Investors have recently focused on the difficulties encountered by the European banks, which hold huge amounts of troubled sovereign debt. However, I am quite worried over the state of the banking system in the United States. The recent changes to monetary policy by the Fed, the attempt by state attorneys general to coerce an onerous settlement over flawed servicing practices, and a continued litigation feeding frenzy have put the domestic banking system at risk. Whatever the legitimate grievances, the desire to both punish the banks and obtain reparations for past practices risks pushing the financial system into a new and immensely damaging crisis.

Large U.S. banks and lenders are currently dealing with a plethora of challenges. The robo-signing and servicing investigation by the state attorneys general is nowhere near being resolved, and news reports indicate that fines in excess of $20 billion are still being sought. The settlement of outstanding litigation by an investor group against Bank of America continues to be opposed by the New York A.G on dubious grounds. The looming impact of Basel III has already started to affect banks' business decisions. (It is my opinion that the recent withdrawal of Bank of America from correspondent lending was due in part to the onerous capital that will be required of banks holding mortgage servicing assets.)

Most recently, the FHFA instituted a suit against 17 major banks and financial institutions over losses on the senior subprime MBS they purchased prior to the GSEs' conservatorship in 2008. While it's difficult to evaluate the merits of the cases, I believe that the notion that Fannie Mae and Freddie Mac didn't know what they were buying is ludicrous. In addition to having the most information on the mortgage and housing markets of any entities in the country, Fannie and Freddie also received more information on the securities than did other investors. (In addition to the normal loan stratifications distributed in the transactions' offering materials, the GSEs received "tapes" that provided detailed loan-level information on each deal's collateral.)

The Fed's recent "twist" operation presents new challenges to banks of all sizes. In addition to lengthening the maturities of its portfolio, the Fed will also be reinvesting the runoff from its MBS portfolio in new MBS. If successful, its simultaneous goals of flattening the yield curve and tightening MBS spreads leave banks with a set of unappetizing and increasingly risky investment options by artificially pushing the yield of low-risk assets below banks' funding costs. Unlike previous monetary easings, banks will not be able to earn healthy returns and burnish their capital by buying and funding low-risk investments. This is particularly important in light of Basel III, which mandates greater capital cushions.

In my view, the environment of continued litigation, regulatory uncertainty (with major provisions of Dodd-Frank still undecided), prosecutorial overreach and limited earnings power leaves the U.S. banking system in a precarious state. In particular, the litigation feeding frenzy (exemplified by the FHFA action) must end, before it pushes one or more major institutions into insolvency and triggers a new financial crisis. The Treasury department should take the lead in facilitating settlements of the robo-signing scandal and allowing negotiated settlements to be finalized, while coordinating the actions and interests of different regulators. (Case in point: The FDIC is opposing the $8.5 billion settlement with Bank of America to which the Fed is a party.)

Ultimately, all parties must understand that the U.S. banks have huge but finite resources. Efforts to either punish wrongdoing or compensate investors must not be allowed to destroy the viability of the banking system and create a new, dangerous and unnecessary crisis.


Bill Berliner is Executive Vice President of Manhattan Capital Markets. He is the co-author, with Frank Fabozzi and Anand Bhattacharya, of the recently-released second edition of Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques. His email address is

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