Editor: Please describe your practice areas.
McCormack: I do complex commercial, class action and securities litigation, with a major focus on financial institutions.
Hall: My practice focuses on dispute resolution in the financial services industry. We advise a wide variety of financial institutions including commercial banks, investment banks, insurance companies, private equity and hedge funds. I get involved in a thoroughly broad spectrum of issues for these clients, including creditor's rights, lender liability, letters of credit, bankruptcy litigation, fraudulent conveyances, securities disputes and the like.
Editor: Please describe the mission of the new financial crisis task force at Chadbourne.
McCormack: Our mission is to help our clients navigate the difficult legal and business problems caused by the financial crisis and the economic downturn. To aid in that effort, we are coordinating the efforts of our litigation, bankruptcy, corporate, insurance, structured finance and real estate practices, both domestically and internationally, to respond to client needs.
Editor: How did you go about bringing a group together to address client needs?
Hall: What we did first was sit down and assess the anticipated needs of our clients, focusing primarily on our financial institution clients. Then we brought together areas of expertise within the firm that we thought will be required to service those needs, as Tom mentioned. This includes a host of different areas from bankruptcy to litigation to securities to structured finance, etc.
We felt that by forming an interdisciplinary team we would be much better able to respond to clients' needs in an expedited and efficient manner. Let me give you an example. Our structured finance attorneys understand the intricacies of derivative transactions, having worked on them from the financing side. They currently work with both our bankruptcy lawyers and our litigation lawyers who are involved on behalf of clients in untangling their interests in derivative instruments and in exercising whatever rights and remedies that they have.
The financial crisis task force stays on top of the issues and developments in the area, which seem to change on a daily basis. We meet weekly to share information and refocus our efforts based on that information in order to better serve our clients in these difficult times.
Editor: What complications do you foresee?
Hall: A lot. It was a complex series of events that pushed our economy into its current state. I expect that it will take an equally complex series of events for us to work our way out of it. Many of these securitization instruments that are at the heart of the problem are extremely complicated.
For example, what we are seeing in the Lehman bankruptcy, in which we represent dozens of creditors, is that what should be a simple issue, such as who the client's counterparty is on a particular instrument, can be very difficult to resolve. Looking forward, as we move into a period of increased regulation, our clients will need our advice and counsel as they try to cope with complex new regulations that impact their daily business operations.
Editor: Do you expect the more liberal terms in the Emergency Economic Stabilization Act of 2008 (EESA) authorizing the Treasury Secretary to grant relief to homeowners on defaulted mortgages in terms of loan modifications will be extensively utilized?
McCormack: So far the government is having trouble figuring out exactly how to help on that front. Both the Bush administration and President-Elect Obama, however, have stated an intention to help homeowners with their mortgages.
FDIC chairwoman, Sheila Bair, in late October proposed a $500 billion guarantee program estimating the actual cost of that program to the tax payers at approximately $50 billion. This proposal was apparently intended to be included in the $700 billion rescue package. Under that program the FDIC proposed protecting approximately 2 to 3 million homeowners by relying extensively on banks to essentially renegotiate and rework mortgages. In that program, the FDIC would agree to share the losses on certain foreclosures.
The White House has been less than enthusiastic about that approach and is concerned that having the FDIC share the losses would potentially encourage additional foreclosures.
A key issue for the government is going to be how to protect property valuations. Obviously too many foreclosures will add to the spiral of diminishing values, further depressing the value of investment instruments that are tied to those values. The issue is in flux as we talk today.
Some of the large banks including Citi and Chase have begun voluntary programs to help with mortgages. These programs essentially rely upon forbearance, restructuring and potentially some limited grants being given in particularly troubled areas.
I think as we sit here today, the government is not sure yet what it wants to do and, because the focus of the $700 billion rescue has moved from buying assets to supporting equity for financial institutions, it really has not addressed how it is going to help individual homeowners.
It seems likely that some variation of the FDIC program will ultimately be adopted - certainly Representative Frank is pressing that - with some restrictions that would provide relief for homeowners in serious risk of losing their homes, while protecting against potential abuse of the program.
Editor: Are the provisions in the U.S. Bankruptcy Code denying courts the power to change the terms of mortgages likely to be removed?
McCormack: The Obama campaign specifically stated that one of the goals of an Obama administration would be to change the rules so that in Chapter 13 bankruptcies individuals could renegotiate the terms of their mortgages. That has not happened yet, but President-elect Obama is sending clear signals that that is what he intends to do.
Editor: The EESA originally proposed that the government buy "toxic" assets from banks. Now the emphasis is on the infusion of capital into banks and other financial entities with the aim to loosen credit. Do you think that this approach is adequate to free up the credit markets or are other measures needed?
Hall: I think that it is a matter of prioritization. The federal government obviously will not have the resources to bail out every part of our economy that is teetering. Whether the current approach will be adequate to free up the credit markets enough to support an economic recovery is something that we will have to watch. In addition to shoring up the balance sheets of financial institutions, the Treasury Department is now focusing on jump-starting lending to consumers, including auto loans, credit cards and student loans. Clearly, anything that contributes to increasing consumer spending will be a vital element of our economic recovery. Many of our problems will simply need to work themselves out without government intervention.
Editor: Do you find that "mark to market" of some securities has been a contributor to balance sheet deterioration for financial institutions which might otherwise be considered healthy?
Hall: Experts have disagreed on that. Some experts argue that "mark to market" regulations have played a role in the credit meltdown though no one is suggesting that they played a decisive role. The problem is that, when there is no market for derivatives held by banks, for example, under "mark to market" rules, banks may be required to recognize immediate losses that adversely affect their balance sheets.
Several weeks ago the SEC relaxed the "mark to market" accounting rules somewhat by allowing managers to use their own judgment when valuing securities in illiquid markets. This means that they can rely on their own financial models that use information that may not be public. Currently the SEC is considering a further relaxation of these rules and has promised to issue a report on that subject soon.
Japan has recently relaxed its "mark to market" rules. The relaxation or suspension of the "mark to market" rules will obviously have a positive impact upon bank balance sheets. The counter to that is that it may unrealistically inflate those balance sheets. So while we can expect some relaxation, I doubt that we will see a complete suspension of these requirements.
Editor: Once the dust settles, do you expect to see much tighter regulation of financial institutions as well as some of the instruments, such as credit default swaps?
Hall: Absolutely. We will see tighter regulation of the financial industry. The only issue is how extensive it will be. There really is very little in the pipeline right now, but congressional leaders have indicated that the new Congress will take up the issue as a priority. I expect that we will see regulatory activity in at least three areas.
First, the area of derivatives and swaps, which currently are largely unregulated, will be addressed. Regulation will likely focus on controlling the risks that financial institutions take in connection with these instruments - such as requiring that they have adequate capital to backstop their obligations.
Second, I think that we will see hedge funds come under some regulatory oversight. At a minimum, I expect reporting requirements will be imposed on hedge funds.
Lastly, we will see a macro assessment of the overall regulatory structure of financial institutions. At present, financial supermarkets are regulated in part by the SEC and in part by bank regulators and in part by state insurance regulators. Questions will be asked concerning the effectiveness of such a disjointed oversight structure.
McCormack: In the testimony that took place before Congressman Waxman's Oversight Committee, a number of witnesses spoke about the present condition of the financial markets and how things should be improved. Several of them warned that the government should not overreact and thereby inhibit the recovery that will ultimately occur.
We will have to keep an eye on how this all plays out over the next six months to a year. The challenge is to adopt necessary regulation to avoid a repeat of the problems we currently face without inhibiting the kind of innovation that has made our country so successful economically.
Published December 1, 2008.
