Credit Crunch Digest
The subprime lending crisis and ensuing credit crunch have resulted in significant losses and numerous lawsuits involving parties to the mortgage lending and securitization process. This digest collects and summarizes recent media reports and announcements regarding potential liability, government initiatives, litigation and regulatory actions arising from the subprime mortgage crisis and credit crunch, as well as the increasing number of reported cases of financial fraud.
This issue focuses on recent significant decisions in civil litigation regarding subprime and other high-risk mortgages and related securities, new developments in criminal, regulatory and civil actions arising from the collapse of the auction rate securities market, the growing number of reported Ponzi schemes around the world, the status of civil and regulatory actions relating to the Madoff and Stanford Financial Ponzi schemes and continuing government efforts to ease the economic impact of the subprime crisis and credit crunch.
Litigation and Regulatory Investigations
Ponzi Schemes and Fraud Actions
Auction Rate Securities
Government and Regulatory Intervention
Litigation and Regulatory Investigations
Moody’s and S&P Lose First Amendment Argument in Lawsuit Over Collapse of SIV Portfolio PLC
On September 2, 2009, Judge Shira Scheindlin from the U.S. District Court in New York rejected motions to dismiss filed by defendants Moody’s Investors Service and Standard & Poor’s (S&P) in a lawsuit filed by institutional investors in Washington state against Moody’s, S&P, Morgan Stanley and Bank of New York Mellon Corp. The lawsuit arises out of the 2007 collapse of SIV Portfolio PLC, better known as Cheyne Finance, a $5.86 billion structured investment vehicle. The defendants allegedly failed to disclose to investors that assets backing Cheyne, including subprime mortgages, were far riskier than represented. The lawsuit is filed on behalf of all persons seeking to recover losses from the liquidation of notes issued by the special investment vehicle between October 2004 and October 2007.
In their motions to dismiss, Moody’s and S&P argued that their ratings of Cheyne were protected by the First Amendment. In her decision, Judge Scheindlin acknowledged that ratings are typically protected from liability unless actual malice is shown because ratings and reports are considered “matters of public concern.” Where a rating agency disseminates its ratings to a select group of investors rather than to the public at large, however, the rating agency is not afforded the same protection. Therefore, because Moody’s and S&P’s ratings of Cheyne were provided in connection with a private placement to a select group of investors and were never widely disseminated, they are not afforded the protection of the First Amendment. Judge Scheindlin denied the motion to dismiss the common law fraud claims against Morgan Stanley and the ratings agencies, but dismissed all claims against Bank of New York and 10 other claims against the ratings agencies and Morgan Stanley. (“Ratings Agencies Must Defend Cheyne SIV Fraud Claims,” NASDAQ.com, September 2, 2009)
Eighth Circuit Affirms Dismissal of NovaStar Subprime Shareholder Lawsuit
In the first appellate decision addressing a subprime securities class action, the U.S. Court of Appeals for the Eighth Circuit affirmed on September 1, 2009 a district court’s dismissal of a class action lawsuit brought against NovaStar Financial Inc. The lawsuit was filed in early 2007 by NovaStar shareholders and named NovaStar, as well as the CEO and the former CEO and CFO of NovaStar. The complaint alleged that the defendants violated anti-fraud provisions of the federal securities laws by concealing the use of “ill-advised loans” in $7 billion worth of mortgage loan securitizations. According to the complaint, NovaStar’s share price dropped by nearly 40 percent immediately after the company announced large losses related to subprime mortgage loans in February 2007.
The U.S. District Court for the Western District of Missouri dismissed the complaint in 2008 based on a finding that the plaintiffs did not satisfy the federal pleading standards for fraud. Specifically, the judge found that the plaintiffs failed to “identify specific false statements” by the defendants and denied the plaintiffs an opportunity to amend their complaint. The Eighth Circuit decision affirmed the district court’s reasoning for dismissing the complaint and denied the plaintiffs’ request to amend because they had failed to file a formal motion for leave to amend. (“8th Circuit Sides With Mortgage Lender in Subprime Fraud Suit,” Andrews Publications, September 8, 2009)
SDNY Preliminarily Approves $150 Million Settlement in Merrill Lynch Bond Action
On August 21, 2009, Judge Jed Rakoff of the U.S. District Court for the Southern District of New York preliminarily approved a $150 million settlement in a subprime-related securities class action lawsuit brought on behalf of purchasers of Merrill Lynch bonds and preferred securities. The complaint alleged that Merrill Lynch failed to disclose its exposure to tens of billions of securities linked to subprime mortgages and asserted violations of Sections 11, 12 and 15 of the Securities Act of 1933. The proposed settlement was reached while motions to dismiss were still pending. Bank of America, which acquired Merrill Lynch, previously agreed to settle related shareholder and ERISA class actions. (“$150 Million Settlement in Merrill Lynch Securities Class Action Lawsuit is Granted Preliminary Approval by District Court Judge,” stockbrokerfraudblog.com, September 8, 2009)
Bank of America Agrees to $55 Million Settlement in Countrywide ERISA Action
On August 5, 2009, parties to an action filed by participants in Countrywide Financial Corp.’s benefits plan whose individual plan accounts were invested in Countrywide stock filed a stipulation of settlement and request for approval. The plaintiffs alleged that the plan’s fiduciaries “allowed imprudent investment of the plan’s assets in Countrywide’s equity” despite knowledge that such an investment was risky. The settlement agreement requires a payment of $55 million, which is to be paid entirely by Countrywide’s fiduciary liability insurers. (“Countrywide Settlement Cost Bank of America $55 Mln,” Bloomberg.com, August 10, 2009)
Ponzi Schemes and Fraud Actions
Real Estate Ponzi Scheme Has Broad Impact in Dubai
Problems currently plaguing Dubai may result from a Ponzi scheme involving the commencement of large construction projects in an attempt to encourage continued investments. Investors in large construction projects have received little return on their investments as a result of the collapse of the real estate market. In addition, S&P lowered its ratings on several government-linked companies and put several Dubai banks on review for downgrade.
Dubai regulatory authorities recently commenced investigations into companies and financial institutions such as Sama Dubai, Nakheel, Al Fajer Properties and Dubai Financial Bank. In addition, a case was recently filed against three executives from a Sama Dubai project called the Lagoons and an executive of the property company Damac alleging that the executives accepted bribes of more than $1.3 million in return for the unlawful reselling of Lagoon plots belonging to Sama Dubai. Also, Dubai’s public prosecutor has charged seven suspects with fraud, forgery and bribery valued at $490 million from the Dubai Islamic Bank in connection with a Dubai construction project called The Plantation. Further, a corruption case alleging bribery has been filed against five executives of real estate finance provider Tamweel Loading and Bonyon Holding. Authorities have arrested 25 executives from a wide range of companies as a means of cleaning up the real estate market in Dubai. In furtherance of this effort, regulatory programs have also commenced, including the “name and shame” program, which publishes the names of companies and individuals charged with corruption. In addition, the Dubai International Financial Centre and the Dubai Financial Services Authority have been granted authority to legislate financial institutions. Analysts expect enforcement actions to increase as Dubai authorities attempt to correct issues with the country’s real estate market. (“Dubai – ‘Sand Castles or Sand Traps,’” Crowell & Moring, September 1, 2009)
SEC Files Lawsuit Against Madoff’s ‘Key Lieutenant’
On August 11, 2009, the Securities and Exchange Commission (SEC) filed an uncontested lawsuit against Frank DiPascali, a “key” employee at Bernard L. Madoff Investment Securities LLC (Madoff Securities). DiPascali pleaded guilty to 10 criminal counts, including conspiracy, fraud and money laundering. In its complaint, the SEC detailed the business operations of Bernard Madoff’s fraudulent Ponzi scheme, which has led to more than $64 billion in investment losses. DiPascali apparently supervised programmers at Madoff Securities, who organized investor accounts on a single computer that fabricated trading activity for each account. Additionally, the complaint describes several schemes developed and/or implemented by DiPascali to deceive investigators and auditors. DiPascali faces a maximum sentence of 125 years in prison as well as civil penalties in a civil lawsuit that he settled with the SEC. (“Madoff Relied on Key Deputy, Stationary to Hide Scam,” Bloomberg.com, August 12, 2009)
Fairfield Seeks to Settle Madoff-Related Lawsuit
Fairfield Greenwich Group has reportedly offered full restitution to settle a lawsuit filed by the Massachusetts secretary of state’s office on behalf of Massachusetts investors who allegedly lost approximately $6 million in the Madoff Ponzi scheme. Fairfield is currently defending several other lawsuits relating to its role as the largest Madoff feeder fund, including an action brought by the U.S. bankruptcy trustee on behalf of Madoff Securities and a purported class-action lawsuit filed in New York federal court. The Massachusetts secretary of state’s office apparently rejected Fairfield’s offer as it seeks to identify all Massachusetts investors affected by Fairfield’s “lack of due diligence” related to the Madoff Ponzi scheme. (“Fairfield’s Offer Nixed,” New York Post, August 17, 2009)
Investors Bring Lawsuit Against AIG for Madoff Losses
On August 19, 2009, Milberg LLP filed a purported class action lawsuit in New York federal court on behalf of American International Group (AIG) policyholders who allegedly lost funds that they invested in the Madoff Ponzi scheme. The complaint alleges that AIG has refused to pay claims for the plaintiffs’ losses under a fraud-protection provision in their homeowner’s insurance policies. According to the lawsuit, AIG has agreed to pay amounts for initial investments with Madoff, but has refused to pay claims for “any alleged gains, growth or appreciation.” (“Two Sue AIG Over Madoff Losses,” The Wall Street Journal, August 19, 2009)
Bermuda Court Orders Kingate to Return $9 Million in Investments
On August 28, 2009, a Bermuda Supreme Court judge ordered Kingate Global Fund Ltd., a former Madoff feeder fund registered in the British Virgin Islands, to return $9 million held in a Bermuda bank account to two of its institutional clients. The two institutional clients, Knightsbridge Fund, Ltd. and Standard Chartered Bank (SCB), invested $6 million and $3 million, respectively, with Kingate for the purchase of shares in Madoff Securities shortly before Madoff was arrested and charged with operating a massive Ponzi scheme. Since then, the $9 million invested by Knightsbridge and SCB has been frozen in Kingate’s account at Bank of Bermuda HSBC. Kingate placed itself into voluntary liquidation on May 8, 2009, and Knightsbridge and SCB subsequently sued Kingate and Bank of Bermuda HSBC for return of the funds. (“Judge Orders $9m to Be Repaid to Two Kingate Institutional Investors,” The Royal Gazette, August 31, 2009)
Argus Settles With Investors in Madoff Ponzi Scheme
On August 31, 2009, the lead plaintiffs in a lawsuit filed against Argus Group Holdings Ltd., Tremont Group Holdings, Inc. and Rye Investments Funds filed papers in New York federal court seeking court approval of a partial settlement with Argus. The lawsuit was brought by investors who allege that they lost billions as a result of investments made by Tremont with Madoff, and that Tremont failed to conduct adequate due diligence of Madoff and monitor fund assets invested with him. The proposed settlement, which does not provide for any monetary payment to the settlement class, will assign certain claims to a litigation trust and applies to policyholders who purchased variable life or deferred variable annuities between May 10, 1994 and December 11, 2008. According to the proposed settlement agreement, policyholders would receive loans if those policies are threatened with lapsing beginning on December 1, 2009 as a result of losses due to investments in the Rye Select Funds or SHL Fund. In addition, the settlement provides that policyholders will have the right to consult with Argus regarding the liquidation of the Cayman Rye Funds. The proposed agreement does not settle claims against Tremont or Rye. (“Argus Group Reaches Settlement in Madoff Litigation,” NASDAQ.com, September 1, 2009)
SEC Report Reveals Embarrassing New Details of Its Failure to Detect Madoff Fraud
A report released on September 2, 2009 by the SEC concluded that beginning in 1992, the agency overlooked numerous red flags in connection with its investigations regarding Madoff’s Ponzi scheme. In the report, H. David Kotz, the agency’s inspector general, found that red flags were missed as a result of incompetence and inexperience, as well as the failure of investigators to follow incriminating evidence. According to the report, the SEC received six substantive complaints regarding Madoff and conducted three investigations and two examinations. The agency did not discover Madoff’s massive Ponzi scheme because it did not verify the trades that Madoff claimed to be making with third parties or to follow up on suspicions that the volume of Madoff’s purported options trades was implausible. The SEC’s Boston office failed to heed warnings of private fraud investigator Harry Markopolos, who beginning in 1999 tried to persuade the SEC to investigate Madoff. Although SEC investigators drafted a letter to the National Association of Securities Dealers seeking independent trade data, they never sent the letter because a review of the data would have been too time-consuming. Further, the SEC failed to internally coordinate its investigation - at one point, two separate branch offices of the SEC had ongoing Madoff investigations without knowing that the other office was conducting the same investigation. Moreover, the SEC’s failure to properly investigate helped Madoff carry out the fraudulent scheme as he used SEC inquiries as a “selling point,” informing investors that the SEC had investigated his operations and failed to detect any fraud. (“Report Details How Madoff’s Web Ensnared S.E.C.,” New York Times, September 2, 2009)
Five Banks Sued by Stanford Investors
Investors in Stanford International Bank (SIB) certificates of deposit filed a lawsuit in Texas state court against Toronto Dominion Bank, Trustmark National Bank, the Bank of Houston, HSBC Bank and Societe Generale. According to the lawsuit, the banks handled deposits for SIB and provided an “essential conduit” for the alleged fraud and should have known that Allen Stanford was operating a Ponzi scheme. (“Stanford Investors Sue Five Banks Tied to Alleged Scam,” CNBC.com, August 24, 2009)
Stanford CFO Pleads Guilty to Fraud Charges
On August 27, 2009, James Davis, the chief financial officer of Stanford Financial Group, pleaded guilty to three felony counts, including mail fraud, conspiracy to commit mail, wire and securities fraud, and conspiracy to obstruct a SEC investigation. Federal prosecutors in Texas accused Davis of misappropriating investor funds as part of an alleged Ponzi scheme that defrauded investors of approximately $7 billion. According to the charges against Davis and other Stanford Financial executives, investors were solicited to purchase $7 billion in certificates of deposit from SIB, which promised high rates of return. Davis pleaded guilty as part of a plea agreement with prosecutors, who will likely recommend a lighter sentence for Davis if they are able to use his testimony against Stanford or other top Stanford Financial executives. As part of the plea agreement, Davis was ordered to forfeit $1 billion in profits that he personally received from the alleged fraud.
According to the plea agreement, SIB’s balance sheets were fabricated by Stanford and Davis, who collaborated “to select a false revenue number.” Additionally, Davis asserts in the plea agreement that Stanford paid more than $200,000 in bribes to Leroy King, the former chief executive officer of Antigua’s Financial Services Regulatory Commission (FSRC), to ensure that the FSRC did not “kill the business of the bank.” Davis further contends that Stanford and other executives at Stanford Financial helped King deceive the SEC when it began investigating SIB in 2005. (“Stanford’s Finance Chief Pleads Guilty,” Financial Times, August 27, 2009; “Plea Deal Reveals New Details About Swindle Case,” Associated Press, August 27, 2009)
Proskauer Law Firm Sued By Stanford Investors
On August 27, 2009, Stanford investors filed a purported class action lawsuit in federal court in Texas against Proskauer Rose and one of its partners, Thomas V. Sjoblom. The lawsuit alleges that Proskauer and Sjoblom aided and abetted Stanford Financial’s fraud and conspired to obstruct an SEC investigation while representing Stanford Financial in a regulatory investigation. According to the lawsuit, under Texas law, Proskauer is liable for $7 billion in losses caused by the fraud. The lawsuit was filed after Davis, the former CFO of Stanford, pleaded guilty to three felony charges related to the fraudulent Ponzi scheme. Davis’ plea agreement implicated Sjoblom in a conspiracy to obstruct the SEC’s investigation of Stanford Financial. (“More Subprime Lawsuit Dismissals and Other Web Notes,” The D&O Diary, August 31, 2009)
$150 Million Fraud Action Filed in New York State Court Involving Saudi Dynasties
Saudi Arabia’s efforts to hasten its recovery from the global financial crisis have been slowed by a multimillion-dollar litigation between Ahmad Hamad Algosaibi & Brothers Co. (AHAB) and Saad Group, two of the country’s largest business groups. The families that run AHAB and Saad are purportedly related and are said to be among the richest people in the world. In May 2009, however, the companies began defaulting on debt owed to 100 Saudi and international banks in the amount of approximately $10 billion to $20 billion, and since then have been pointing fingers at each other to explain their financial problems. AHAB filed suit in a New York federal court alleging that Maan al Sanea, who is one of Saad’s owners and of the largest individual investors in HSBC Holdings, embezzled approximately $10 billion by forging documents for loans. Al Sanea is also named in a third-party complaint in an action filed by UAE lender Mashreqbank alleging non-payment of $150 million. In efforts to resolve the dispute, the Saudi government has established a special committee to schedule repayments from the companies to Saudi banks. The dispute has “left the fate of as much as $20 billion in debt in question” and purportedly “paralyzed lending to the private sector.” Saudi Arabia, which is the world’s largest oil producer, has also suffered due to a decline in oil prices and demand, which caused the government to enforce a stimulus package in November 2008. (“Saudi Arabia Business Spat Threatens Riyadh Bid to Be Middle East Boomtown,” The Wall Street Journal, August 22, 2009; “A $10 Billion Saudi Fraud Claim,” Economist.com, July 17, 2009)
Details Emerge Regarding ‘Lebanon’s Madoff’
Salah Ezzedine, a prominent businessman in Lebanon, recently declared bankruptcy because of mounting debts in the amount of $1.95 billion. As a prominent financier and close personal friend of senior leaders of the Hizbollah, Ezzedine invested in Lebanon’s Shia population, organized pilgrimages to Mecca, and ran a prominent publishing house and children’s television station. After sustaining substantial losses when oil prices dropped in 2008, Ezzedine began seeking money from Lebanese investors, including high-ranking members of Hizbollah, by promising a 40 percent return on investments. Ezzedine, now known as the “Abu Madoff” or the Madoff of Lebanon, ultimately was unable to pay investors the promised returns. (“‘Lebanon’s Madoff’ Bankrupted After Bouncing $200,000 Cheque to Hizbollah,” The Independent, September 8, 2009; “Hizbollah Helped Locate Bankrupt Businessman,” The Daily Star, September 5, 2009)
Auction Rate Securities
NYAG Sues Charles Schwab for ARS Practices
On August 17, 2009, New York Attorney General (NYAG) Andrew Cuomo sued Charles Schwab Corp. in New York state court alleging that the company falsely described auction rate securities (ARS) as similar to money market funds or certificates of deposit without disclosing to investors the liquidity risks associated with those types of securities. Cuomo alleges that the company knew or should have known of the substantial decline in demand for ARS toward the end of 2007. After the ARS market collapsed in February 2008, Charles Schwab customers were left holding approximately $789 million worth of the securities. The complaint requests that the court order Charles Schwab to repurchase the securities from investors and pay penalties and costs.
Charles Schwab has responded to the allegations by alleging that the NYAG has released the real culprits behind the ARS collapse and shifted responsibility to Charles Schwab. Charles Schwab argued that Wall Street firms are responsible for creating, marketing and abandoning the ARS market, which led to its ultimate collapse. Further, Charles Schwab alleged that it and its investors were misled by the ARS underwriters about the ARS market. The company said that the NYAG is “going too soft” on banks that underwrote the securities, including Citigroup, Inc., UBS AG and Goldman Sachs Group Inc., by settling ARS-related claims. (“State Sues Schwab Over Auction-Rate Securities,” The New York Times, August 17, 2009; “Schwab Vows Court Fight in Cuomo’s Auction-Rate Securities Suit,” Bloomberg.com, August 18, 2009)
FINRA Recommends Disciplinary Action in Connection With Weisel’s Purchase of ARS
The Financial Industry Regulatory Authority (FINRA) has recommended that disciplinary action be taken against Thomas Weisel Partners LLC in connection with the company’s purchase of ARS. In a July 27, 2009 filing, FINRA stated that the recommendation “involves potential violations of [FINRA] and Municipal Securities Rulemaking Board rules” as well as anti-fraud provisions of federal securities laws. During the past year, state regulators and the SEC ordered banks to repurchase more than $50 billion in ARS from investors. FINRA has also settled with nine firms, imposed fines totaling $2.6 million and ordered the return of more than $1.2 billion to clients. In May 2009, FINRA fined four brokerages $850,000 to settle claims alleging that the companies failed to disclose risks associated with ARS to investors prior to the market’s collapse in February 2008. (“Weisel Says FINRA Recommends Disciplinary Action,” Bloomberg.com, July 27, 2009)
Wachovia Ordered to Repurchase $325 Million in ARS
On August 11, 2009, The Pennsylvania Securities Commission (PA Commission) announced that it had reached an agreement with Wachovia Securities LLC under which Wachovia will repurchase $324.6 million in ARS from Pennsylvania investors and pay a $2.52 million assessment to the commonwealth for its role as a broker-dealer in the ARS market. Wachovia sold more than $12.8 billion in ARS to investors nationwide. Commission Chair Robert Lam alleges that Wachovia failed to properly supervise its agents in connection with the sale of ARS and engaged in business practices considered “unethical and dishonest.” The PA Commission continues to investigate other firms regarding their alleged misconduct in connection with their sale of ARS. (“Wachovia to Buy Back $325 Million in ARS,” The Wall Street Journal, August 11, 2009)
Anschutz Sues Ratings Agencies and Banks Over ARS
Anschutz Corp. filed a lawsuit on August 17, 2009 in California federal court against S&P, Moody’s and Fitch Rating, as well as Merrill Lynch & Co. and Deutsche Bank AG, in connection with $59 million in losses from ARS underwritten, rated and sold by the defendants. In 2006 and 2007, Anschutz purchased $59 million worth of ARS and has been unable to sell the securities since the market collapsed in February 2008. The complaint alleges that the banks deceived investors about the risks associated with ARS. In addition, the ratings services allegedly falsely promoted the products as safe investments by giving them their highest or second-highest ratings and received billions from the banks for the ratings. The lawsuit also asserts causes of action for fraud, violations of securities laws and negligent misrepresentation against the banks. The ratings agencies have also been sued by the California Public Employees’ Retirement System and other investors in connection with their ratings of securities backed by subprime and other high-risk mortgages. (“Anschutz Sues Bond Raters, Banks Over Auction Rate Securities,” Bloomberg.com, August 19, 2009)
Credit Suisse Broker Convicted of Securities Fraud
After three hours of jury deliberations, a jury on August 17, 2009 convicted former Credit Suisse Group AG broker Eric Butler of conspiracy to commit securities fraud, securities fraud and conspiracy to commit wire fraud. Butler was indicted last year and charged with conducting an illegal scheme whereby he fraudulently sold millions in subprime securities in an effort to generate higher commissions. Butler allegedly misrepresented to investors that the securities were backed by students loans guaranteed by the federal government and were a safe investment. Investors later learned that the securities were actually linked to ARS. Butler faces a maximum sentence of 45 years in prison. On July 22, 2009, Butler’s co-defendant, Julian Tzolov, pleaded guilty to conspiracy, wire fraud and securities fraud and now faces potential life in prison. Tzolov testified for the prosecution against Butler and said that the two men worked together to defraud investors. Butler and Tzolov were employed as managing directors of Credit Suisse’s private banking division and allegedly sold approximately $900 million in subprime-related securities to Credit Suisse clients. Butler intends to appeal the verdict. (“Ex-Credit Suisse Broker Eric Butler Guilty of Securities Fraud,” Bloomberg.com, August 18, 2009)
Federal Judge Dismisses ARS Action Against Citigroup
On September 11, 2009, U.S. District Court Judge Laura Taylor Swain dismissed a consolidated action against Citigroup, Inc. filed on behalf of purchasers of ARS underwritten by Citigroup. The consolidated complaint alleged that Citigroup manipulated the ARS market by intervening in auctions to prevent them from failing. In dismissing the complaint, Judge Swain found that the lead plaintiff failed in part to meet the pleading standards required to assert market manipulation. The opinion states that the consolidated complaint did “not include specific allegations as to which defendants performed what manipulative acts at what times and with what effect,” but rather relied “on general and conclusory allegations regarding defendants’ practices in connection with ARS auctions.” Judge Swain concluded that “[a]bsent particularized allegations regarding defendants’ alleged manipulative conduct, plaintiff cannot state a claim for market manipulation.” The lead plaintiff has until October 1, 2009 to file an amended complaint. (“Judge Dismisses Auction-Rate Securities Suit Vs Citigroup, The Wall Street Journal, September 11, 2009)
Government and Regulatory Intervention
77 Troubled Banks Seized by the FDIC in 2009
On August 14, 2009, the FDIC seized Colonial Bank, a regional bank headquartered in Montgomery, Ala. Colonial Bank, a unit of Colonial BancGroup Inc., which has since filed for bankruptcy protection, is the largest bank to fail since Washington Mutual Inc.’s collapse in September 2008 and the sixth largest bank failure in U.S. history. Colonial Bank had assets of $25 billion and 346 branches in five states. The bank’s failure is due largely to aggressive real estate lending in Florida. In December 2008, the federal Treasury Department agreed to invest more than $500 million from the Troubled Asset Relief Program (TARP) if the bank could raise $300 million in capital from another source. Federal agents, acting at the request of the special investigator general of TARP, commenced a criminal investigation into one of Colonial Bank’s lending units and related accounting irregularities after the bank requested TARP funds. Regulators ultimately sought a buyer for the troubled bank and reached an agreement to sell its branches, deposits and most of its assets to BB&T Corp. The FDIC entered into a loss-sharing agreement with BB&T on $15 billion of Colonial Bank’s assets. The bank’s collapse will cost the FDIC $2.8 billion.
Regulators also recently seized four other banks, including Community Bank of Arizona, Union Bank in Arizona, Community Bank of Nevada and Dwelling House Savings and Loan Association of Pittsburgh. The combined assets of these four banks are $1.82 billion and the banks have $1.65 billion in deposits. As of August 15, 2009, there had been 77 bank failures in the U.S. this year and 32 since July 1, 2009. The FDIC’s seizure of these four banks will cost the FDIC’s deposit insurance fund an estimated $874.8 million. (“Large Real Estate Lender Fails,” Capitalhillblue.com, August 15, 2009; “BB&T Takes Over Colonial Bank,” The New York Times, August 14, 2009; “Colonial BancGroup Files for Chapter 11 Protection,” NPR.Org, August 26, 2009)
Banks Still Dealing With Troubled Loans
In a report released on August 11, 2009, a five-member congressional oversight panel headed by Elizabeth Warren, a professor at Harvard Law School, found that although the Treasury Department’s $700 billion bailout program stabilized the banking system, banks still have issues dealing with troubled assets on their books. TARP’s original intent was to buy troubled mortgages and mortgage-backed securities. The government, however, decided to invest money directly into U.S. banks. As a result, U.S. banks continue to hold billions in assets that they cannot properly value or sell. The report warned that as a result, thousands of small and medium-size banks with assets of $600 million to $100 billion may be short a total of $21 billion in capital if losses on their troubled assets increase. The Federal Reserve estimated that in May 2009, U.S. banks still had approximately $599 billion in assets to write down. The report recommends that the Treasury “either expand its current program to purchase troubled assets” or pursue a different strategy. (“Troubled Assets May Still Pose Risk,” The New York Times, August 11, 2009)