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Extra9/22/2008 12:01 AM ET

Anatomy of a bank collapse

As Congress gears up to delve into troubles in the finance industry, the fall of regional bank IndyMac sheds light on how poor practices can combine with questionable oversight to create a disaster.

By ProPublica

As wildfires continue sweeping the financial markets, analysts and legislators agree on the need to sift through the ashes of earlier blazes to learn what went wrong and how to prevent future disasters.

The U.S. Senate Committee on Banking, Housing and Urban Affairs had scheduled a hearing last week to discuss recent bank failures and the role regulators played in them. The hearing was postponed because of new developments in the financial crisis, but senators are expected to return to the topic.

One major focus: the controversy surrounding one of the largest bank failures in the nation's history, the July collapse of Independent National Mortgage Corp., known as IndyMac.

One of the key witnesses senators want to hear from is John Reich, director of the Office of Thrift Supervision, which oversees the nation's savings and loan institutions. They are expected to ask him why OTS regulators didn't respond more forcefully to the obvious failings of Pasadena, Calif.-based IndyMac.

As he has in the past, Reich may well try to turn the blame back on a prominent member of the banking committee itself, Sen. Charles Schumer. In June, the New York Democrat sent a letter to the regulatory agencies -- which quickly found its way into the news media -- questioning IndyMac's solvency.

"All prospects of rescuing IndyMac disappeared after a June 26 letter to the OTS and the FDIC from Senator Charles Schumer that publicly expressed concerns about IndyMac's viability and caused depositors to withdraw approximately $1.3 billion from their accounts," Reich told a meeting of the American Bankers Association in Orlando in July.

While Schumer's famously ill-timed letter clearly hastened IndyMac's end, a detailed review of filings with the Securities and Exchange Commission and the Office of Thrift Supervision for December 2007 and March 2008 suggest that prospects for keeping the S&L afloat were all but nonexistent: The lender's demise was a matter of when, not if.

The filings raise the question of whether federal regulators felt it was more important to protect the bank's shareholders and executives than to safeguard the Federal Deposit Insurance Fund that would ultimately pay for the losses. The current cost of the IndyMac failure, according to the FDIC, is $8.9 billion -- a number that would undoubtedly have been smaller had the OTS called in the FDIC six months earlier.

"There are always questions when a bank fails," said William Ruberry, an OTS spokesman, who dismissed criticisms of OTS's actions as "Monday morning quarterbacking."

Good money after bad

The IndyMac filings from early this year painted a truly dire picture. The S&L was heavily involved in issuing so-called Alternative-A (Alt-A) mortgages, one cut above the infamous subprime category. Defaults on the Alt-A category were high and climbing. The firm was losing money at a growing rate, and its stock price had plummeted.

A conservative strategy by the OTS would have been to downgrade the S&L, and thereby limit the risk to the FDIC fund that protects insured deposits. Instead, to buy time in the hope that a new business plan would improve IndyMac's earnings, regulators let the firm take modest write-downs of 5% or so in some of its troubled mortgage assets. This helped IndyMac keep its risk-based capital ratio barely above the 10% floor and allowed it to qualify as "well-capitalized," thus avoiding being added to the FDIC's list of problem institutions.

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As a result, IndyMac was able to keep borrowing from the Federal Home Loan Bank and pulling in insured deposits. The insured deposits rose to $16 billion as of March 31, compared with $8.8 billion on June 30, 2007. The result: much greater exposure for the FDIC when IndyMac finally collapsed.

The OTS has assembled a chronology of its efforts to forestall IndyMac's collapse, according to spokesman Ruberry. Many of these actions were informal in that they involved the agency working in consultation with the firm. While Ruberry would not share the chronology before the hearing, the agency has put an IndyMac timeline with a list of some enforcement actions on its Web site.

By 2006, the company was one of the biggest purveyors of Alt-A single-family mortgages, which are generally offered to people with good credit scores but often with little or no verification of income.

Continued: Early warnings

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