations." The evidence is simply overwhelming -- the only real question here is why the government hasn't moved more quickly to call the banks to account.
But listen to the industry response! Paul Miller, a former bank examiner now working as an analyst for FBR Capital Markets & Co., declared in a research note that it was time to "stop punishing banks." Demanding that the banks make restitution for the losses would hurt the economy, he argued.
The Federal Housing Finance Authority is "reacting in their own self-interest as opposed to that of the broader U.S. economy," Miller wrote. Their claims "drain capital from the banking system, and they cause banks to overly tighten credit standards, which pushes potential home buyers onto the sidelines."
Securities analyst Richard Bove warned that the lawsuits proved that the U.S. government "is committed to breaking up the banking industry."
The audacity! Talk about your all-purpose, gilt-edged get-out-of-jail-free cards! The U.S. government should refrain from punishing the malefactors who brought down the economy, because doing so would negatively hamper the economy! And even better, the Obama administration, which helped to inspire Tea Party anger and alienated its own left-wing base by moving heaven and earth to keep the banking industry intact, is now supposedly "committed" to breaking up the banking industry.
The economy argument simply doesn't hold water. First of all, banks have already tightened their credit standards and are reluctant to make loans. If they wouldn't make loans when their profits were high, the government needn't worry over much about the effect that draining more capital from the banking system might have. But secondly, there is no way that legal action on this scale will be resolved in any kind of short-term time frame. Goldman Sachs, Citigroup and Bank of America will have access to the best legal teams money can by, and any resolution will likely take years, by which point, one hopes, the economy will be on sounder footing, and the banks will be able to pay their fines without causing undue economic sabotage.
And then there's the reasoning offered by FHFA itself, in a note released Tuesday clarifying the rationale behind the suits:
Some have claimed that these suits will disrupt economic recovery, or endanger the targeted banks, or increase their cost of capital. While everyone is concerned with these important issues, the long-term stability and resilience of the nation's financial system depends on investors being able to trust that the securities sold in this country adhere to applicable laws. We cannot overlook compliance with such requirements during periods of economic difficulty as they form the foundation for our nation's financial system. Therefore, through these lawsuits, FHFA turns to the courts to adjudicate the violations that it has alleged in its complaints.
Of course, it's probably also worth noting that nothing particularly economically advantageous is likely to happen, in the short term, as a result of the FHFA's move, aside from some modest deficit-reducing benefits in the event that some of the losses the government was forced to eat bailing out Fannie Mae and Freddie Mac are offset by any restitution from the banks.
Which brings us to one final observation. Could this have been managed any less effectively, from a political point of view? After bailing out the banks, and becoming widely perceived as more concerned about Wall Street than Main Street, the feds waited three years to aggressively confront the banking industry, and then buried the news of their action on a Friday before a three-day weekend. More people probably remember the score of a college football game played Saturday than what the FHFA did on Friday.