The Wall Street Journal reported Monday morning that the Federal Deposit Insurance Corporation (FDIC,) rather than being part of the solution to the subprime mortgage crisis, was actually among those institutions that caused it.
The FDIC which shuttered IndyMac Bank a week ago and is operating it as a "bridge bank" until a viable buyer can be found, followed the same procedure in 2001 when it closed Superior Bank, FSB in Hinsdale, Illinois. The agency typically follows one of three scenarios when it determines that a financial institution can no longer survive. It (rarely) closes the bank completely, pays off its insured depositors, and does its best over a period of months or years to sell off the bank's assets to pay uninsured depositors and replenish the bank insurance fund. More typically, it goes in on a Friday afternoon, and closes the bank, reopening the next Monday under the name of another bank which had arranged to buy the old bank, usually at a huge discount, well before the actual closing went down.
In the third instance, usually followed in the case of banks almost too large to for another healthy bank to absorb, the FDIC retains many of the former bank's employees, and along with FDIC staff runs the failed bank for a period of months or years. During this time the goal is to improve the bank's balance sheet and perhaps to split the banks component parts into more easily digested pieces ' various branch offices sold to one bank, a credit card portfolio to another, naming rights to the local sports stadium to a third, and the mortgage operation to a fourth. Existing mortgage loans are often placed in "pools" to be auctioned off to investors.
Superior Bank was, in the early 2000s, a leading subprime lender and that operation continued, under FDIC supervision, for months. During this time, according to the Journal, Superior funded more than 6,700 new subprime loans worth more than $550 million. Most of these loans were subsequently sold to another bank. The problems was, many of these loans suffered from the same deficiencies as other subprime loans ' unqualified borrowers, inflated appraisals, and inadequate verification of borrowers' incomes.
The WSJ states, "Hundreds of borrowers who took out Superior subprime loans on the FDIC's watch ' some with initial interest rates higher than 12 percent ' have lost their homes to foreclosure." The FDIC stopped funding new Superior loans in early 2002 and closed the lending operation by mid-year.
Admittedly the FDIC's involvement in subprime lending was pretty small potatoes but it could still be costly for the regulator. First of all, the FDIC's problems with Superior loans could lead to charges that bank regulators were not necessarily on top of the subprime mortgage situation. Second, numerous lawsuits may be lurking in the shadows.
Beal Bank, SSB, a Texas-based bank bought a portfolio of Superior loans, about half of them originated while the FDIC was operating the bank. Beal has now filed suit in the U.S. District Court in Washington, D.C charging that many of the loans it purchased were made improperly and are plagued with problems. Beal produced an internal FDIC legal assessment which acknowledged that a "small number of loans appear to be fraudulent from inception" and estimating that the FDIC's liability could be as much as $70 million.
FDIC has responded in court, estimating that about 1,500 of the 5,314 loans it sold to Beal either have defaulted or are nonperforming. The agency has already repurchased 247 mortgages, 73 of which were originated during the FDIC/Superior time period, for violations of federal anti-predatory-lending laws. The agency said that it has already provided compensation to affected borrowers who received the predatory loans and has instructed its servicer to stop any foreclosure actions. Beal originally paid $339 million for the loan portfolio it purchased.
Bank of America has also suffered losses from its purchase of Superior-originated loans. BofA has "realized losses" which generally occurs after foreclosure takes place, on 511 of the 3,964 loans in the mortgage pool it bought. So far B of A has not threatened legal action.
While FDIC may continue operating IndyMac for months until it either finds a buyer to purchase the bank or manages to dismantle it into its component parts, it has no intention of becoming a party to any lending on the part of the bank's mortgage arm.