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[Art Deco]

  [image: The New York Times] <http://www.nytimes.com/>

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March 2, 2013
Promises, Promises at the New York Fed By GRETCHEN
MORGENSON<http://topics.nytimes.com/top/reference/timestopics/people/m/gretchen_morgenson/index.html>

TWO weeks ago, I wrote a column about a secret
agreement<http://www.nytimes.com/2013/02/17/business/dont-blink-or-youll-miss-another-bank-bailout.html?ref=business&_r=1&>struck
in July 2012 by the Federal
Reserve Bank of New
York<http://topics.nytimes.com/top/reference/timestopics/organizations/f/federal_reserve_bank_of_new_york/index.html?inline=nyt-org>and
Bank
of America<http://topics.nytimes.com/top/news/business/companies/bank_of_america_corporation/index.html?inline=nyt-org>.
The existence of the confidential deal was disclosed recently in court
filings, which showed the New York Fed releasing Bank of America from all
fraud claims on mortgage securities the Fed had bought as part of the
government’s rescue of the American International
Group<http://topics.nytimes.com/top/news/business/companies/american_international_group/index.html?inline=nyt-org>in
2008.

A.I.G., which is suing Bank of America to recover losses it suffered on
those securities, has calculated the value of the fraud claims at $7
billion.

Late on Thursday, a copy of the actual
agreement<http://graphics8.nytimes.com/packages/pdf/business/Exh.pdf>came
to light. It was filed by Bank of America in a California court that
is hearing the matter of who owns those fraud claims — A.I.G. or the New
York Fed. The agreement was also filed by the New York Fed in a related
lawsuit in the Southern District of New York, where the New York Fed asked
that the court keep the agreement under seal.

A reading of the document makes it clear why.

The agreement spells out the terms of a deal in which the New York Fed
received $43 million from Bank of America’s Countrywide unit. The money
changed hands to settle a narrow dispute involving cash flows on several
mortgage securities held by an investment vehicle, known as Maiden Lane II.
That vehicle was created by the New York Fed as part of the rescue of
A.I.G., which had held the Countrywide securities. The previously
confidential agreement released Bank of America from all litigation claims
on the securities held by Maiden Lane II.

But in exchange for that $43 million, the New York Fed did something else
for Bank of America. It agreed to testify on behalf of the bank in its
legal battle against A.I.G. over fraud claims.

In that matter, Bank of America has argued that A.I.G. has no right to sue
it for fraud because A.I.G. sold the securities to Maiden Lane II and so
transferred the litigation rights to the New York Fed. A.I.G., however,
maintains that the Maiden Lane agreement never specified the transfer of
the right to sue for fraud and that an explicit transfer is required by New
York law, which governs the agreement. The New York Fed provided Bank of
America with two affidavits supporting the bank’s view of who owned the
mortgage securities’ fraud claims.

Two weeks ago, it was unclear why the New York Fed gave Bank of America the
affidavits. But now, its promise to testify “as needed,” shown in the
formerly confidential settlement, addresses that oddity. It was a
contractual obligation.

Interestingly, the New York Fed did not tell the California court that its
affidavits came about because of its deal with Bank of America. The
affidavits came from James M. Mahoney, a vice president at the New York
Fed, and Stephanie A. Heller, its deputy general counsel.

But those affidavits differ from the position taken earlier by Thomas C.
Baxter Jr., the New York Fed’s general counsel. In a letter to A.I.G. in
October 2011, Mr. Baxter said that he and his colleagues “agree that A.I.G.
has the right to seek damages” under securities laws for the instruments it
sold to Maiden Lane II.

Michael Carlinsky, A.I.G.’s lawyer at Quinn Emanuel Urquhart & Sullivan,
said on Friday that he found it “disturbing” that the New York Fed made a
contract to “assist Bank of America in its defense of A.I.G.’s lawsuit.”

Also on Friday, I asked the New York Fed why it had included this promise
of legal support for Bank of America in the settlement agreement. Jack
Gutt, a spokesman, said in a statement that the New York Fed had intended
to hold the litigation rights and that the declarations were true.

“The New York Fed did not agree to provide the declarations to benefit B.
of A., but rather because doing so helped the New York Fed obtain the best
possible settlement” for Maiden Lane II, Mr. Gutt said. “In agreeing to
this provision as part of what the New York Fed believed was a favorable
settlement agreement, the New York Fed was concerned exclusively with
advancing the taxpayer interest.”

I also asked a Bank of America spokesman whether the bank had paid more in
the settlement because of the New York Fed’s promise to testify. He
declined to answer that question, saying, “Countrywide provided fair value
for a complete release of claims by the Federal Reserve Bank of New York,
and the Fed agreed to provide testimony standing behind what it had
formally represented to Countrywide regarding the assignment of claims from
A.I.G.”

Edward J. Kane, a professor of finance at Boston
College<http://www.bc.edu/schools/csom/faculty/bios/kane.html>who has
written extensively about financial regulators who are too close to
the industries they regulate, discussed with me the unusual terms of the
New York Fed’s deal with Bank of America.

“The Fed seems to have thrown off all restraints on its behavior in just
trying to get through the crisis and the aftermath of the crisis,” Mr. Kane
said. “It’s like a slippery slope, and they just keep sliding a little
further.”

The New York Fed was also criticized last week in a related ruling by Lewis
A. Kaplan, a federal judge for the Southern District of New York. A.I.G.
had asked Judge Kaplan to oversee the dispute over who — A.I.G. or Maiden
Lane II — owns the fraud claims in these securities. Even though the Maiden
Lane agreement required that any disputes between the New York Fed and
A.I.G. be heard in a New York court, the New York Fed argued that the
matter should be decided in California.

Although Judge Kaplan declined to take the case from the California court,
he said in his ruling that the New York Fed appeared to be trying “to
circumvent and defeat the forum selection clause to which it is bound by
its agreement with A.I.G.” The New York Fed’s actions, he wrote, “perhaps
are unattractive and, indeed, wrongful.”

Mr. Gutt said that the New York Fed was not trying to “defeat a forum
selection clause, but rather to fulfill a contractual obligation.”

The federal judge’s words are nonetheless strong. And they highlight the
reputational risk that the New York Fed may have taken on as a result of
these events.

Of course, the reputations of many financial institutions have taken a
beating in the years after the crisis, as Sarah Bloom Raskin, a governor of
the Federal Reserve System, acknowledged in a speech last Thursday. Her
remarks<http://www.federalreserve.gov/newsevents/speech/raskin20130228a.htm>,
titled “Reflections on Reputation and Its Consequences” and delivered at a
Federal Reserve Bank of Atlanta conference, explored the reputational
damage suffered recently by United States financial institutions.

Ms. Raskin called on policy makers to think about reputation as it relates
to the banks they oversee. If examiners are watchful for threats to an
institution’s reputation, she said, other risks posed to investors,
creditors, trading partners and taxpayers may come to light.

“Sociologists and economists have long remarked upon the central role that
social trust plays in healthy markets,” she said, according to her written
remarks. “Social trust is the glue that holds markets and societies
together. In the context of banking, social trust and reputation are
related concepts.”

Surely this holds true in the context of central banking as well.


-- 
Art Deco (Wayne A. Fox)
art.deco.studios at gmail.com
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