Bank closings are carefully planned events, and they are usually handled quietly, smoothly, and uneventfully. The bank's depositors hardly know that anything has happened. For the vast majority, their money is safely protected by the FDIC's deposit insurance system. A bank is typically closed on a Friday afternoon and reopened under new ownership the following Saturday or Monday morning. Customers generally see the same bank employees at the same branch offices; only the name of the bank has changed. This well-rehearsed pattern is designed to maintain public confidence in the U.S. financial system and to prevent banks' depositors from trying to withdraw all of their funds at the same time.
But IndyMac was no ordinary bank, and this would be no ordinary closing.
IndyMac was a poster child for how home mortgage lending had spiraled out of control during the preceding boom years. The bank had been launched in 1985 as a division of Countrywide, a California mortgage lender that encountered its own troubles in 2007. IndyMac became independent of Countrywide in 1997, and it gradually came to specialize in something called Alt-A mortgages, which were typically offered to borrowers whose credit profiles were better than subprime but not strong enough to qualify for prime loans. In the case of IndyMac, borrowers could obtain home mortgage loans without going through a formal credit review process – they simply stated to loan officers their income, asset, and debt levels. After the crash, these arrangements became known as “liar loans” or “ninja loans” (no income, no job, and no assets).
IndyMac did not keep most of the mortgages it originated. They were packaged together, sold, and used as collateral for mortgage-backed securities. This originate-to-sell model also was not unique to IndyMac. Many banks found that they could increase their profits by selling mortgage loans soon after they made them. The sales proceeds could then be used to make new loans, which could create a steady stream of income. As long as there was an appetite in the market for mortgage-backed securities, there would be a need to create new home mortgages. This would create additional pressure to further weaken lending standards in order to find new customers.
With housing prices rising throughout the United States, IndyMac found many willing borrowers. The bank's profits tripled from 2001 to 2006, according to the New York Times. During 2006 alone, IndyMac originated $90 billion in new mortgages, and racked up $342.9 million in profits. The bank had established 182 loan production offices around the country to help it find new customers, and at its peak it was the nation's 10th-largest mortgage lender.
To help finance its mortgage lending, IndyMac had raised $20 billion in deposits through the Internet, deposits placed at its 33 branches in Southern California, and from the brokered-deposit market. The bank offered higher interest rates than anyone else so it was easily able to attract rate-chasing deposits. The bank had also borrowed $10 billion in high-cost money from the Federal Home Loan Bank of San Francisco (FHLB-SF).
This toxic cocktail of high-cost funding, weak lending standards, and a constant churning of new loan originations left IndyMac highly vulnerable in the event of a downturn in the housing market. Predictably, problems for IndyMac started once housing prices began to fall in 2006 and 2007. Borrowers who never had the income or assets to support their mortgages began to understand how overextended they were and started defaulting on their monthly payments. As home values dropped below the amount owed on the mortgages, there were even some strategic defaulters who stopped making their mortgage payments even though they still could afford them. They simply didn't want to own a house that was worth less than their outstanding mortgage balance, known as “upside down” in the mortgage business.
IndyMac had not focused its lending activities on the subprime market. Most of its mortgage loans were made to middle- to high-income families, who were interested in the convenience, leverage, and favorable rates they could obtain from the bank. IndyMac's difficulties were a clear indication that the problems in the mortgage market had extended well beyond subprime loans.
IndyMac had also ramped up its lending to home builders, who were squeezed by the downturn in the housing market. At the end of the first quarter of 2008, IndyMac had $1.06 billion in loans outstanding to home builders – more than half of which had been categorized as “nonperforming.” By the spring of 2008, IndyMac officials knew the bank was in serious trouble. It had lost nearly $615 million the year before, and the company's share price had fallen to $6. Conditions worsened in the first quarter, with IndyMac reporting $184 million in losses. The bank's chief executive, Michael Perry, acknowledged that it would not return to profitability “until the current decline in homes prices decelerates.” Around this time, IndyMac was talking to private equity firms about acquiring the institution. When no buyers could be found, the bank started planning to shutter its mortgage lending business.
At the FDIC we had long been aware that IndyMac was dangerously exposed to the downturn in the real estate market. By the late spring, our concern was growing, so we set up a meeting with senior officials at the Office of Thrift Supervision (OTS), the federal regulator responsible for supervising IndyMac. FDIC Chairman Sheila Bair and I, and two senior officials from the Federal Reserve, met with John Reich, who was the Director of OTS, and Scott Polakoff, a former FDIC regional director who was now serving as the OTS deputy. Polakoff suggested that the OTS could supervise a gradual reduction in the size of the bank until its problems were more manageable. My colleagues and I from the FDIC didn't think it was a good idea to leave the people who had created the problems at the bank in charge of a gradual wind-down of its operations. I told the group that IndyMac was going to be the most expensive bank failure since the FDIC was created in 1934.
The FDIC had dodged a bullet earlier, in January 2008, when Bank of America purchased Countrywide, a troubled bank like IndyMac, except that it was much larger. If Countrywide had failed, the public disruption could have been tremendous and the losses to the FDIC's deposit insurance fund enormous. Bank of America was less fortunate, incurring over $40 billion in losses associated with its purchase of Countrywide and its subprime mortgage loans.
After our meeting at OTS, we anticipated an August closing, which would have given us time to quietly market the bank to prospective buyers. But our already-tight timeline was altered by an unexpected development.
On June 26, Senator Charles Schumer (D-NY) sent a letter to banking regulators highlighting the weakened condition of the bank. The letter stated: “There are clear indications that IndyMac…could face a failure if prescriptive measures are not taken quickly.” While the letter didn't say anything we didn't already know, Senator Schumer took the unorthodox step of publicly disclosing his concerns to the Wall Street Journal, which published an article about the IndyMac letter the following day. One day after that, on June 28, the Pasadena Star-News, which served many of the communities in which IndyMac operated, published an article with the headline “IndyMac Appears Close to Collapse.”
Panic quickly set in. Customer withdrawals quickly reached $100 million per day, and there were extremely long lines of bank customers waiting to get their money – a scenario rarely seen since the bank failures of the Great Depression.
IndyMac's customers withdrew $1.3 billion in the 11 days following release of the Schumer letter, according to OTS. John Reich, the OTS head, said that Schumer's letter gave the bank a “heart attack” and “undermined the public confidence essential for a financial institution.” Indeed, an OTS press release said that “the immediate cause of the closing was a deposit run that began and continued after the public release of a June 26 letter to OTS and the FDIC from Senator Charles Schumer of New York.”1
Because of the accelerated timeline, there was no time to carefully prepare for the bank's closing. Within days of Senator Schumer's letter being released, IndyMac was on the verge of running out of money. The week after the Schumer letter, the bank announced plans to reduce its workforce from 7,200 to 3,400, and to close its wholesale and retail new loan divisions. But that didn't stop the hemorrhaging. The bank's stock price, which had been $50 in 2006, fell to just 28 cents on July 11.
We knew IndyMac had to be closed immediately. Without a ready buyer there were only two choices: we could shut the bank down completely or we could take it over and run it ourselves. Both options were (in the polite terminology of economists) suboptimal.
IndyMac