Who Really Robbed FDIC $6 billion

I asked on Monday who robbed FDIC $6 billion from the IndyMac Bank failure. Too bad more of you didn’t chime in. Come on, don’t be shy. It’s not fun if it’s just me yapping all the time. Anyway, here are my thoughts.

1. Defaulted Borrowers. IndyMac took in deposits and lent out the money as home loans. That’s what a Savings & Loan does. Every borrower signed a promise saying they will make payments by the payment schedule. Not all borrowers are fulfilling their promise though. Because of these defaulted borrowers, IndyMac collapsed. Since FDIC has to make the depositors whole, the defaulted borrowers in effect took money from FDIC. Some borrowers may not have wanted the money in the first place. They’ve been marketed to by IndyMac, misled by realtors, mortgage brokers and what not, but that doesn’t change the fact that they took the money from IndyMac and they are not paying the money back as promised. In the end, they took and kept the money from FDIC. Imagine if all IndyMac’s loans were current, the bank would not have failed.

A related interesting question is, will FDIC do wholesale loan modification for IndyMac’s borrowers? Sheila Bair, the head of FDIC, often criticized banks for not doing loan modifications fast enough. Now that FDIC owns IndyMac’s mortgage portfolio, will it foreclose on defaulted borrowers? If it doesn’t, will that become an open invitation for more defaults? Or will it forgive loan balances and keep the borrowers in their homes? If FDIC doesn’t do anything differently than another bank, then all the criticisms on other banks are just empty talk. Other banks must be watching closely what FDIC does to IndyMac’s loans now that FDIC’s own money is on the line.

[Update] A Google search found this on the Wall Street Journal: FDIC’s Bair Halts Some Foreclosures in IndyMac Portfolio. If I have a mortgage with IndyMac, I’d stop paying immediately, knowing that Bair will not let IndyMac Federal foreclose on me. I’d wait until IndyMac Federal comes to me with a principal reduction offer. Then I start paying again.

2. Depositors. This may be a surprise, but depositors also robbed FDIC. Before it was closed by the authorities, IndyMac’s rates on deposits were among the highest in the country. People flocked to IndyMac for the high rates. The interests IndyMac paid to the depositors actually turned out to be FDIC’s money. IndyMac had $19 billion deposit when it was closed. If those deposits earned on average 2% a year more than say what Bank of America offered in the last five years, that’s $1.9 billion of FDIC’s money right there. Although it sounds unfair to the bank customers, if a bank wants to be strong, it cannot pay super high interests to its customers.

FDIC should change its policy and add a risk sharing component to its insurance. If a bank fails and FDIC has to cover the loss, then all current or past depositors should pay back the excess interest they earned from the bank X years prior to the failure. This is not too hard to implement. The bank has records on who the customers are. This risk sharing does not diminish the value of FDIC insurance either. The principal and regular interests are still protected. Only the excess, above-market interests have to be paid back. This way the customers will not chase the high rates as much as they do now.

Let’s also take a look at some other players who had a role in the bank collapse but didn’t necessarily take FDIC’s money.

3. IndyMac Management. IndyMac Management took the wrong risk. It thought the Alt-A mortgages were a well-compensated risk but it turned out that the risk was vastly under-estimated. Although IndyMac Management’s poor decisions caused the bank’s failure, I doubt that the management took in much substantial amount for themselves relative to the $6 billion number. Even if we claw back 100% of management’s salary and bonus for the last five years, it’s probably just a small percentage compared to the $6 billion cost of the bank failure. They took some of FDIC’s money, but not much.

4. Senator Charles Schumer. Senator Charles Schumer is like the child who yelled the emperor had no clothes. He publicly released a letter in June questioning IndyMac’s viability. This publicity prompted a lot of depositors to withdraw their money from IndyMac. IndyMac wasn’t able to  withstand that kind of bank run. Senator Schumer might have pushed IndyMac over the edge but he didn’t take FDIC’s money.

5. Short Sellers of IndyMac Stock. A reader pointed to short sellers who drove IndyMac’s stock price to the pennies. Short sellers profited from the stock decline but their profit came from other investors who bought IndyMac’s shares at higher prices. They didn’t take FDIC’s money.

6. Office of Thrift Supervision (OTS). OTS is IndyMac’s primary regulator. It should’ve watched more closely on IndyMac and either rein it in or close it down before the problem got out of hands. If it had taken actions sooner, FDIC’s loss wouldn’t be so large. However, OTS didn’t take FDIC’s money.

7. FDIC. FDIC is a secondary regulator for IndyMac. It provides deposit insurance to IndyMac. A threat of pulling IndyMac’s insurance would have stopped IndyMac dead in the tracks. But FDIC didn’t do that. They stood by watching IndyMac handing out its money to borrowers and depositors. If FDIC were a private insurance company, I bet they wouldn’t be that passive. Because by definition you can’t incur a loss by taking money from yourself, FDIC didn’t take FDIC’s money.

8. Allan Greenspan, George Bush, … The policy may be wrong which caused IndyMac’s failure and FDIC’s loss, but they didn’t take FDIC’s money.

9. Real Estate Sellers. This one is a little tough. The real estate sellers sold their homes in arm-length transactions for market prices at the time. The prices they got turned out to be pretty good in retrospect. To the extent they sold to IndyMac’s borrowers who now defaulted or will likely to default soon, you can argue that the defaulted borrowers passed FDIC’s money to those sellers. But because money is fungible, you can also argue everything the defaulted borrowers bought was bought with FDIC’s money. And those who accepted FDIC’s money from the defaulted borrowers bought a lot of other stuff with FDIC’s money. By six degrees of separation, even my salary has a small part of FDIC’s money. But I won’t go that far. The real estate sellers didn’t have control over which lender the buyers chose or whether the buyers would default. Between two sellers, say one sold to a buyer who borrowed from Bank of America and didn’t default and the other sold to a buyer who borrowed from IndyMac and defaulted, if we say the former didn’t take FDIC’s money but the latter did, that’s just a luck of the draw. So I say stop at the defaulted borrowers and not chase the money further down the chain.