James M. Cirona: In Memoriam

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

The death of a successful banker and regulator

James M. Cirona died January 4, 2014.  I doubt that many readers know of Jim’s work even if they follow finance.  That is a shame for Jim was one of the most important reasons the savings and loan debacle did not cause a financial crisis and a Great Recession.  The reason Jim was so effective was that he understood that the factor driving the debacle was a surging epidemic of accounting control fraud and he had the leadership abilities and the courage to expand and focus the resources of the Federal Home Loan Bank of San Francisco (FHLBSF) to stop that epidemic.

Cirona takes on Charles Keating

Jim led the initiative to target as our priority cases the fraudulent S&L while they were still reporting record profits.  This took courage because these frauds, particularly Charles Keating’s Lincoln Savings, had immense political power.  The Financial Crisis Inquiry Commission report makes clear that the failure of banking regulators to make the banks reporting high profits their priority for regulatory intervention was a key failing.

Keating, however, pretended to be horrified by the policy because Lincoln Saving reported that it was the most profitable S&L in the Nation when it was in reality a cesspool of fraud.  On July 1, 1986, Keating sent a letter to President Reagan’s chief of staff and many other prominent officials.  The cover letter transmitted a memorandum to S&L clients by the Nation’s leading firm representing S&Ls.  The firm memorandum explained our agency strategy.  It noted that we were making it a top priority to examine intensively the S&Ls reporting the highest profits even when they had relatively low reported loan defaults.  Keating’s cover letter said that the memorandum proved that we were “Nazi” and running a “police state.”  He then used a classical simile, claiming that our policies were “like Jupiter eating his children.”

The FHLBSF took the lead in recommending that fraudulent S&Ls be placed in conservatorship while they were still reporting extreme profits.  This made Cirona number one on Keating’s enemy list, and Keating loved to destroy people he considered his enemies.

Cirona understood control fraud, so he understood Lincoln Savings and similar S&Ls

As I have often explained, accounting control fraud produces three “sure things.  The bank is guaranteed to report high (fictional) profits in the near term, the officers were sure to be made promptly wealthy by the compensation system, and the bank was sure to suffer catastrophic losses.  George Akerlof and Paul Romer drove this point home forcefully in their famous 1993 article (“Looting: The Economic Underworld of Bankruptcy for Profit”).

“[M]any economists still seem not to understand that a combination of circumstances in the 1980s made it very easy to loot a financial institution with little risk of prosecution. Once this is clear, it becomes obvious that high-risk strategies that would pay off only in some states of the world were only for the timid. Why abuse the system to pursue a gamble that might pay off when you can exploit a sure thing with little risk of prosecution?” (Akerlof & Romer 1993: 4-5).

Akerlof and Romer also explained the “circumstances” that produced this criminogenic environment.

“The S&L crisis, however, was also caused by misunderstanding. Neither the public nor economists foresaw that the regulations of the 1980s were bound to produce looting. Nor, unaware of the concept, could they have known how serious it would be. Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better. If we learn from experience, history need not repeat itself” (Akerlof & Romer 1993: 60).

Cirona was one of the most important “regulators in the field who understood what was happening from the beginning.”  Cirona did not simply understand, he acted on that understanding on an emergency basis for many years in the face of virulent opposition from the frauds, their political cronies, and the leader of our own regulatory agency.

The advantages of having spent decades as an honest, competent banker

People that ignore control fraud fail to see that the interests of what they inaptly call “the banks” and competent regulators are the same.  Ben White at Politico, for example, describes a “war against big Wall Street banks” by Congress and regulators.  All war metaphors involving financial regulation fail, but this one fails spectacularly because it does not even understand the antagonists.  Banks are not human.  They do not fight and they cannot win or lose.  Now we all (I’ve done it many times) use the short-form “banks” when we really mean the “shareholders” or, when the bank has failed, the “creditors.”  Because he had been a banker, Cirona understood once he became an S&L regulator that when we were reversing the “three de’s” (deregulation, desupervision, and de facto decriminalization) that created much of the criminogenic environment that created the epidemic of looting we were the shareholders’ and creditors’ best friends.  The grave threat to the shareholders/creditors came from the S&L’s controlling officers and their cronies.  We were the only entity that could save the shareholders/creditors from suffering even greater losses inflicted by the officers and their cronies.  This is nothing new.  Classical economists emphasized the point hundreds of years ago when they explained why the rule of law was essential to any economy.  The financial regulators are the “regulatory cops on the beat” to protect the shareholders and creditors’ interests and limit Gresham’s dynamics.

Creating effective regulatory cops on the beat

In the S&L debacle, Federal Home Loan Bank Board Chairman Edwin Gray began to reregulate the industry one year after the bipartisan passage of the disastrous Garn-St Germain Act of 1982 and Gray continued the reregulation in the face of virulent opposition from Congress, the White House, the industry, state S&L regulators, and the business press.

The re-supervision of the industry began in 1984 against the even more virulent opposition of OMB, the industry, the Congress, the Texas Attorney General, and a group of politically-connected Californians very close to then Governor Wilson.

My, and the Nation’s, debt to Cirona

Jim was the most successful regional leader of that resupervision effort.  He was my boss and friend.  His courage, in response to the couched threats and urgings of Gray’s successor, M. Danny Wall, that I be fired are the only reasons I kept my job.  Wall could only fire me “for cause” under the statute, but Jim could have fired me without cause or simply asked for my resignation.  Instead, Jim warned me not to gratuitously give Wall any ammunition to fire me, and backed me to the hilt.  Before I came to the Federal Home Loan Bank of San Francisco (FHLBSF), Jim (the President) and Mike Patriarca (the head of examination and supervision) had already assembled a team that was far ahead of any other region in identifying the worst frauds for closure even while they were reporting record profits and in making high quality criminal referrals.

Wall could have fired Cirona without cause, but Cirona was so well-respected in the Federal Home Loan Bank System that Wall did not dare to do so.  Cirona refused to bend when Wall demanded that the agency cave to the combined intimidation of Keating, the Keating Five, and Speaker Wright.  Wall took the unprecedented action of removing our jurisdiction over Lincoln Savings because we refused to cave to the intimidation.  The result was a disaster.  Lincoln Savings was allowed to grow and became the most expensive bank failure in U.S. history.

Cirona blocks Wall’s attempted giveaway to Bob Bass

Cirona also refused to bend on the sweetheart deal Wall’s team tried to get us to support for Bob Bass’ acquisition of the Nation’s largest S&L.  Wall had excluded the FHLBSF from any participation in or information about the negotiations of the deal even though it was to acquire an S&L that we regulated.  Wall’s people that were drafting the deal bragged that it was “the deal of the century” (it was, but they thought it was the deal of the century for the agency, not Bob Bass).  Wall’s team told us that they had they had taken the Bass negotiating team to the cleaners.  The Bass negotiating team was led by David Bonderman.  He was such a good negotiator that he took Wall’s folks to the cleaners and left them believing they had done the opposite.  (Bonderman did, however, blunder badly in buying WaMu during the current crisis.  His one area of blindness was not understanding control fraud.)

The Bass deal would have gone sailing through, but Lincoln Savings blew up after they yanked our jurisdiction and Wall became nervous that we might criticize the Bass deal once it was completed and we got access to the deal terms.  At the 11th hour Wall gave us access to the deal terms and asked us to certify that the deal terms would not impair our ability to regulate the S&L.  We weren’t allowed to criticize the economics of the deal.  The deal mandated that the S&L make a $1.5 billion unsecured loans to fund a highly leveraged $1.5 billion corporate takeover fund that would be owned by Bass.  The deal mandated that the interest rate on the loans to the insider must be set at the equivalent of a teaser ARM.  That meant that the S&L was required to give a deeply below-market loan to the controlling insider.  The profits of the takeover fund would go to Bass, not the S&L that was providing nearly all the funds to create the takeover fund’s pseudo-equity.

The deal also removed our normal regulatory authority to close an insolvent affiliate or S&L.  In sum, Bass got all the upside and he could retain control of the S&L even if losses in his takeover fund became so large that they bankrupted the fund and the S&L.  We could only place it in receivership if the insolvency reached $300 million.  To state the obvious, except to Wall’s team, the deal was crazy from the standpoint of the S&L, the federal insurance fund, and the regulators.  Bass and Bonderman knew that the loan terms were so outrageous and unfair to the S&L that its officers and board of directors could never approve the loans without breaching their fiduciary duties of care and loyalty.  Their “creative” answer was for the acquisition deal to mandate that the S&L’s officers and directors approve the loan on the outrageous terms specified in the deal.

Wall’s team did not understand that the terms of the acquisition deal contained this mandate, indeed, they did not understand that the deal mandated a grossly sub-market interest rate on a loan.  Wall’s team also did not realize that the deal terms crippled our normal supervisory powers until the S&L was deeply insolvent.  I explained these facts in detail (along with dozens of other defects) in writing.

Darrell Dochow was Wall’s head of supervision.  He had engineered the removal of our jurisdiction over Lincoln Savings and was the official most nervous that we would criticize the Bass deal.  It was his idea to force us to certify in writing that the deal would not impair our ability to supervise the S&L – while forbidding us to criticize the economics of the deal.  It was all very clever right up to the point where we explained why the deal would impair our ability to supervise the S&L, impair the S&L’s health, and set a terrible precedent by mandating the approval of otherwise unlawful and unethical deal terms to benefit the corporate insider at the expense of the S&L.  Dochow was always too clever by half, and now he was trapped in his own cleverness.

In fairness to Dochow, he neither negotiated nor understood the deal terms.  He is not a lawyer and he is an exceptionally poor financial analyst.  The deal terms I described in my memos were so outrageous that the Bank Board negotiators should have broken off negotiations with Bass because he was making it obvious that he intended to run the S&L in a manner that put it and the federal insurance fund at grave risk in order to create an opportunity for him to massively increase his personal wealth.  Dochow must have felt I had to be wrong because if I was right the agency’s “deal of the century” was an unmitigated disaster.  Surely his colleagues would not have negotiated the atrocity that my memos described.

Dochow called a grand meeting to clear up our concerns.  In the pre-meeting I described the takeover fund and why the problems were so severe that we would certify in writing that the deal would harm the S&L’s safety and soundness, put the insurance fund at undue risk, violate law, regulation, and fiduciary duty, and make it impossible to effectively regulate.  Dochow responded that Bonderman had repeatedly described what the deal did and personally assured Dochow that it had no unfair elements.

Dochow started the meeting with Bonderman by stating that the FHLBSF was concerned that the corporate takeover fund loan had the defects I’ve described here.  Dochow then said that he had assured the FHLBSF that the deal had no such provisions and asked Bonderman to state his agreement with Dochow’s assurances.  The single most satisfying moment I had as a regulator was provided by Bonderman’s response to Dochow.  Bonderman said that the terms of the deal did exactly what I said and that those specific deal terms were what provided the paramount value in the deal to Bass.  Bonderman literally pounded the table and barked that Bass wouldn’t change the deal to meet the FHLBSF’s 11th hour objections.   It was the stunned look on Dochow’s face when Bonderman made these statements that was priceless.

Wall’s people didn’t realize that they’d given away the store under the draft deal terms until that moment.  The deal was such a giveaway and so indefensible that even Wall insisted on removing the key deal terms we’d criticized and – Bass still did the deal.  But Bass lost what our economists estimated would have been an additional $1.5 billion in economic value under the draft deal terms.  Wall’s folks had missed $1.5 billion in goodies because they had not understood the deal they negotiated.

Cirona knew that Dochow and Wall (his bosses) wanted us to come to opposite answer about the Bass deal.  He refused to do so.

Saying no to Wall to his face, in public

I was at a meal at a restaurant with both of them when Wall complained that Cirona insisted on sending Wall recommendations opposing what Wall wanted to do even when Cirona knew there was no chance that Wall would listen to our recommendation.   Wall said flat out that he wanted Cirona to stop doing this.  Cirona replied that what we owed our bosses at all times was to make our best professional recommendations and that we would always follow that policy.  Wall looked dumbfounded and furious.

Admitting our error even when it could only help Wall bash us: Saving the Nation $450M

The FHLBSF regulated MeraBank, an Arizona S&L owned by Pinnacle West.  The Bank Board required its holding company, Pinnacle West, to execute a net worth maintenance agreement promising to maintain MeraBank’s capital at or above its regulatory requirement.  Pinnacle West had no significant assets or capital on a “stand alone” basis.  On a consolidated basis, it reported enormous capital because of its ownership of an Arizona electrical utility.  MeraBank reported that it exceeded its capital requirement and that it was profitable.  The FHLBSF was asked to approve MeraBank’s acquisition of several failed Texas S&Ls, which would involve us opining that MeraBank had the necessary financial strength.  One of our senior supervisors, Eric Shand, approved the recommendation of his staff to approve the acquisition.  The written approval was sent on Thursday with the Bank Board meeting to approve the deal to occur the next morning.

Late Thursday afternoon, Shand came to me and expressed unease at his approval of the deal and asked me to look at it.  My review showed that Shand’s analysts had approved the deal based on three primary findings.  First, MeraBank had a net worth maintenance agreement from a parent holding company with very high reported capital (reportedly, billions of dollars).  In a financial sense they were reporting that MeraBank had a capital cushion so large that it exceeded 100% of its assets.  Second, MeraBank reported positive capital in excess of its requirements.  Third, MeraBank had generally reported profits.

I advised Shand that his unease was well warranted.  First, the net worth agreement was not something we could rely on because (a) the validity of such agreements had never been tested in the courts and (b) the only way to collect on it was for the publicly-elected commissioners of APUC to vote a very large rate increase for Arizona customers and direct the utility to upstream the revenue to Pinnacle West as a dividend.  It was dubious that APUC had the power to order such a dividend and it was inconceivable that APUC would take any of the actions essential to make it possible for Pinnacle West to pay an unlimited liability that could run into the billions of dollars.

Second, MeraBank reported that it met its capital requirement only because of enormous accounting “goodwill.”  Our experience was that goodwill rarely had any real economic value.  There were also excellent prospects that MeraBank had failed to recognize enormous losses on its assets, which were very poor credit quality.

Third, MeraBank’s reported positive earnings were explained overwhelmingly by the accounting effects of the goodwill, which produced extremely large (and wholly fictional) non-cash “income” in the early years.  If one backed out the faux income generated by the goodwill MeraBank would have reported substantial losses for the last several years of its operations.  The fact that it was generating negative cash income gave further credence to the likelihood that it had failed to recognize large losses on its bad assets.  It was likely that MeraBank was deeply unprofitable.

Shand agreed with each of these points.  He informed our top supervisor, Michael Patriarca, of our findings, who informed Jim.  We agreed, at Shand’s urging, that it was essential that we withdraw our prior recommendation, recommend that the acquisition not be allowed, and inform the Bank Board immediately of our actions.

Some additional information is necessary to understand the context of the MeraBank’s proposed acquisition of the failed Texas S&Ls.  The year was 2008, an election year, and Wall had three priorities.  First, he was covering up the scale of the S&L debacle, claiming that no funds were needed from Treasury to resolve the (non) debacle.  He would later openly admit that he did this as a loyal Republican to help Bush get elected president in 2008.  Second, and related, he was running the “Southwest Plan” (where “Southwest” was largely a euphemism for “Texas”).  Third, he was rushing to close deal before tax benefits expired at the end of 2008.  Of course, the Treasury does not “save” any money when the regulatory agency shells out such benefits, but Wall made it sound like it helped Treasury.

We knew that there was no chance that Wall would take our recommendation.  We knew that he would use our analytical mistake to ridicule us openly at the Bank Board meeting.  We knew that he would use our mistake on MeraBank against us in connection with his war against the FHLBSF in connection with his removal of our jurisdiction over Lincoln Savings.  We knew that if we said nothing there was no chance that our error would be spotted by Wall’s staff and that they would give us (mild) thanks at the Bank Board meeting.  There was unanimity that we would immediately correct our error.  That is the type of team Cirona led and inspired.

Our counterparts, Dochow’s Washington, D.C. subordinates, told us that they agreed with our corrected analysis and with our recommendation that MeraBank not be approved as an acquirer – and that they would make the opposite recommendation to the Bank Board because they knew that making an honest recommendation would not block the deal and would enrage Dochow and the Bank Board members against them personally.  We recommended denial.  Wall and his senior staff attacked us and made the opposite recommendation.  They approved the acquisition.

Within months, it was obvious even to Wall and Dochow that MeraBank was a disaster.  Pinnacle West’s lawyers developed a clever strategy to eliminate their “capital maintenance” obligation.  They would “dividend” their interest in MeraBank to their sharehlders.  No shareholder would own enough stock in MeraBank to be a “controlling party” and only “controlling parties” are subject to a capital maintenance agreement.

But a technical problem arose – MeraBank was wholly owned by Pinnacle West so it had only issued a single share.  Pinnacle West’s answer to the mechanical problem was to get MeraBank’s board of directors, which it obviously dominated, to issue millions of shares so they could do the dividend.  The supervisory team that Jim had recruited was transitioning to what would become the West Region of the newly created Office of Thrift Supervision (OTS).  We flew to the MeraBank board meeting and made clear that since the issuance of the shares would destroy MeraBank’s most valuable asset (the capital maintenance agreement) it would be a total breach of the fiduciary duties of loyalty and care for a board member to vote in favor of the issuance – particularly if they were officers or employees of Pinnacle West.  This emergency intervention stopped the clever finesse of the capital maintenance agreement and resulted in a $450 million settlement with Pinnacle West that reduced the cost to the Treasury of resolving MeraBank by that amount.

Standing up to politicians and backing his staff

When a powerful Republican at the Hoover Institution wrote to Cirona to urge him to purge gay employees Cirona did not give an inch.  If your response is “of course,” I would remind you that this was about 1984 and that Wall (when he was a top legislative aide in 1987) urged Gray to fire Joe Selby, our most prestigious supervisor in our most troubled region (Texas), on the “grounds” that Speaker Wright wanted Selby fired on the “grounds” that Selby was gay.  Further, in 1987, once he ran the agency, Wall bragged that by appointing a new head of the Federal Home Loan Bank of Dallas he and Selby’s new boss had forced Selby to resign.  Think of the insanity.  In the heart of the crisis we lost our most prestigious supervisor in our most troubled district (Texas) on the “grounds” that he was gay.  Wall also used the new head of the FHLB Dallas to recommend that our jurisdiction over Lincoln Savings be removed.

One of the travesties that exemplifies why the current crisis caused such catastrophic harm compared to the S&L debacle is that there were no Grays, Cironas, Patriarcas, or Selbys in the banking regulators’ leadership ranks.  Instead, Dochow, who was demoted multiple levels and left to run one of OTS’ most obscure field offices road his non-supervisions of WaMu, Countrywide, and IndyMac to ride back to power during the Bush administration.  In a painful irony, the OTS director promoted Dochow to run the OTS West region.  The supervisory personnel of the FHLBSF staffed the OTS West Region after FIRREA removed supervision from the FHLBs.  Dochow was in charge of the office that had resisted his disastrous surrenders to the industry and had provided key testimony that had led to his disgrace.  He proceeded to become an even greater disgrace.  Dochow discredited and led to the elimination of both the Federal Home Loan Bank Board and its successor agency, OTS. More importantly, he made both crises worse.


We will never be able to quantify precisely how much our Nation owes to Jim Cirona in terms of preventing losses and preserving our integrity.  The reduced losses are in tens of billions of dollars (and if Wall and Dochow had listened to Jim more those savings would have increased substantially).  Integrity is intangible, but in some sense priceless.  I have a friend who worked personally with Larry Summers and Timothy Geithner who chastises me for criticizing them because he views them as intelligent and effective.  I am morally sure that my friend, had he ever had the privilege of working with Jim, would have a very different perspective.

Jim Cirona was an exceptionally effective private banker and public official.  It was his repeated willingness not to talk about putting his job on the line, which he never did, but to actually put his job on the line when it was necessary to do so in order to do the right thing and to protect his staff when he was convinced that we were doing the right thing that set him apart from so many people.  Fiat justitia, ruat caelum (let justice be done, though the heavens fall).  Jim knew that the best way to prevent a collapse was to do justice when doing justice was hard and dangerous.

The Nation never knew, and thirty years later has forgotten the little it did know, about Cirona, Gray, Selby, and Patriarca.  The left and right have, overwhelmingly, both dismissed effective regulation as impossibile.  Financial regulation has, of course, failed for 15 years but that is because it was designed to fail by the ideologues that create a self-fulfilling prophecy of failure by putting people in charge who do not believe in regulation and who are all too often seeking to cash-in on the other side of the revolving door.

Gray knew that his actions would render him unemployed and unemployable in the prime of his life.  Cirona knew his actions were likely to get him fired.  Selby faced actual death threats and knew as soon as President Reagan appointed Wall as Gray’s successor that he would be fired if he did not resign.  Patriarca risked firing on multiple occasions by having my back and by testifying so powerfully at the House hearings on the removal of our jurisdiction over Lincoln Savings.  Many of us were sued for hundreds of millions of dollars and Keating hired private investigators to try to find dirt on some of us.

It is only with the passage of time that we can get a real appraisal of the general magnitude of how much we owe to these four men.  They would be the first to emphasize that it was not a question of four people.  There were over 2,000 people in the Federal Home Loan Bank System working to protect the public.  But the S&L debacle also teaches, if we are attentive, how much leadership matters.  Gray’s predecessor, Dick Pratt, and Wall actively made the problem worse (far worse in Pratt’s case).  Dochow’s conduct in both crises exemplifies the damage caused by poor supervisory leadership.  Unlike Pratt and Wall, Dochow was a career regulator who had no excuse for not knowing better.  Cirona was the one closer to the trenches with the analytical skills who ensured that the FHLBSF prioritized the frauds and stood strong against pushback from the frauds, their political cronies, and even our bosses in Washington, D.C. Jim was a handsome, calm, friendly and polite man.  He did not seek conflict but he did not shirk it when standing strong was essential to fulfill our duty to the public.  He sheltered me when Wall, Dochow, Keating, and Keating’s lawyers and detectives tried to follow Keating’s orders to “Get Black … Kill Him Dead.  He was our bridge over troubled waters.

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


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