Bank of America Foreclosure Reviews: How Promontory Became a Shadow Regulator (Part VA)

Today we release the two latest posts in our whistleblower series on the Bank of America foreclosure reviews, focusing on the role of the “independent” consultant hired to perform the reviews, Promontory Financial Group.

The Plot So Far

As we described in earlier posts in this series (Executive Summary, Part II, Part IIIA, Part IIIB, Part IV, and Part IVB), OCC/Federal Reserve foreclosure reviews meant to provide compensation to abused homeowners were abruptly shut down at the beginning of January as the result of a settlement with ten major servicers. Whistleblowers from the biggest, Bank of America, came forward to provide compelling evidence that the bank and its independent consultant, Promontory Financial Group, attempted to suppress evidence that borrowers had been harmed by the false and deceptive practices of the mortgages lenders. Together, they reviewed over 2500 files. When asked to estimate the percentage of harm and serious harm they found, the lowest estimate of harm was 30%, with the majority judging the rate of harm at or over 90%. Estimates of serious harm ranged from 10% to 80%.

In this post and the next, we focus on how Promontory was badly conflicted and incompetent. Here we discuss how it has become a powerful, yet unaccountable shadow regulator. In the next post, we show how it made a hash of the foreclosure reviews and probe what the egregious expenses might be hiding.

Promontory, the Shadow Banking Regulator

Promontory has increasingly come to serve as the dominant shadow regulator in the financial services arena. It is difficult to name a player who occupies a similar role in any other heavily regulated industry.

Promontory has been an influential player virtually from its inception. Its founder and CEO, Gene Ludwig, was the Comptroller of the Currency under Bill Clinton and recognized the potential of the then-sleepy agency to end run other regulators.* After a stint as vice chairman of Bankers Trust, Ludwig established Promonotory and began hiring former regulators, along with attorneys with financial industry experience and former bank officers. The firm gained public visibility when Ludwig prepared a review for the board in the wake of a currency trading scandal at Allied Irish Bank.

As the firm became larger, Promontory recruited more senior and well connected former regulators, both to work at the firm and to serve on its advisory board. Its roster includes former SEC chairman Arthur Levitt, former Nixon and Ford administration official and NASD chief Frank Zarb, and Fed vice chairman Alan Blinder as advisors. Uber lobbyist Ken Duberstein is also on the advisory board. Fed governor Sarah Bloom Raskin is a former Promontory managing director. Their current staff is virtually an alumni association of the people who ran TARP, 1990s deregulatory advocates in Europe and Australia, and examiners from the OCC and Fed. And it doesn’t hurt that their public relations is handled by a former executive editor of American Banker. Analyst Josh Rosner has described Ludwig and the pre-eminent bank regulatory lawyer Rodgin Cohen of Sullivan & Cromwell as probably the two private sector parties most responsible for bank deregulation in the U.S.

Since Promontory is private, it is impossible to know its mix of revenues. However, its activities focus heavily on the adept circumvention of regulations. For instance, it operates CDARS, the Certificate of Deposit Account Registry Service, which is a service that divides large deposits and distributes them across a network of over 3000 banks. This is regulatory arbitrage, taking deposits that would otherwise exceed FDIC deposit insurance ceilings and breaking them into amounts that fall below the limits. A Bloomberg article, “Exploiting FDIC Loopholes Enriches Former U.S. Bank Regulators,” noted:

“These guys know how to work the system,” says {Sherrill] Shaffer, [former chief economist at the New York Fed] who’s now a professor of banking at the University of Wyoming in Laramie…Promontory charges banks more in fees, about $12.50 per a $10,000 one-year CD to get access to federally insured funds, than the FDIC itself charges in insurance premiums, typically $5-$7 per $10,000 deposited.

Another one of its major activities is getting financial firms out of hot water. From Promontory’s website (emphasis ours):

Promontory Examination and Enforcement Advisory Services offers financial and regulatory risk diagnostic and remediation services aimed at preempting, complying with, and mitigating the severity of regulatory enforcement action.

As one reader quipped,

Promontory has been running this scam for a long time. I used to be involved in Patriot Act/Anti Money Laundering Compliance industry working with the largest banks in the world. Every time there was a regulatory action, Promontory was brought in to be the overlord. The running joke was that there the OCC and FRB stapled Ludwig’s business card to consent orders.

Marcy Wheeler has called this the “Get Out of Jail Free industry”. But recently, Promontory’s most visible engagements have involved failed efforts at prettying up diseased managements. For instance, it told MF Global’s board that the broker-dealer had “robust risk management” a mere five months before it failed. And not only was this reading “absurdly sanguine,” but it was remarkably self-serving. Promontory was retained in 2009 to help implement reforms in the wake of an alleged trading scandals, so the report was an assessment of its own work. Similarly, Promontory prepared an analysis for Standard Chartered of wire transfers with Iran and other sanctioned countries, and reported only $14 million were out of compliance. The bank later admitted that at least $250 billion were impermissible, an over four order of magnitude difference.

But unlike the formal regulatory apparatus, whose actions are subject to supervision in the form of Congressional elbowing, Inspector General investigations, and Freedom of Information Act requests, Promontory is accountable only to its clients. It’s unlikely that prospects will be deterred by a few high profile failures. After all, in the overwhelming majority of cases, egregious massaging of the facts by bank-friendly consultants gets a free pass from regulators. Sheila Bair provided examples in her book Bull by the Horns. For instance, she described how she was pressing for management changes at Citigroup in the wake of a bailout in the form of guarantees on $306 billion of toxic assets. A consultant was brought in to shield CEO Vikram Pandit:

I met with Parsons, Grundhofer, and O’Neill on June 22 to discuss their willingness to boost capital and change management. They showed willingness to make some management changes, but resisted further capital raising….Throughout the ensuing negotiations…we were able to get significant management changes…Citi also agreed to hire an independent consultant to review its management from the top down and benchmark their qualifications and performance against other banks’…

When the “independent consultant” report came back in the fall, it compared Pandit to small European bank CEOs and gave him glowing marks. As for its review of the rest of Citi’s management, it gave high grades to Pandit loyalists while criticizing those who were not viewed as part of the Pandit team…

That was my first and last experience in asking bank consultants to assist regulators in reviewing bank operations. They are hopelessly conflicted, given their desire to secure future consulting work at those big banks. The consultants clearly considered their primary client to be Vikram Pandit. Indeed, they reported to him regularly on their review and sought his input until we found out about it and objected…..But Citi’s primary regulators, the OCC and NY Fed, didn’t seem to mind one bit.

Troublingly, Ludwig is also the Managing Principal of GenCap, a private equity firm that “invests in financial services businesses with a particular focus on community and regional financial institutions, specialty finance and related services.” It is impossible to maintain any sort of a Chinese wall between an investment business and a consulting business where the firm gets not only inside information about bank operations but also pending regulatory actions when the same person heads both businesses.**

Promontory was Badly Conflicted at Bank of America

The track record of “independent” consultants hired when banks are under regulatory scrutiny is their real job is not to investigate but put lipstick on pigs.

Since the official policy of the Obama Administration has been to declare peace with honor in the struggle against bank misdeeds, it was well understood by observers that the independent foreclosure reviews were never meant to be a serious exercise. The reviewers were conflicted, and Promontory was no exception. It had performed a “corporate governance review” for Countrywide’s board in November 2007. Recall that Bank of American had already made a $2 billion investment in the troubled subprime player in late August. The review is credited with getting Countrywide CEO Angelo Mozilo to accept that the bank was a goner and Something Needed to Be Done. Accordingly Bank of America announced its acquisition of Countrywide in early January 2012.

In other words, the Promontory work seems to have led directly to Countrywide getting Bank of America to stump up for the rest of bank at a rich price given the distress it was in (over market prior to the leak of the acquisition news). So finding a lot of borrower damage resulting from the Countrywide lending and subsequent servicing would show Countrywide to have been an even bigger garbage that it is already known to be. Given Promotory’s role in moving the deal forward, that’s hardly the sort of adding-insult-to-injury news that Bank of America would want to hear.

And it isn’t simply that Bank of America is a juicy potential client for Promontory. The firm already has close ties to the bank. It was deeply involved in a cost-cutting project launched under new CEO Bryan Moynihan called Project New BAC. And don’t think that expense reduction programs are tedious bean counting exercises. They are arguably the most lucrative consulting service. Cost cutting advisors are paid a percentage of the savings, and at a large bank, the rewards are rich. And the consultants naturally never question whether the assignment is warranted. As we wrote when the project was made public by a flattering article in the New York Times:

The New York Times piece is hagiography about the cost cutting process at Bank of America, in which the Charlotte bank will shed 30,000 jobs, more than 10% of its workforce. It starts with the misrepresentation of calling the belt-tightening a “turnaround plan.” That implies that the business of the bank is in trouble and the headcount reduction measures can save the day.

This is utter bunk. Bank of America was already a very cost and efficiency driven bank, to a fault. It botched its acquisition of the private bank US Trust by imposing its stingy ways on customers who had every reason to demand a bit of cosseting. It went so far as to impose ATM fees on a customer base that typically held 6 to 7 figure balances in checking accounts.

Banking expert Chris Whalen has called the cost cutting effort “criminal”. He points out the obvious: there is nothing wrong with the bank’s operating businesses. The threat to BofA’s survival comes from litigation on its mortgage backed securities business….

It is important to understand the business model of these firms… the whole project [is] accounted as a restructuring, with their compensation buried in the total.

To give an sense of how large the fees might run…a guesstimate by an informed source is that the fees on a medium-large project, say $400 million in savings, would be 5% or $20 million. Fees presumably scale down as deal sizes increase, so the $5 billion BofA assignment would presumably be set at a lower percentage. By contrast, the going rate for bona fide restructuring specialists like Houlihan Lokey or Gordian Group (remember these deals are accounted for as restructurings) are in the 0.75% to 1.5% range.

So given a high profile, high stakes project for a large and extremely profitable client, the last thing Promontory would want to do was to find borrower harm in the foreclosure reviews, since that would not only cost the Bank of America dearly through mandated payments to wronged borrowers but could also stoke litigation from homeowners*** and investors.

Our next post will discuss what whistleblowers told us about how Promontory managed its foreclosure reviews at Bank of America and PNC.

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* I engaged Ludwig when I lead the Mergers & Acquisitions Department at Sumitomo Bank to advise on a complex international real estate syndication venture. We would meet infrequently over the 1990s. Ludwig mentioned with some pride that at the OCC, he had outflanked the Fed on certain issues.
** This isn’t the first time Ludwig has been insensitive to issues of propriety. See here for details of a brouhaha over a Ludwig coffee meeting with Clinton, bankers, and Democratic fundraisers.
*** The OCC consent order that included the foreclosure reviews stipulated that borrowers who received a payment under the review did not waive their rights to litigate for additional damages.