But the regulator has sued only a handful of 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 only five of the 345 banks that have collapsed since 2008, or about 2 percent. The 39 former executives named in the 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-and-loan crisis, when they sued officers and directors at about one-quarter of the more than 1,000 institutions that failed.
“In all areas, the FDIC has been far later and far weaker in terms of enforcement than during the S&L crisis,” 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 cases should be strong, given that they had so many warnings,” he said.
The FDIC said the criticism is premature.
The agency typically takes 18 months to investigate a bank failure, FDIC spokesman David Barr said. If the agency finds evidence of wrongdoing by executives or board directors, it first holds settlement talks, which can go on for months, before suing.
With the wave of U.S. bank failures not cresting until 2009 and 2010, Barr said 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 in Illinois for $10.4 million. It was the agency’s third lawsuit filed this year against a failed bank.
But Barr 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.”
Although 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, paying loan officers based on loan quantity instead of quality, and investing too heavily in real estate loans.
One such bank was Integrity Bancshares 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, according to an audit by the FDIC’s Office of Inspector General. The FDIC closed Integrity Bank in August 2008.
Attorneys representing five of the Integrity Bancshares defendants could not be reached for comment, and it was unclear from official documents who represented the other three.
The FDIC has taken a huge hit on near-worthless loan portfolios inherited from failed banks such as Integrity Bancshares, leading 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, because the FDIC insurance fund is financed by the banking industry. 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 can file lawsuits accusing officers and directors of negligent 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.
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 such as Integrity, and thus missed the opportunity to sound a warning that banks had made huge bets on loans of dubious quality.
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 an additional 100 or so directors and officers. Together, the actual lawsuits and the authorized ones have combined claims totaling $2.6 billion.
The FDIC’s own autopsy reports on individual failed banks — known as material loss reviews — along with the recent court filings describe warnings to bank executives about dangerous business practices, including too-aggressive growth, heavy concentration of loans in commercial construction and failure to properly administer loans.
But the examiners didn’t do much about it.
At Integrity Bancshares, the FDIC’s lawsuit says that examiners began warning as early as 2003 that the bank was growing too fast, underwriting too many commercial building loans, and was guilty of “major lending limit violations.”
Black, the former OTS official, said the agency’s bank reviews show how the FDIC followed a hands-off approach adopted by 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.”
The failure of FDIC examiners to force failing banks to curb dangerous behaviors may be another 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.