Real Financial Reform, Part II | The Shawmut Redemption

The Shawmut Redemption…

Reforms that need reform…

Compiled by: Larry Walker, Jr. –

On November 16, 1993, the New York Times reported the following:

In a move showing banking regulators’ increased emphasis on ending loan discrimination, the Federal Reserve Board has, for the first time, blocked a large bank merger because of concern over possible bias against minority groups in mortgage lending.

By a 3-to-3 vote, with one abstention, the Fed declined to approve the Shawmut National Corporation’s acquisition of the New Dartmouth Bank of Manchester, N.H., because of concern that Shawmut, based in Hartford, may not have complied with fair-lending laws.

The Justice Department is investigating a Shawmut subsidiary, the Shawmut Mortgage Company, for possible lending bias…

“Obviously we’re disappointed with the decision,” said Brent Di Giorgio, a spokesman for Shawmut, which has $27 billion in assets. “Notwithstanding the decision, Shawmut is proud of its lending record to minorities.”

Over the last year Shawmut has begun several programs to increase lending to low-income Americans and minority groups that some community activists say have made Shawmut a leader in the industry.

These programs include establishing mortgages with down payments of as little as 2.5 percent that use more flexible income criteria, hiring more minority mortgage staff workers and sending around home buyers from minority groups to check that Shawmut employees are not discriminating.

“The Fed is sending a strong signal to the banking industry that they’re going to be looking at banks’ lending practices,” said Joseph Duwan, a banking analyst with Keefe, Bruyette & Woods. “Clearly Shawmut is being made a little bit of scapegoat.”

The End of Shawmut National

So what happened to Shawmut National Corporation? Two years after being extorted by the Federal government, in conjunction with various social justice organizations, the bank ceased to exist. Let’s follow the trail from the end of Shawmut, to the $700 billion dollar Federal Bank Bailout:

1995 – Fleet Financial Group, Inc. acquires Shawmut National Corp.

1996 – Fleet Financial Group Inc. acquires Westminster Bancorp

1999 – Fleet Financial Corp. acquires BostonBank Corp. and becomes FleetBoston Financial Corp.

2001 – FleetBoston Financial Corp. acquires Summit Bancorp.

2004 – Bank of America Corp. acquires FleetBoston Financial Corp. for $47 billion.

2005 – Bank of America acquires MBNA Corporation and becomes Bank of America Card Services for $35 billion.

2007 – Bank of America acquires LaSalle Bank for $21 billion.

2007 – Bank of America acquires US Trust and becomes Bank of America Private Wealth Management

2008 – Bank of America acquires Countrywide Financial for $4.1 billion and Merrill Lynch for $50 billion as part of the Bailout deal.

2009 – The Federal Government invests $45 billion of taxpayer’s money in Bank of America through the Troubled Asset Relief Program (TARP). Bank of America’s pays back the $45 billion along with $4.5 billion in dividends and fees.

The Bailout

The Federal government’s solution was of course to create new agencies, more regulations, and to spend more borrowed money with the excuse that this time it will be different. Although it claims that it could make money as did off of Bank of America, so far, the US Treasury, Office of Financial Stability’s $700 billion bailout has, through 4/30/10, disbursed $517.1 billion, been repaid $186.9 billion, and is owed a balance of $330.2 billion.

1993 to 1995

So what happened in-between Shawmut National’s reprimand, the denial by the Fed to acquire other banks, and it’s ultimate demise?

William A. Niskanen, in his May/June 1995 Cato Policy Report, got it right when he stated that, “Redistributive rules among or between buyers and sellers, however, usually lead one or more parties to leave the market.” His reasoning was correct. His prediction was dead on. The arguments he posed way back then are worthy of repeating.

He said, “A market is where people come to make exchanges. Every market has its own rules, and markets thrive or wither, in part, depending on the choice of those rules. Clear rules for payment; the penalties for nonpayment, fraud, and nonperformance; and the rules for resolving disputes, for example, usually induce growth of the market, increasing the expected net benefit to each party. Redistributive rules among or between buyers and sellers, however, usually lead one or more parties to leave the market. U.S. financial markets today face several major new policy threats. Most of the new threats have a common pattern: the government is using existing regulatory authority or proposing new authority to aid some parties in the market at the expense of others.”

Mr. Niskanen continued, “Federal bank regulators and the Department of Justice have increasingly reinterpreted their authority under existing law to develop an extensive system of credit allocation. The four statutes under which bank regulations are issued are the Fair Housing Act of 1968, the Equal Credit Opportunity Act of 1974, the Home Mortgage Disclosure Act of 1975, and, most important, the Community Reinvestment Act of 1977. The common objective of those four laws was to reduce the alleged discrimination in bank lending to minorities. I say “alleged” because the premise that banks discriminate is both implausible and unsupported.”

With regard to Shawmut National Corporation, he continued, “In summary, there is no consistent evidence that banks discriminate among loan applicants by race, either consciously or inadvertently. In Washington, however, no good deed goes unpunished. Two major banks with records of outreach to minority borrowers have been subjected by the Department of Justice to what is best described as extortion. In a major 1993 case, following actions against three small banks, the Federal Reserve held up approval of several proposed acquisitions by Shawmut National Corporation pending resolution of a discrimination suit brought by Justice against Shawmut’s mortgage company subsidiary. The facts of the case are clear. During the period when the alleged discrimination occurred, Shawmut had an aggressive program to increase mortgage lending to minority applicants. Shawmut relaxed its normal lending criteria, substantially reduced the rejection rate on loan applications by minorities, and doubled the amount of new mortgage lending to minorities. Although no private person filed a discrimination complaint, the Department of Justice charged Shawmut with discrimination, based on findings that some of the loan officers had not been as aggressive as others in approving loans to minority applicants and that Shawmut had no internal review procedure to ensure that all the loan officers used the same lending criteria. In order to remove the barrier to approval of its proposed acquisitions, Shawmut agreed to settle that absurd case, set aside $1 million as a settlement fee, and worked with Justice to find some “victims” of the alleged discrimination to share the fee.”

My Conclusion:

The chickens have come home to roost. The Progressives got what they wanted. Loans were made to people who should not have gotten them, who could not afford them, and who were bad credit risks in order to satisfy unreasonable government policies. In other words, the banks came up with whatever programs were necessary to ensure that anyone who applied for a loan got one. That took care of there ever being any question that a loan was denied based on racial discrimination. The banks used Option ARMs, no-doc, stated income or whatever it took to comply with the extortion. And what happened? The buck got passed. Banks were sold and acquired. Loans were packaged, sold and re-sold until they finally came back to their source, right smack in the government’s lap. The entire banking system nearly collapsed, and the Federal government came close to taking out the entire global economy. And it’s not over yet.

Have progressive politicians learned their lesson? Apparently not, as we see today, the progressives are trying to blame the crisis on those who simply carried out their warped policies. They are demonizing bank executives, Wall Street, Corporations, stock traders, and any and everyone who carried out their wishes. But it doesn’t take a degree from Harvard to figure out who’s really to blame. All one needs to do is look at how a progressive government manages itself. It is $13 trillion dollars in debt. Its trusted reserves of Social Security and Medicare have been emptied and left with IOU’s. And now it is heading towards $22 trillion of debt by the year 2020.

Obama had one thing right though, we do need to fundamentally transform the USA. However, that’s the only thing he got right. Policy-wise, he’s on the wrong track. He only offers to make a bad situation worse. Community organizers like Obama are part of the problem, not the solution. You cannot fix a problem when you are the problem. What America needs is a radical return to its founding principles of limited government, and free enterprise. We’ll know that we’re on the right track when every culpable progressive dimwit has been placed behind bars.

Real Financial Reform, Part I: The Option ARM

click to enlarge

Compiled by: Larry Walker, Jr.

While Progressives, both left and right, feign anger arguing the merits of criminalizing Goldman Sachs, one of the most profitable companies remaining in the United States, folks on Main Street are contemplating the real cause of the economic crisis of 2007. At least, that’s what I’m pondering.

For example, in reviewing the Office of Inspector General’s report regarding the fall of Downey Savings and Loan Association (Downey) it is clear to me that firms like Goldman Sachs were not the source of the problem. Punishing Goldman Sachs for profiting from a ‘crummy deal’ does not get to the root of the problem, nor will it prevent the next crisis. Where Senator Carl Levin fell short was in that, he failed to investigate the origination of the ‘crummy deals’ which continue to run rampant from coast to coast. But that’s what happens when you let amateur government workers have too much power.


Downey was taken over on November 21, 2008 by the FDIC at a cost of $1.4 billion. This placed it into the top ten most expensive institutions taken over by the FDIC during this crisis. It is revealing to note that in the report, we are told that the primary cause of Downey’s collapse was its high concentration of option adjustable rate (ARM) loans and its lack of documentation in loans:

“The primary causes of Downey’s failure were the thrift’s high concentrations in single-family residential loans which included concentrations in option adjustable rate mortgage (ARM) loans, reduced documentation loans, subprime loans, and loans with layered risk; inadequate risk-monitoring systems; the thrift’s unresponsiveness to OTS recommendations; and high turnover in the thrift’s management. These conditions were exacerbated by the drop in real estate values in Downey’s markets.”

The OTS made constant recommendations to the bank but of course, the OTS was stripped to the very minimum because of bank lobbying over the past decade. The policy implication here becomes radically clear that if we are to have a legitimate oversight board, it must have the power to enact regulations on the books. That is probably one thing many people fail to understand right now. Many of the regulations necessary are already on the books. Yet the bodies governing these policies are so weak and pathetic, that banks were able to ramrod legislation that essentially made them shells with no ability to enforce the laws.’

Downey by the end of 2005 at the height of the bubble had 91 percent of its single family home loan portfolio in option ARMs. They basically went 100 percent with this toxic product. 73 percent of Downey’s option ARMs had negative amortization potential which of course did occur and imploded the bank. Just take a look at this stunning chart:

As the chart shows, Downey was in the game early on. Thus, their recast of 5 years on their typical option ARM started imploding much earlier and led to their demise in 2008 even before the major wave of option ARMs will swarm the market in 2010 through 2012. The disturbing facts also come out regarding teaser introductory rates which artificially allowed people to buy more home than they could afford. With the availability of “no-doc” loans anyone with a desire to get a loan got one. The fact that 91 percent of their SFR loan portfolio is option ARMs is appalling. Institutions in California basically created a casino with housing even though agencies knew of the longer term implications. In regards to policy, this gives us clear implications:

  1. Do not bailout any mortgage product that is an option ARM.
  2. Government agencies overseeing these institutions must have teeth to act and stop companies before things get out of hand. Imagine the police with no power to enforce the laws on the book.
  3. Clearly these products had no life outside of the bubble. They should be labeled as such and any institutions engaging in these products goes forward at their own risk. No bailouts ever.


The bottom line, in Part I, is that Goldman Sachs was not in the loan origination business, and thus had nothing to do with the root cause of the financial crisis of 2007. Most of the culprits, banks who originated crummy deals, have already gone out of business. From January of 2009, through April 23rd of this year, there have been 197 bank failures. Of a certainty, there will be many more. The real questions should be (1) who legalized Option ARM’s?, and (2) who was responsible for regulating them? Try starting there and get back to me when you have a serious solution to a serious governmental failure.


Option ARMs
An “option ARM” is typically a 30-year ARM that initially offers the borrower four monthly payment options: a specified minimum payment, an interest-only payment, a 15-year fully amortizing payment, and a 30-year fully amortizing payment.

These types of loans are also called “pick-a-payment” or “pay-option” ARMs.

When a borrower makes a Pay-Option ARM payment that is less than the accruing interest, there is “negative amortization”, which means that the unpaid portion of the accruing interest is added to the outstanding principal balance. For example, if the borrower makes a minimum payment of $1,000 and the ARM has accrued monthly interest in arrears of $1,500, $500 will be added to the borrower’s loan balance. Moreover, the next month’s interest-only payment will be calculated using the new, higher principal balance.

Option ARMs are often offered with a very low teaser rate (often as low as 1%) which translates into very low minimum payments for the first year of the ARM. During boom times, lenders often underwrite borrowers based on mortgage payments that are below the fully amortizing payment level. This enables borrowers to qualify for a much larger loan (i.e., take on more debt) than would otherwise be possible. When evaluating an Option ARM, prudent borrowers will not focus on the teaser rate or initial payment level, but will consider the characteristics of the index, the size of the “mortgage margin” that is added to the index value, and the other terms of the ARM. Specifically, they need to consider the possibilities that (1) long-term interest rates go up; (2) their home may not appreciate or may even lose value or even (3) that both risks may materialize.

Option ARMs are best suited to sophisticated borrowers with growing incomes, particularly if their incomes fluctuate seasonally and they need the payment flexibility that such an ARM may provide. Sophisticated borrowers will carefully manage the level of negative amortization that they allow to accrue.

In this way, a borrower can control the main risk of an Option ARM, which is “payment shock”, when the negative amortization and other features of this product can trigger substantial payment increases in short periods of time.

The minimum payment on an Option ARM can jump dramatically if its unpaid principal balance hits the maximum limit on negative amortization (typically 110% to 125% of the original loan amount). If that happens, the next minimum monthly payment will be at a level that would fully amortize the ARM over its remaining term. In addition, Option ARMs typically have automatic “recast” dates (often every fifth year) when the payment is adjusted to get the ARM back on pace to amortize the ARM in full over its remaining term.

For example, a $200,000 ARM with a 110% “neg am” cap will typically adjust to a fully amortizing payment, based on the current fully-indexed interest rate and the remaining term of the loan, if negative amortization causes the loan balance to exceed $220,000. For a 125% recast, this will happen if the loan balance reaches $250,000.

Any loan that is allowed to generate negative amortization means that the borrower is reducing his equity in his home, which increases the chance that he won’t be able to sell it for enough to repay the loan. Declining property values would exacerbate this risk.

Option ARMs may also be available as “hybrids,” with longer fixed-rate periods. These products would not be likely to have low teaser rates. As a result, such ARMs mitigate the possibility of negative amortization, and would likely not appeal to borrowers seeking an “affordability” product.


My Budget 360

Obama’s Scattershot: Works without Faith

By: Larry the Tishbite :

Definition: Scattershot – covering a wide range in a haphazard way (indiscriminating, undiscriminating – not discriminating)

Obama’s philosophy – Tell the people what they want to hear. Make it sound fabulous. Bend and stretch the truth when necessary. Convince the masses that everyone should agree with him. Demonize any opposing view points, because no one else could possibly have a solution. Make a broad range of neo-reforms and hope that something sticks. Because, after all, progress means getting stuff done, whether it’s the right stuff or not is irrelevant.

First, there was the financial bailout which was meant to save us from “the worst financial crisis since the seven year famine of Genesis 41:54“. [Boy am I tired of hearing that line.] The fact that, from the time Obama took over through April 23rd of this year, 197 banks have failed, including the 7 Illinois banks that failed on that day, is not even mentioned. Instead of admitting failure and going back to the drawing board, Obama, and his worshipers, continue to blame the ‘too big to fail’ entities for the crisis of 2008, and seek ways to prevent ‘that crisis’ from ever happening again. It seems like progress, but Obama is actually ignoring the fact that the original problem has yet to be resolved. When things seem to be improving, Obama will take credit, and when the situation worsens, Obama will blame the seers, bloggers, or anyone other than himself, or his policies.

Then there was the famous economic stimulus which was going to cap the unemployment rate at 8% and add 2 million and some-odd jobs in short order. Well, since that didn’t happen, Obama came up with a new measurement: ‘jobs created or saved’. Thus, if you saved one job you somehow could claim to have created six, or some nonsense. Once again, instead of admitting defeat and going back to square one, the obamanists, claimed victory and now say everything is fine. (That reminds me of the true definition of F.I.N.E.) Never mind the fact that the published unemployment rate was 10.2% at the end of March of 2010 and much higher if you count all of those who have permanently left the workforce. As is his custom, if the latest statistics seem favorable, Obama will take credit, and if things are not looking favorable, he will blame bloggers, Glenn Beck, Fox News or anyone other than himself or his socialist entourage.

And last but not least, there was Obamacare which was supposed to reduce deficit spending by $138 billion in the first decade, and then knock off another $1.2 trillion long after Obama could possibly be in office. Well for one thing, it looks like there may not be any savings in the first decade, and Obamacare may actually add to the deficit. But then there’s the real catch-22: How can one have the audacity to claim that Obamacare will reduce deficit spending by $138 billion during the same decade that deficit spending is actually being increased by more than $10 trillion? Maybe it’s just me, but that doesn’t equal any kind of savings whatsoever. If I put $1,000 in my savings account this year, but actually wind up adding $10,000 of credit card debt, am I not really worse off by $9,000? I think so.

I could name dozens of other Obama policies that follow the same pattern. Whether it’s nuclear defense, foreign policy, education, financial reform, climate change, energy, you name it, it’s just one big scattershot. The story is the same. Shoot a scattershot and hope that something sticks, take credit for any positive outcomes, pass blame for any negative results.

Oh, and then there’s that little quirk regarding the fact that the greatest benefits of any Obama policy don’t occur until long after he has been expelled from office. What’s up with that? That’s a neat way to CYA when none of your plans make any sense, and when everyone knows it. That way, Obama can blame the next administration for repealing his mistakes prematurely. In the end, this will only work to ensure that Obama goes down in history as the worst president since James Earl Carter.

I have made a few costly mistakes in my life, and I learned some valuable lessons. It never helped to sit around blaming everyone else for my mistakes, and I didn’t need some 3rd party changing the rules to prevent me from making the same mistake. I messed up, I paid the price, and I will never make those same mistakes again. I have also learned that the scattershot technique doesn’t work. I have learned to focus my energies on my personal areas of expertise, and to promptly concede what I don’t know.

In my world, we slay one dragon at a time. In Obama’s world, he seems to slay his own credibility one policy at a time.

The seven years of plenty ended in July of 2007.

29 There will be seven years of great plenty in all the land of Egypt. 30 After that, there will be seven years of famine, and all the good years will be forgotten, because the famine will ruin the country. 31 The time of plenty will be entirely forgotten, because the famine which follows will be so terrible. 32 The repetition of your dream means that the matter is fixed by God and that he will make it happen in the near future. 33 “Now you should choose some man with wisdom and insight and put him in charge of the country. 34 You must also appoint other officials and take a fifth of the crops during the seven years of plenty. 35 Order them to collect all the food during the good years that are coming, and give them authority to store up grain in the cities and guard it. 36 The food will be a reserve supply for the country during the seven years of famine which are going to come on Egypt. In this way the people will not starve.” 37 The king and his officials approved this plan,…