Kirk Victor is a GOVERNING contributor.E-mail: firstname.lastname@example.org
Neil Barofsky spent less than three years in Washington as special inspector general for the Troubled Asset Relief Program. But when he left last year, the former New York prosecutor had plenty of bruises. He had been in bloody battles with top government officials over his efforts to prevent fraud and require more transparency in the way the $700 billion program was administered. He had gone head to head with federal power brokers at the Treasury Department who, he claims, were protecting mammoth banks rather than watching out for distressed homeowners.
So when he saw New York state bank regulator Benjamin Lawsky vilified for filing a money-laundering lawsuit against Standard Chartered Bank, Barofsky had a strong sense of the undercurrents. As he saw it, the bulk of the scathing attacks on Lawsky came not from big financial firms and Wall Street, but from anonymous Washington sources. Their grievance: The state regulator had “jumped the gun” and supposedly undercut investigations being conducted by federal prosecutors.
Despite the public scolding, Lawsky managed to negotiate the largest money-laundering settlement in history -- a $340 million agreement announced in August. That achievement reinforced the sense among some that when bad actors on Wall Street or in other industries are not held accountable by Washington, it’s up to the states -- in this case, New York -- to take the initiative and fill the void.
There is a track record backing up that sentiment. State attorneys general have a long history of joining together to take on huge national industries and interests. In the 1990s, for instance, state AGs led the battle against big tobacco companies to recover funds for treatment of people with tobacco-related illnesses -- a stance that culminated in a multistate settlement in 1998. Similarly, in the 1980s a group of state attorneys general, dubbed the Chowhounds, pursued companies making dubious nutritional claims on food packages after they concluded that the Food and Drug Administration and Federal Trade Commission were looking the other way rather than investigating the companies’ spurious promises.
The situation has become more tendentious in recent years, particularly in regard to banks and other financial institutions. In that area, some state AGs see federal regulators as unwilling or unable to act in the interest of consumers -- and just as unwilling to let the states take action. But new laws and regulations put in place in the aftermath of the Great Recession may finally give states the teeth they’ve been asking for.
There’s a lot of bad blood between state AGs and some federal agencies. One of the uglier fights concerns a turf battle that occurred in the early and mid-2000s. At the time, state attorneys general initiated actions against predatory and misleading loans and mortgages -- the very financial instruments that led to massive numbers of foreclosures at the start of the economic downturn and which continue today. When state AGs took action, they came up against an unexpected and formidable obstacle. The Office of the Comptroller of the Currency (OCC) claimed the states did not have the authority to proceed. The states were, the OCC said, “preempted” by federal law. In other words, the OCC -- not state attorneys general -- had sole control over regulating the practices of national banks.
The rationale for preemption is straightforward enough: Having one national regime for businesses to follow avoids their having to comply with the sometimes conflicting regulations issued by 50 different states. Still, state attorneys general were frustrated and angry at being unable to protect citizens who had been misled into taking on loans they couldn’t afford or who had fallen prey to other deceptive banking practices.
Moreover, after invoking preemption, the OCC did nothing to address the onrushing problems, and nor did the Federal Reserve, says Illinois Attorney General Lisa Madigan. The result was that standards for underwriting loans were, she says, “eviscerated during the housing bubble.”
In reviewing the history of that failure to protect homebuyers, Madigan, who has been Illinois’ attorney general since 2003, says that in her first year as AG, her office received about 22,000 consumer fraud complaints involving homeowners, and that those numbers have increased steadily ever since. The cases often involve people with mortgage terms that they had never seen before and many of which were designed to fail.
“We saw the practices that we knew were going to destroy people’s homes and their communities and ultimately destroyed our economy,” Madigan says. “We are on the front lines with our consumers -- we see things first. We can be reactive in a way that [Washington] can’t. Here in Chicago or Springfield, I literally have consumers, and in this context homeowners, walking into our office every single day.”
North Carolina Attorney General Roy Cooper makes a similar point. “It is important not to take 50 sheriffs off the beat, particularly when the world of finance can be the Wild West.”
But it has been hard to get the OCC to see things that way, says Indiana Attorney General Greg Zoeller. Zoeller, who knows Washington well after serving as an assistant to Dan Quayle when he was a senator and then vice president, sees the OCC as an agency that “seems to have little respect for the role of states to the point where they are not even making an effort to maintain some relationship.”
A spokesman for the OCC answers state charges by pointing out that “while the dual banking system provides separate regulatory frameworks for state and federal banks, the OCC has always been committed to working with state regulators to ensure bank customers are treated fairly. Today, we are also working closely with the [Consumer Financial Protection Bureau] in support of its consumer protection mission.”
Phil Angelides, former California treasurer and chairman of the Financial Crisis Inquiry Commission, which Congress created in 2009, says that stopping the states from pursuing fraud claims in their backyards was a big mistake. “If you look back at the financial crisis and the emergence of predatory and abusive lending practices, and the out-of-control subprime lending practices, what is really quite striking is the extent to which the state attorneys general who saw the problems in their own states began to act.”
At the same time that the federal government tied the hands of state governments, Angelides says, they then “sat on their own hands.” He does not claim that greater state action in and of itself would have stopped the financial crisis from happening. “But it would have been a pressure point if the states had been allowed to be aggressive against many of the practices that metastasized wildly from the mid-2000s on.”
After spending the last three years trekking to Capitol Hill to lobby for changes in banking laws and after litigating the preemption issue, a number of state attorneys general are heartened by progress that is beginning to occur in their relationship with Washington. They cite three important events as the source of their optimism: A Supreme Court case in 2009, passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, and the formation of a state-federal task force earlier this year to investigate misconduct contributing to the financial crisis through the pooling and sale of residential mortgage-backed securities.
Illinois’ Madigan says the 2009 case, Cuomo v. Clearing House Association L.L.C., enables states to go after fraud even against national banks, with some conditions. The case, she says, has helped to bring about more collaboration between the states and Washington. That was apparent earlier this year when 49 state attorneys general, joined by the Justice Department and the Department of Housing and Urban Development, struck a $25 billion agreement with the nation’s five largest mortgage servicers -- Bank of America Corp., JPMorgan Chase & Co., Wells Fargo & Co., Citigroup Inc. and Ally Financial Inc. -- to address mortgage loan servicing and foreclosure abuses. It is the largest federal-state civil settlement ever obtained. (The Oklahoma state attorney general reached a separate deal.)
Just as the Cuomo case gives state AGs more power to go after national banks, the enactment of the Dodd-Frank Act limits the OCC’s preemption authority. Of course, there are some exceptions that allow preemption, including if state law favors state-chartered institutions over national banks or if state law “significantly interferes” with a national bank’s operations. “[But] there is more cooperation because now the federal people can’t just ignore the state people,” says Rep. Barney Frank of Massachusetts and co-author of the Dodd-Frank legislation.
The law does not go quite as far in freeing the states as Frank would have liked, given the conditions that still permit preemption in certain limited circumstances. The real test will come, he says, if an administration that does not favor the Dodd-Frank law assumes power and tries to roll back some of its provisions.
But perhaps the most promising evidence -- at least for some -- of an improving relationship came in October when New York Attorney General Eric Schneiderman announced that he had filed a lawsuit against JPMorgan Chase for fraudulent misrepresentations in promoting sales of residential mortgage-backed securities to investors. It marked the first action since President Obama created the federal-state task force. The Justice Department and Securities and Exchange Commission provided resources to help put the case together.
There are still some AGs who feel a lot more needs to be done to give states a bigger role. They point to Schneiderman’s aggressiveness, saying it again underscores states’ willingness to move ahead of their federal counterparts. “Federal regulators have been somewhat gun-shy about going after major banks and brokerage firms,” observes Andrew Stoltmann, a securities lawyer. “State regulators are more willing to rock the boat than federal regulators.”
But at an October press conference with federal officials on the task force, Schneiderman stressed that the case his office brought was the result of an “incredible collaborative enterprise,” adding that, “by doing it together, we’re providing a lot more bang for the buck for the American people.” He signaled that more cases are coming.
Even as he praised the state-federal task force, Angelides of the Financial Crisis Inquiry Commission foresees more battles between the states and the feds. “There is a greater level of cooperation today, but that doesn’t mean there aren’t turf battles and it doesn’t mean that there aren’t going to be conflicts.”
The states also have a potential new ally in Washington since the Dodd-Frank Act created an agency whose sole purpose is to protect consumers. The Consumer Financial Protection Bureau is far less likely to be a captive of banks or financial firms. Its director, Richard Cordray, is himself a former state attorney general from Ohio.
Even so, some state attorneys general are still so wary of Washington that they have not embraced the new consumer agency. In a meeting in March of the National Association of Attorneys General, Cordray asked the state attorneys general for a “quick turnaround” on a memorandum of understanding to protect the confidentiality of data shared by their offices. He didn’t get anywhere near unanimous approval -- only a dozen attorneys general have signed it.
While the Protection Bureau has the potential to be an important partner with state agencies, the agency is something of a political lightning rod. Some Republican lawmakers view it as too powerful and not subject to sufficient oversight. In addition, because Cordray is a recess appointee who has not been confirmed by the Senate, some GOP legislators question his legitimacy. Several state attorneys general have even joined a lawsuit that challenges the constitutionality of the Bureau and Cordray’s appointment. They charge that the law gives the Treasury Department too much power to liquidate failing financial firms.
Cooper of North Carolina, a champion of the new agency, acknowledges that there have been difficulties early on, but he is upbeat about prospects for collaboration. “We now have a partner that can join hands with us to fight financial fraud, particularly in areas where we know we are preempted by federal authority,” he says.
Over the past decade, state AGs have been frustrated by the way federal consumer protection was spread out in numerous federal agencies. Oftentimes, particularly with the OCC, the AGs would get little to no response when they sent in a complaint. “It would fall into a black hole,” Cooper says.
The new agency will change that history, Cooper predicts. “There is a natural resistance among a number of states about working with the federal government, and there is a healthy dose of skepticism because of some past events,” he says. But any lingering enmity in the states ultimately will dissipate. “There are always going to be stumbling blocks when you work with state and federal [offices],” he says. “But the desire is there. We have formed working groups where we are talking to each other. In the end, it will work."
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