The good news is that we finally have the second group ofindictments of senior bank officers. The prosecution involves officers of United Commercial Bank (UCB), a roughly $10 billion San Francisco bank that originally specialized in lending to Chinese-Americans and became primarily a commercial real estate (CRE) lender. The indictment deals only withthe cover up phase of UCB’s senior officers’ frauds. I will show in future posts that the reportedfacts on UCB’s loans were consistent with accounting control fraud. The UCB case is so rich in lessons that itwill take a series of articles to capture what the case reveals about thedegradation of regulation and prosecution of elite accounting controlfrauds.
Here are the most essential facts. In 2002,a court found that UCB’s senior managers had engaged in fraud to hide losses ona large loan for the purpose of fraudulently inducing another bank to bear thelosses. It found the senior officers’conduct so outrageous that it awarded substantial punitive damages. The FDIC, the SEC, and the Department ofJustice did nothing in response to the fraud.
There is no indication that the FDIC filed a criminal referral.
UCB then went on campaign to grow massively (to reach the minimum size, $10 billion, to acquire a Chinese bank) by making CRE loans. UCB made so many CRE loans so rapidly that itshowed up as an exceptionally high risk bank under the joint agency guidelineson CRE concentrations. Despite this dangerous concentration, its record of engaging in fraud, and examination reports that found pathetic underwriting on CRE loans, the FDIC rated UCB’s managers as “1” or “2” (the top possible ratings).
The joint agency guidelines were typical products of theanti-regulators’ destruction of effective regulation. The guidelines were designed to beunenforceable and they met their designers’ goals. The anti-regulators did not believe it waslegitimate to regulate – one could only natter at the frauds and crazies thatwere destroying the economy. The damage that using guidelines instead of enforceable rules causes to effective supervision and prosecution will be subjects of future postings.
Making loans without appropriate underwriting causes banks serious losses. When bad underwriting iscompounded with extreme concentrations in high risk assets the resulting lossesare commonly fatal. When one adds in accounting control fraud the result is catastrophic losses.
The UCB case allows us to form critical insights about theFDIC’s examination, supervision, and Inspector General (IG) functions. Each needs to be revamped on an urgentbasis. UCB was not a difficult case, yetthe FDIC got it spectacularly wrong. Oneof the future articles will focus on these problems. The FDIC has had less ferventlyanti-regulatory leaders than its sister agencies, so if the FDIC has fallen this low it bodes poorly for federal financial regulation.
On October 22, 2008, the FDIC recommended that UCB beadmitted to TARP on the basis that it was a well-run and well-capitalizedbank. The FDIC claims, with no criticalinquiry from its IG, that this recommendation (which added roughly $300 millionto the cost of resolving UCB’s failure) was appropriate because UCB’s seniormanagers’ misled the FDIC about UCB’s true financial condition. Yes, they did deceive the FDIC, but the FDICshould have removed UCB’s senior managers in 2002 and it should have known thatUCB’s purported income and capital were likely false from that date. An anonymous whistleblower wrote to theTreasury Department to warn that UCB’s CEO could not be trusted. The FDIC then “considered” the warning bydeciding that it should not investigate the warning. Had they taken even the most minimal step that a high school student could employ (a web search) the FDIC would have found that UCB’s senior managers had led a major fraud in order to cover uploan losses.
It is disturbing that the FDIC did not make criminalreferrals against UCB’s senior managers in 2002 and did not remove and prohibitthem from the industry. It is disturbingthat the FDIC did not prevent UCB’s massive growth in highly risky assets. It is disturbing that the FDIC failed torecognize the signs of accounting control fraud in UCB’s CRE lending. It is disturbing that the FDIC rated UCB’smanagement and asset quality as sound or even exemplary. It is disturbing that the FDIC ignored thewhistleblower’s warnings about UCB and recommended that it be given TARPfunds. But it is inexcusable that the IGreport, the function of which is to examine the agency’s mistakes so that theycan be fixed, never mentions that a court found in 2002 that UCB had defraudedanother bank by covering up a huge loss on a major loan.
Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.
Follow him on Twitter: @WilliamKBlack