The NYCB-Signature deal was a spectacular regulatory failure

The decision to allow New York Community Bancorp’s Flagstar Bank to purchase Signature Bank spectacularly disappointed the American public for many reasons.

While most reporting to date has focused on NYCB’s commercial real estate lending exposures, which have certainly increased the bank’s risk, there are deeper and much more dangerous risks. Flagstar’s growth in just two quarters of 2022 far exceeded the performance posted by all three regional banks that failed in 2023 in the years leading up to their failure. With the acquisition of New York Community Bank, Flagstar’s assets grew from $25 billion in September 2022 to $90 billion in December 2022. Then, with the acquisition of Signature, Flagstar grew to $123 billion in assets in March 2023.

The complexity of combining and integrating the operations of previously separate entities is time-consuming and often burdensome, even under the best of circumstances. Therefore, it was not surprising that federal banking regulators highlighted problems related to rapid significant growth leading to inadequate internal controls as one of the main causes of regional bank failures in 2023. Similarly, given two major mergers within a few months, it is not surprising that Flagstar’s internal control failures were serious, requiring restatements of its financial statements and changes in its board of directors and senior management.

The broader implications of the recent Flagstar mergers are that the bank now poses a real systemic threat to our financial system. At current asset levels, in the event of a bank failure, it is reasonable to expect that another systemic risk exception would be applied, similar to what we saw in 2023 with Silicon Valley Bank and Signature. This would likely result in significant costs and harm to taxpayers, Main Street and the American public.

While allowing cross-mergers was wrong, it is equally inexplicable that regulators appear to have ignored or disregarded banks’ history of illegal and discriminatory behavior. Regulators have a special role to watch for such behavior and take decisive action to stop it.

When NYCB announced its initial plan to acquire Flagstar in 2021, it followed the usual process of seeking approval from federal and state regulators. However, the application process was not smooth.

New York’s regulator gave approval, but the Federal Deposit Insurance Corporation was “so concerned about Flagstar’s fair lending failures” that it would not support the merger, according to one news report. The Consumer Financial Protection Bureau also took action against Flagstar for discriminatory practices in its mortgage lending business, and the bank was the subject of a private lawsuit alleging discriminatory practices that harmed African-American borrowers. Because only state regulators approved the merger, NYCB has engaged in what appears to be blatant regulatory arbitrage.

In April 2022, NYCB withdrew its pending merger proposal and began the process of becoming a national bank. This required the banks to restructure the merger so that Flagstar acquired NYCB, rather than the other way around as before. The regulator change also meant that the OCC would now decide on the merger application. The agency inexplicably approved the merger, which was finalized in December 2022.

What is incredible is that the OCC allowed these banks to engage in what appeared to be blatant regulatory arbitrage, going from one regulator to another to obtain a different outcome. This is reminiscent of the infamous and discredited “charter purchases” that occurred before the 2008 crash and were a major cause of the Dodd-Frank Act’s elimination of the Economic Surveillance Authority. The OCC’s apparent willingness to do this and ignore a pattern of racially discriminatory behavior by merger participants adds insult to injury.

As the regional banking crisis unfolds in 2023, less than 100 days have passed since the merger with NYCB was approved. Many of the complex aspects of the merger of the two banks were at a very early stage. Nevertheless, regulators allowed Flagstar to become an approved bidder in an auction for then-failing banks. To make matters worse, regulators selected him as the winning bidder in the Signature tender.

Given the recent merger and discrimination, it is shocking that Flagstar was even approved as a qualified bidder. It is even less clear how regulators could have selected it as the winning bidder. Conducting a merger and successfully integrating banks is a huge challenge, even under the best of circumstances. In this case, regulatory approval required these banks to do it all at once in what were likely the worst circumstances.

Americans deserve better from financial regulators, and they deserve to know how this could happen. There should be a thorough but independent investigation into the regulatory conduct of the mergers leading to NYCB’s problems.