By Ben Hallman
The Center For Public Integrity
As the chief undertaker of the Great Recession, the Federal Deposit Insurance Corp. has briskly shuttered 347 failed banks since 2008, at a cost to the government insurance fund of about $76 billion.
But the regulator has moved at glacial speed in suing officers and directors to recover some of that money, despite a pattern of risky behavior by executives at many failed banks described by the agency's own watchdog in a recent analysis.
To date, the FDIC has sued officers and directors at just five of the 347 banks that have collapsed since 2008, or about 2 percent of the total. The 39 former executives named in these civil lawsuits are fighting the FDIC's accusations of negligence and mismanagement. And time is running out for the FDIC to file lawsuits in some of the early bank failures because of a three-year statute of limitations.
At this pace, critics say, the FDIC is falling short of what banking regulators did a generation ago in the U.S. savings & loan crisis, when they sued officers and directors at about one-quarter of the more than 1,000 institutions that failed.
"Everything is wrong about this," said William Black, a University of Missouri-Kansas City law professor who was a top lawyer at the Office of Thrift Supervision and its predecessor when U.S. savings and loan thrifts were collapsing in the late 1980s and early 1990s.
"The FDIC is suing a tiny percentage of officers compared to the S&L crisis," Black said. "The cases should be strong, given that they had so many warnings."
The FDIC said the criticism is premature.
It typically takes the agency 18 months to investigate a bank failure, said FDIC spokesman David Barr. If the agency finds evidence of wrongdoing by executives or board directors, it first holds settlement talks, which can also go on for months, before suing.
With the wave of U.S. bank failures not cresting until 2009 and 2010, Barr said that the FDIC still has plenty of time to sue officers and directors whose misconduct led to a bank's collapse.
On March 1, the FDIC sued four former bank directors and officers of Corn Belt Bank and Trust Co. in Illinois for $10.4 million. It was the agency's third lawsuit filed this year against a failed bank.
But Barr also cautioned that not every bank failure will result in a lawsuit. The purpose of the civil lawsuits, he said, is to hold bank leaders accountable if they did something seriously wrong.
"We have to be careful and judicious before filing," he said. "We don't want there to be a chilling effect on open banks that are seeking to find qualified board members."
ONE BANK, UNDER GOD
While public attention has focused on the Wall Street banking giants that packaged toxic pools of mortgages into little-understood securities, some community banks also fueled the financial crisis by making unsound loans, awarding bonuses based on loan quantity instead of quality, and investing too heavily in real estate loans.
One such bank was Integrity Bancshares, Inc. of suburban Atlanta, which promoted a "faith-based" business model that included free Bibles for customers.
When the economy soured, so did the bank's loan portfolio, which was concentrated in risky construction and development loans secured only by the speculative projects themselves. The FDIC closed Integrity Bank in August 2008.
The FDIC has taken a huge hit on near-worthless loan portfolios inherited from failed banks like Integrity Bancshares. That has led to a gaping $7.4 billion hole in the FDIC's insurance fund to protect depositors.
It's up to member banks, not taxpayers, to close that gap. In 2009, the banking industry was forced to prepay three years of insurance assessments totaling $46 billion. At least some of those costs get passed along to consumers through higher fees and more expensive lending.
Civil lawsuits are another way to help replenish the government's insurance fund. As the receiver for closed banks, the FDIC file so-called professional liability lawsuits accusing officers and directors of negligence in some aspect of management.
In January 2011, the FDIC sued eight former Integrity Bancshares executives to try to recoup $70 million of the estimated $295 million that the failure cost the government insurance fund. Attorneys representing five of the defendants could not be reached for comment, and it was unclear who represented the other three.
Richard Newsom, who spent 17 years as a bank examiner, including at the FDIC, said the agency failed to dig into loan portfolios at so-called "healthy" banks like Integrity, and thus missed the opportunity to sound warning that banks had made huge bets on loans of dubious quality.
"The examiners were not even looking at loans," he said.
This has left investigators playing catch-up, which explains in part the paucity of lawsuits, he said. It is much easier to investigate an open bank than to reconstruct what happened at a closed bank, where the loans and executives have scattered to the four winds, he said.
So far, the five lawsuits filed by the FDIC seek to recover about $427 million. The agency says it has also authorized potential lawsuits involving another 100 or so directors and officers. Together, the actual lawsuits and the authorized ones have combined claims totaling $2.6 billion.
EXAMINERS TOOK HANDS-OFF APPROACH
Even though FDIC examiners weren't routinely digging into loan portfolios, they still likely did more than any other regulator to sound the alarm on bad banking practices in the run-up to the financial crisis.
The FDIC's own autopsy reports on individual failed banks -- known as material loss reviews -- along with the recent court filings describe examiners' warnings to bank executives about dangerous business practices. Many of the failed banks followed a common trajectory of too-aggressive growth, hyper concentration of loans in commercial construction, and failure to properly administer loans.
But the examiners simply didn't do much about it.
For example, United Commercial Bank, which served the Chinese-American community in San Francisco, was closed by the FDIC and the state of California in November 2009, one year after it got a $300 million government bailout from the Troubled Asset Relief Program.
A year earlier, examiners had bestowed on UCB a favorable "2" rating on the FDIC scale used to classify a bank's overall condition. That rating denotes "satisfactory performance by management and the board and satisfactory risk management practices," according to FDIC guidelines.
The bank received the favorable rating even while examiners identified a number of serious problems, including a large number of exceptions to the bank's lending policy so it could make more loans, and a "combative culture" where management failed to downgrade non-performing loans, according to an FDIC report.
UCB's failure cost the insurance fund $1.5 billion. The FDIC hasn't taken any public action against former bank officers and directors, though it still has time to do so.
Black, the former OTS official, says the agency's review of banks like UCB shows how the FDIC followed the hands-off approach of many financial regulators during the past decade. "You could warn, but not say no," he said. "The people at the top of the regulatory ranks didn't think it was legitimate to tell the industry not to do something."
At Integrity Bancshares in Georgia, the FDIC's lawsuit says that examiners began warning as early as 2003 that the bank was growing too fast, was underwriting too many commercial building loans, and was guilty of "major lending limit violations."
Loans to Integrity Bancshares' biggest borrowers exceeded Georgia statutory limits by tens of millions of dollars. Integrity Bancshares compounded the problem by loaning the borrowers even more money, which they used to make interest payments on their initial, failing loans, according to the lawsuit. Bank officials approved policies "void of the most basic prudent lending controls," according to the FDIC lawsuit, ignored a softening real estate market in 2006, and did nothing to address the risk created by "a growth-at-all-cost strategy."
Among those sued by the FDIC in the Integrity Bancshares case is Georgia state Sen. Jack Murphy, who recently became chairman of the state Senate's banking committee. He was a member of Integrity's board of directors until six months before the bank collapsed.
"I know Georgia banking laws and I know that I not only followed the letter of the law but the spirit of the law as well," Murphy said in a statement, according to the Associated Press. Murphy could not be reached by the Center for comment.
The failure of FDIC examiners to force failing banks to curb dangerous behaviors may be a problem for the agency as it seeks to hold former officers responsible for damages.
Defense attorneys in a FDIC lawsuit against former officers of 1st Centennial Bank, a failed Southern California bank, have said they plan to use the FDIC's inaction while the alleged wrongdoing was taking place as a central plank of their case.
But Francis Grady, a former FDIC lawyer, said that what the FDIC does as a regulator is not necessarily binding on what it does as a receiver of a failed bank. If the FDIC can prove negligence by an officer or director, it can make that person pay, he said.
"Just because the FDIC didn't catch something in 2005 and now it looks like that something was complete stupidity, that's not a defense," he said.