April 9, 2012 is the twenty-fifth anniversary of the most infamous savings and loan fraud, Charles Keating's successful use of five U.S. senators to escape sanction for a massive violation of the law. The senators were Alan Cranston (D. CA), Dennis DeConcini (D. AZ), John Glenn (D OH), John McCain (R. AZ), and Donald Riegle (D. MI). They became infamous as the "Keating Five." I was one of four regulators who attended the April 9, 1987 meeting. I took the notes of the meeting, in transcript format, that were so detailed and accurate that the senators testified that they were sure I had tape recorded the meeting. I worked closely in the same regional office with my three regulatory colleagues for years, but I do not know their political affiliation (if any).
Many people know the Friends (Quakers) credo -- "speak truth to power." Michael Patriarca made that credo real at the Keating Five meeting.
Bank Board Chairman Gray personally recruited the two individuals with the best reputations in the U.S. as effective financial regulators, Joseph Selby and Michael Patriarca, to serve respectively as the top field regulators in our Dallas and San Francisco office, which had jurisdiction over Texas, California, and Arizona -- the epicenters of the S&L fraud crisis. James Cirona, the president of the Federal Home Loan Bank of San Francisco (FHLBSF), strongly supported Patriarca and made the crackdown on the frauds his top priority. The Bank Board in general and the FHLBSF in particular rapidly became far more effective regulators, particularly with respect to frauds like Keating. The four regulators at the April 9 meeting were Cirona, Patriarca, Richard Sanchez (Lincoln's "Supervisory Agent") and me.
We understood modern finance theory -- and we knew it was false, indeed, absurd. We also called it predictions false in blunt, non-bureaucratic language, particularly the claims that securities markets automatically excluded fraud because the participants' interest in the value of their reputations trumped self-interest. Consider this exchange between Senator DeConcini and Michael Patriarca. (I have edited it slightly for the sake of brevity, but it is important to know that during the exchange Patriarca informed the senators that we were making a criminal referral against Lincoln Savings' senior officers. Patriarca also explained that the S&L's outside auditor, Arthur Young, had given a "clean" audit opinion despite an accounting treatment that allowed an absurd $12 million revenue recognition for a deal that was unwound.)
McCAIN: Why would Arthur Young say these things about the exam -- that it was inordinately long and bordered on harassment?
DECONCINI: Why would Arthur Young say these things? They have to guard their credibility too. They put the firm's neck out with this letter.
PATRIARCA: They have a client.
DECONCINI: You believe they'd prostitute themselves for a client?
PATRIARCA: Absolutely. It happens all the time.
DeConcini phrased his question in a manner designed to force Patriarca to back off his criticism of Arthur Young (AY) -- what regulator would dare tell a group of U.S. senators that AY, one of the most prestigious audit firms in the world, would act as a "prostitute"? I cannot convey to you how startled the senators were. They expected to be leaning on four field regulators. Five U.S. senators against four regional bureaucrats is equivalent to the sending the NBA champions, playing at home, against an NCAA Division III college basketball team. The senators had clearly never seen anything like us. Patriarca was always an outstanding leader, but this was his finest five minutes.
We will know that an administration is serious about financial reform when it appoints officials like Mike Patriarca as regulatory and enforcement leaders. The key lesson that Gray and Patriarca understood is that it was essential to hire officials willing to tell four senators (Cranston was managing a bill on the floor of the Senate when the exchange happened) that of course some AY audit partners would prostitute themselves for a fraudulent client -- "it happens all the time." Let's hire people as regulators and prosecutors with a track record of success, integrity, and courage. The problem is that recent administrations have preferred to appoint the people with a track record of failure and poor integrity. The reason for that preference is the old accounting joke -- pick the audit partner who responds to the interview question ("what is two plus two") by saying: "what would you like it to be"? The joke, of course, is an admission that professional prostitution is far too common among audit partners.
I call on President Obama to recognize the hero of the silver anniversary of the Keating Five meeting by appointing Michael Patriarca as head of the Office of the Comptroller of the Currency. We need regulators who will speak truth to power.