Which Aspect of the FDIC’s Litigation Failures is the Most Embarrassing and Damaging?

By William K. Black
(Cross posted at Benzinga.com)

On March 11, 2013 the Los Angeles Times published a revealing article by E. Scott Reckard entitled:  “In major policy shift, scores of FDIC settlements go unannounced.”

The article’s summary statement captures the theme nicely.  “Since the mortgage meltdown, the FDIC has opted to settle cases while helping banks avoid bad press, rather than trumpeting punitive actions as a deterrent to others.”

The article contains four key facts we did not know about the FDIC’s leadership and its litigation director.  The only question is which of these three facts provides the most revealing insight into the disgrace that the FDIC has become.  The first fact is that the banks and bank officers can now cut deals with the FDIC designed to keep their settlements secret.  What that tells us is that the FDIC’s leaders are indifferent or clueless about deterrence and earning public respect for the integrity of the FDIC’s efforts to hold the officers who drove the crisis accountable.

The second key fact that we learned from the article is that the size of the settlements, for some of the most culpable fraudulent mortgage lenders, is so embarrassingly low that the FDIC’s litigators and investigators have proven to be an embarrassing failure.  Consider these settlements:

“Many of the FDIC settlements reviewed by The Times are small, but others required larger payments from prominent lenders. Quicken Loans and GMAC’s Residential Capital unit, for example, separately agreed to pay $6.5 million and $7.5 million, respectively, over soured loans they had sold to IndyMac.”

Those settlements are likely to be at least an order of magnitude too small given the size of IndyMac, the terrible quality of its portfolio, the typical nature of reps and warranties provided by the sellers, the enormous incidence of false reps and warranties observed in similar cases, and the defendants’ ability to pay far larger damages.

Other settlements reveal that the FDIC is allowing even the controlling officers of the most notorious fraudulent lenders to walk away wealthy.

“At least 10 undisclosed settlements involved officers and directors accused of contributing to the collapse of their own banks. Those include 11 insiders at Downey Savings & Loan in Newport Beach who paid a total of about $32 million, most of it covered by corporate insurance policies. In the Downey case, the FDIC announced last year that four of the insiders had agreed to be banished from banking, including Maurice L. McAlister, Downey’s co-founder, who died Feb. 13.

But the announcement mentioned nothing about the payments or sanctions against the seven other former insiders. Out of the $32 million, McAlister was required to pay $1.93 million out of his own pocket, with the other insiders paying a combined $1.75 million. Insurers that provided coverage for civil wrongdoing by officers and directors paid the remaining $28.4 million.

The FDIC also has resolved certain claims involving IndyMac, including a $1.4-million settlement in May 2011 with the thrift’s former president, Richard Wohl.”

The McAlister and Wohl settlements are disgraces.  The FDIC’s senior and legal leadership has proven itself unfit and should resign.

That disgrace provides the transition to the third aspect of the FDIC’s embarrassment revealed by the article.

“The FDIC also may have been emboldened by success in a rare case it took to trial, according to a recent report from consulting firm Cornerstone Research.

The trial led to a Dec. 7 federal jury verdict in Los Angeles ordering three former IndyMac executives to pay $168.8 million for what the FDIC said was reckless approval of 23 loans to developers and home builders who never repaid them. It was the highest award possible in the case.

Another FDIC lawsuit, seeking $600 million from former IndyMac Chairman and Chief Executive Michael Perry, was resolved for a fraction of the claim Dec. 14. Perry agreed to pay $1 million himself, allowed the FDIC to pursue an additional $11 million from insurers and agreed to be banned from the industry.

The news was first announced in emails sent to news organizations — not by the FDIC, but by Perry’s defense attorneys, who considered the outcome a victory.”

These four paragraphs display the relevant contrast.  In the “rare” case the FDIC was willing to litigate they obtained a $168.8 million recovery.  In the Perry case, the FDIC allowed one of the most culpable defendants in the entire crisis grow wealthy by making enormous numbers of fraudulent liar’s loans.  The FDIC’s decision to accept the Perry settlement requires a descriptor that is worse than a “disgrace.”  It is reprehensible.  It is no wonder that Perry’s defense attorneys made public the settlement as a PR move because they were so delighted with the FDIC’s collapse.  A collapse like this does not represent simply a litigation failure.  It also constitutes a moral collapse by the FDIC’s leaders.  They simply lack the integrity and courage to represent our Nation.

The third fact that emerges is that the FDIC’s real purpose in entering into these settlements crafted to try to keep the public from learning about them is not to secure a higher settlement but to protect the FDIC leadership from embarrassment for their failures of nerve, competence, and any understanding of the overriding need to ensure that no executive walks away making a profit from fraudulent lending.

The fourth fact that emerges is that the FDIC does not understand how a banking regulator and its litigators must deal with control fraud.  It is fine for the FDIC to lose half its litigated cases against the senior officers who run control frauds where its wins lead to large awards that remove any gains the controlling officers received from the bank.  What the “C-suite” defendants need to understand is the moral certainty that the FDIC will, as a matter of principle, never agree to a settlement that leaves a non-judgment proof controlling officer with wealth he gained by leading the bank to make fraudulent liar’s loans.  When elite defendants engage in fraud the banking regulators’ paramount task is not to maximize the expected value of the recovery – it is to deter future frauds because control fraud causes catastrophic losses and drives our recurrent, intensifying financial crises.  The defendants need to know that the FDIC will be remorseless in litigating against the senior officers running control frauds.

The actions of Perry’s lawyers in publicizing the FDIC settlement tells us what an embarrassing defeat they inflicted on the FDIC because it was unwilling or incapable of summoning the moral courage to litigate the case.  Is there anyone left in the banking regulatory ranks with a fire in their belly?  Is there no one who has had enough and will insist that the fraudulent controlling officers limp away bankrupt rather than strut away wealthy?

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

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

9 responses to “Which Aspect of the FDIC’s Litigation Failures is the Most Embarrassing and Damaging?

  1. Thank you Prof. Black for your insight to our – once again – defective and nearly absent government, where collusion is the norm, not the exception.
    Former FDIC head Sheila Bear is considered something on an inside hero in all this, as much as any insider can in the Bush-Obama Administrations (http://en.wikipedia.org/wiki/Sheila_C._Bair). It sounds like most of these settlements and cases were made after her mid-2011 resignation. It would be interesting to hear her opinion on how the FDIC has fallen down since then.

  2. Sunflowerbio

    shouldn’t remorseless be relentless?

  3. The greatest job category growth should not be in healthcare aides and parking attendants, but in forensic accountants and forensic auditors, and IT auditors, etc., but instead, due to the absolute corruption of a completely fraud-based society (and there is no other adequate term to describe it, other than a completely fraud-based society where any and all forms of competitive — or meritocratic — hiring are a complete joke, accordingly) we see endless articles (and it is a tremendous article and posting by Prof. Black, please don’t misunderstand) of this sort, and will continue to do so until the global elites finally completely dominate the Web (probably not in the distant future, but relatively sooner).

    • You mean the ratwing trolls, I suppose, who infect most blogs with lies and venom. I can never figure out if they are paid posters for the neocon cabal or if they are actually insane.
      Paul Ryan and Sean Hannity are their heroes.

    • Optimist, you are.

  4. Johnny Garza

    Thank you professor Black, for your insight and the fact that you share your consistent research, it serves the working class greatly. I am of the opinion that the only thing we have left to change this corrupt government is to call for a labor movement that stops work in America. A true blue general strike the likes of which we saw in the late 19th century. It is articles like those that you bring to light and posts like this that you share that gives us hope for better things to come. We must in my view change the tone in our fight and replace words such as reform to platform and progressive to populist. I believe Mr Firestone or Professor Randall Wray spoke on this in an earlier post. I agree whole heartily. You are an American hero sir.

  5. Sickening. The FDIC, that is – not the article, which is like any autopsy. Gruesome, but necessary.

    Whenever I recommend “The Best Way to Rob a Bank is to Own One”, I always ask whether the person has high blood pressure – and whether they are on their meds.

    Thanks again,

    -dp

  6. Pingback: Naked Capitalism on the Attacks on Krugman | Seniors for a Democratic Society

  7. Thanks for this article. I found out the truth about the FDIC the hard way. I live in MA which in theory has some stringent consumer protection laws. In practice no one cares and bankers get away with fraud and theft. Despite opting out of overdraft protection I was charged just under $200 in fees in one day! But apparently that is not abusive. In direct violation of the FDIC regulations, yet a complaint and supposed investigation resulted in nothing. Somehow the bank got away with lying and falsifying evidence, even in court! And now they are trying to harass me and sue me. Sorry, I know thats long and a little off track. The point remains that the FDIC is a puppet organization that helps banks (like Middlesex “Savings” Bank) steal money they never worked for simply because “we can”.