Norma Jean Scott, a 63-year-old Alabama retiree, thought she was being prudent three years ago when she stashed her $100,000 retirement nest egg in a pair of certificates of deposit. Her bank, CapitalSouth, promised her 5.7 percent interest for five years.
"I thought that was in concrete," she said, "and backed by my government."
But then CapitalSouth collapsed and the government brokered a deal to sell its business to another institution -- Louisiana-based IberiaBank.
The bank's new owner promptly cut Scott's interest rate - to 1.6 percent.
An astonished Scott received a letter from the FDIC, similar to thousands that quietly have been sent to customers of failed banks around the nation in recent months: "Your deposit agreement with the Failed Institution is no longer in force."
Fixed-term CDs, into which Americans have invested some $2.6 trillion, are popularly assumed to be among the safest, most inviolable of any federally insured savings methods. But as the financial crisis has pushed 116 banks into failure this year alone, the government has routinely allowed the new owners to lower interest rates on CDs that were previously sold.
"Isn't a contract a contract?" Scott asked. "What good is a contract or anything you sign if they can say, hey, we're going under so we don't care - we don't have to pay that anymore?"
Scott dashed off a complaint letter about IberiaBank Corp. to the Federal Reserve Bank of Atlanta, which supervises bank holding companies. Replied Jeff Bragg, the Atlanta Reserve's director of consumer compliance on Oct. 14: "When an institution fails, its interest-bearing deposits can be re-priced."
"That's just cruel and terrible," Scott said. "You save and scrimp your whole life, and then this can happen? My husband was a simple railroad machinist and I sold Avon. . . We only wanted our hard-earned money in a safe place - not where the government would let a new bank take some of it away."
Bankers, regulators and lawyers involved in the sale of failed bank assets say the practice is increasingly commonplace, legal, and even encouraged by the FDIC, which sometimes has difficulty convincing anyone to buy a collapsed bank with its load of bad loans, troubled assets, and promises to depositors.
A review by the Huffington Post Investigative Fund of the purchase agreements between the FDIC and buyers of failed banks shows that every contract includes a standard clause allowing the new bank to set interest on CDs and other existing deposits "at rates it shall determine" - rather than honor obligations to depositors.
"Acquiring institutions are given the opportunity to change interest rates after a bank has failed," FDIC spokeswoman LaJuan Williams-Dickerson said. "Typically, the assuming institution will reduce the rates on the deposit products that are priced above the current market rates."
Many institutions from California to Florida have indeed lowered interest rates on deposits, the Investigative Fund has found. Customers usually are given the option of withdrawing money from their CDs without paying a penalty. But they often are unlikely to find prevailing interest rates as good as those they would be giving up. The highest current rates for two-year CDs barely top 2 percent.
It doesn't work in reverse. Customers don't have the option of negotiating lower rates on the money they owe the new banks on loans or mortgages.
Margaret Carlson, a 70-year-old retired teacher who lives in El Cajon, Calif., found out one day in July that more than $100,000 in multiple CDs she bought from Temecula Valley Bank would no longer be honored at the interest rates she'd anticipated. Interest on one of the CDs dropped from 4.0 to 2.1 percent.
Temecula, too, had been seized by the FDIC and its deposit accounts were sold to a new company, First-Citizens Bank & Trust Company of Raleigh, N.C.
The next day, Carlson found herself in a line at a bank branch with a dozen other customers complaining about the same thing. She estimates her losses in the interest she expected to earn at more than $2,000.
"It may be legal," she says, "but it's unethical, unfair and unjust. We seniors already feel like we're like a cat on a hot tin roof because you just don't know what's going to happen. I could live another 20 years. I don't want to outlive my money. I want to help my grandchildren with their tuition. But where can I put it now? What can I trust - Treasury bonds?"
While the practice has drawn little public attention, questions are flooding the FDIC's call-in centers in Washington and Dallas. An operator there estimated that about one-third of the roughly 500 callers each day are from customers concerned about lowered interest rates on deposits, especially CDs, by new owners of failed banks.
Regulators and banking executives explain the policy as a necessary incentive for buyers to bid on a collapsed institution with a broken balance sheet. By paring interest rates promised to customers, a failed bank's new owners can avoid liability for a significant sum - perhaps nearly $10 million for a typical bank with around $650 million in total deposits, estimates Rodney K. Brown, chief executive of the California Banking Association, who praises the FDIC's approach.
"Call it inventive, call it accommodative, call it creative - clearly they're doing things to assist healthier financial institutions in acquiring failed institutions," said Brown, a Southern California banker of three decades. Bidders on failed banks "want to maximize their return. And that means not only mitigating your loss exposure on loans, but buying a good core franchise that's managing the deposit costs."
In their exuberance, some failed banks offered excessively high interest rates to attract depositors. It's only fair, says Brown, to allow new owners to bring them more into line with prevailing prices.
"I can see where customers may be disappointed," said Denyette Depierro, a senior counsel in the American Bankers Association's office of regulatory policy. "But some of the banks that have failed were offering rates that really are not sustainable."
Zonnie Breckenridge, a Dallas attorney who specializes in so-called purchase and assumption transactions between the FDIC and buyers of seized banks, says the FDIC has "had to be more creative to attract buyers," especially in some markets where failed banks are hard to turn over.
One such market might have been central Florida, where Ocala National Bank failed early this year. At the time, one of its customers, retired paralegal Michelle Rockman, was about midway through a five-year CD she'd bought at 4.4 percent. She had sold all her other investments and put the proceeds into the CD so she'd no longer run the risk of the stock market.
"I wanted to feel safe and secure, " she recalled.
What Rockman didn't know was that Ocala's fate had already been sealed by the miscues of its executive decision-makers. For years, regulators had been tracking the bank's heavy losses amid unraveling of risky loans to construction companies and land developers that worsened with the financial crisis.
Even as the bank lost money, it paid millions of dollars in dividends to its holding company, benefitting the family that owned the bank, according to a report by the inspector general at another of Washington's banking regulatory agencies, the Office of the Comptroller of the Currency. (Executives of Ocala National and members of the family did not return phone calls seeking comment.)
In January, the OCC shut the bank down and the FDIC sold it to Winter Haven, Fla.-based CenterState Bank of Florida, which was unwilling to acquire Ocala's problem loans but paid about $3 million for its deposits - a bargain, CenterState figured, for immediate access to thousands of new customers. [Corrected Nov. 4, 2009: The bank was shut by the OCC, not the FDIC as originally reported.]
But it wasn't much of a bargain for Rockman, with her 4.4 percent CD. Her new interest rate? Three percent.
Still, that was better than the 2 percent being offered elsewhere. So she left her money where it was.
About half of Ocala's 10,000 depository accounts were CDs. The bank allowed customers with checking and other accounts to keep their original interest rates while dropping rates on many other CD accounts - only reasonable, said John C. Corbett, CenterState's CEO, because in its desperation to shore up its books Ocala had offered CDs at "irrationally high rates."
"Look, a CD is a contract between you and a bank," he said. "When the bank fails, you have a contract with a bank that no longer exists. So the FDIC steps in as a receiver and the FDIC, like a bankruptcy judge, has the power to repudiate any and all contracts."
Rockman said she was horrified by the prospect of losing interest earnings over the next few years. "I don't blame the banks," she said. "I blame the government."