Monthly Archives: January 2013

Discussion of IndyMac Bank’s 2007 Safety and Soundness Regulatory Examination

Unbelievably, I am advised by counsel that more than four and one-half years after IndyMac Bank’s seizure by the FDIC on July 11, 2008, IndyMac Bank’s Regulatory Safety and Soundness (“CAMELS”) examination reports and other regulatory information concerning IndyMac Bank remain confidential federal government property. Neither I, nor anyone else, is able to disclose information from these documents, unless the government has already placed it in the public domain. The only information related to IndyMac’s Safety and Soundness examinations of which I am aware is in the public domain comes from the U.S. Treasury’s Office of Inspector General’s (“OIG”) Material Loss Report for IndyMac Bank dated February 26, 2009. As a result of this regulatory rule, my discussion of the 2007 safety and soundness examination below is severely restricted. (I call on the OCC, the successor to the OTS, and the FDIC to promptly release all historical regulatory reports related to IndyMac Bank and all sworn, investigative testimony, including my own, that the FDIC obtained in the pre-litigation phase. Publicly releasing these IndyMac-related documents and testimony is in the public’s interest. They have a right to read and learn from them, and make their own judgments. And there really is no good reason for these documents and testimony to continue to be confidential, other than certain federal banking regulators might not want all the facts and the truth to emerge.)

The OIG’s Material Loss Report for IndyMac Bank discloses on page 17, in Table 1, that IndyMac Bank received a Composite (“Overall”) Rating of “2” and a Component Rating of “2” for each and every Component; for both the 2007 Safety and Soundness examination (commencing on January 8, 2007) and for the 2005/2006 examination (commencing on November 1, 2005). These were the best numerical ratings IndyMac Bank had ever received from its regulator, since becoming a Thrift in mid-2000. In fact, as the OIG report notes in Appendix 5, pages 67/68, the 2007 examination only had three matters that IndyMac Bank’s regulators felt required the board’s attention (“MRBA”):

  1. “Ensure that the conduit division address (IndyMac’s own) internal audit findings.”
  2. “Re-evaluate senior management incentive compensation to ensure that it was weighted in accordance with the employees responsibilities.”
  3. “Ensure the new forecasting process was implemented.”

The Office of Thrift Supervision (“OTS”) reviewed these regulatory ratings and their exam findings with IndyMac’s independent board and management in a meeting on March 9, 2007.

In the Treasury OIG’s 2009 Material Loss Report, Page 3, they stated the following: “OTS examiners reported Matters Requiring Board Attention (MRBA) to the thrift, but did not ensure that the thrift took the necessary corrective actions….OTS relied on the cooperation of IndyMac management to obtain needed improvements. However, IndyMac had a long history of not sufficiently addressing OTS examiner findings.”

This is an outrageous statement by the Treasury OIG; it is utterly and completely false. Each year since becoming a federal thrift in mid-2000, IndyMac Bank management took the OTS’findings/recommendations so seriously that we often begin implementing them even before the examination was completed and their report prepared and presented to the board. (My statement in this paragraph is absolutely truthful and can be verified by many other senior managers and independent directors of IndyMac Bank. It also could be verified by the public release of IndyMac Bank’s safety and soundness examination reports by the OCC and the sworn investigative testimony obtained by the FDIC.)

As any bank would, we placed significant weight on these formal regulatory safety and soundness examinations (their ratings and findings) and they materially affected our decisions and actions. And they did when we received this March 2007 report, the last one before the unprecedented financial crisis occurred. After all, as the Treasury OIG report notes, IndyMac Bank’s 2007 safety and soundness examination had 40 regulators involved and over 4,614 man-hours devoted to it (at a significant cost to IndyMac and its shareholders). In fact, later that March, I personally bought $1 million of additional IndyMac stock, as did IndyMac Bank’s independent director who chaired the board’s enterprise risk management committee. I bought the stock because it had declined during the quarter to roughly book value per share, due to our 4th quarter 2006 earnings miss (which included some modest credit deterioration) and first quarter spread-widening in the private MBS marketplace. I also took comfort in knowing that our banking regulators, who understood these same relatively modest market and credit deterioration issues, continued to feel (as they had in recent years) that the risks we were taking were appropriate and manageable in relation to our management expertise, loan loss reserves, and capital base. (I also took some comfort in a Moody’s credit upgrade that occurred in mid-March 2007; see discussion below.)

See the attachment below for a description of U.S. banking regulators numerical (from “1” or Best to “5” or Worst) safety and soundness ratings. (The attachment below was obtained from The Federal Reserve System’s publicly available website.)

I excerpted from this attachment the regulatory descriptions of “2” ratings; because as noted above, in 2007 IndyMac Bank received a “2” for its Composite and each and every Component rating. (I did however replace the generic terms “Bank” or “Institution” in these descriptions, with “IndyMac Bank” or “its”, in order to more accurately depict the safety and soundness views of our regulator at that time; just months before the depths of financial crisis of 2007/2008 surprised nearly everyone):

2007 Safety and Soundness Examination Ratings and Ratings Descriptions: As Presented by the OTS to IndyMac Bank’s Management and Board of Directors on March 9, 2007:

Bank Composite: “Overall”, Rating of 2 – IndyMac Bank is fundamentally sound and stable and in substantial compliance with laws and regulations.

Bank Component: Capital, Rating of 2 – IndyMac Bank has a satisfactory capital level relative to its risk profile.

Bank Component: Assets, Rating of 2 – IndyMac Bank has satisfactory asset-quality and credit-administration practices. The level and severity of classifications and other weaknesses warrant a limited level of supervisory attention. Risk exposure is commensurate with capital protection and management’s abilities.

Bank Component: Management, Rating of 2 – IndyMac Bank has satisfactory management and board performance and riskmanagement practices relative to its size, complexity, and risk profile. Minor weaknesses may exist, but they are not material to safety and soundness and are being addressed. In general, significant risks and problems are effectively identified, measured, monitored, and controlled.

Bank Component: Earnings, Rating of 2 – IndyMac Bank’s earnings are satisfactory. Earnings are sufficient to support operations and maintain adequate capital and allowance levels. Earnings that are relatively static, or even experiencing a slight decline, may receive a 2 rating provided the institution’s level of earnings is adequate in view of the assessment factors listed above.

Bank Component: Liquidity, Rating of 2 – IndyMac Bank has satisfactory liquidity levels and funds-management practices. IndyMac Bank has access to sufficient sources of funds on acceptable terms to meet present and anticipated liquidity needs. Modest weaknesses may be evident in funds-management practices.

Bank Component: Sensitivity to Market Risk, Rating of 2 – IndyMac Bank’s market-risk sensitivity is adequately controlled and there is only moderate potential that the earnings performance or capital position will be adversely affected. Risk-management practices are satisfactory for the size, sophistication, and market risk accepted by IndyMac Bank. The level of earnings and capital provide adequate support for the degree of market risk taken by IndyMac Bank.

You sure wouldn’t understand these positive regulatory views from the Treasury OIG’s biased and inaccurate Material Loss Report. In fact, Appendix 5 of this report (“OTS IndyMac Examination and Enforcement Actions”) only discloses negative findings/recommendations from IndyMac Bank’s annual safety and soundness examination reports and not any of the positive comments. I believe the OIG excluded positive comments from their report, because they did not fit their biased and inaccurate narrative/conclusions. (How in the world can the Treasury OIG say they conducted their material loss examination and issued their report under Generally Accepted Government Auditing Standards, when it is so biased and violates so many of those standards?). Common sense would tell you that the 2007, “2” numerical ratings (the second-best rating possible) were supported in the 2007 safety and soundness report by other more positive comments. Here are a few of the key comments:

(Please note: I had listed 12 positive comments here in my original draft, but upon the advice of counsel I have reluctantly removed them for the reasons discussed above.)

Think about these March 2007 regulatory ratings and related regulatory descriptions, in relation to what has been said by the FDIC about our management of IndyMac Bank. Also, in mid-March 2007, Moody’s Investor Services, Inc. publicly upgraded IndyMac’s investment-grade credit ratings: raising Bancorp to Baa3 and Bank to Baa2; consistent with Standard & Poor’s Financial Services, LLC and Fitch Ratings, Inc. These were the independent and informed views of the government-regulated, “Big Three” National Statistical Rating Agencies at that time. And we now see from The Federal Reserve Board’s 2007 minutes (recently disclosed and discussed in the press after their five-year confidentiality period had expired), that the Fed itself was uncertain about what action to take and really had no clue about the magnitude of the financial crisis until much later in 2007; well after the FDIC-R said in their meritless lawsuit against me, “That Mr. Perry should have known that this crisis was coming and therefore he was negligent in failing to reduce the Bank’s core lending volume (in 2007) further and faster than the bank was already doing; by $10 billion more, almost immediately between April and October.” I don’t really think that is right or fair, because it would have required me to predict a future event that had never occurred in my lifetime or even my father’s lifetime and take highly radical actions. A prudent banker is not supposed to “bet-the-bank” on a highly unlikely event occurring.

As I have said many times, as 2007 began, virtually no one saw the financial crisis coming (and the few that did, severely underestimated its magnitude); certainly I did not. At each step throughout 2007 and 2008, the decisions I made and the actions I took (with the information available to me at the time), were the prudent and appropriate ones to keep IndyMac Bank safe and sound. They were done in consultation with the management team and our board, supported by our primary regulators at the OTS, and by our shareholders (after the crisis was well-known, I wrote a February 12, 2008 letter to shareholders, filed with the SEC as an 8-K, taking responsibility and offering to resign without any contractually-obligated severance if they held me responsible and therefore decided not to re-elect me to the board. IndyMac’s shareholders instead re-elected me with roughly 97% of the vote).

It’s only the FDIC who is inappropriately utilizing hindsight judgment and trying to blame their own insurance decisions (remember they approved our nonconforming mortgage banking business model for deposit insurance in July, 2000), losses, and temporary insolvency on others. The FDIC itself did not foresee this crisis coming and took no actions pre-crisis to warn bank CEOs like myself or bolster and protect the insurance fund.

Note: I believe the FDIC, and others, have unfairly denigrated The Office of Thrift Supervision as result of IndyMac Bank’s and others failure during this unprecedented financial crisis (Dodd-Frank abolished the OTS. It was subsumed within the OCC). The FDIC would say (and their lawyers have in court) that “it doesn’t matter what the OTS said, they were abolished because they got it wrong….” I can tell you for a fact that the OTS regulators I met and dealt with were hard-working, experienced, knowledgeable, independent, and highly ethical (they wouldn’t even accept a bottle of water from us during a meeting). Unfortunately for the OTS, thrifts like IndyMac Bank received no government assistance; we were deemed “Not Too Big To Fail”. Let’s not forget though that the OTS wasn’t the regulator of any of the Too-Big-To-Fail Banks that were bailed out by the government. They weren’t the regulator of any of the Wall Street firms that failed or were saved by various government interventions (firms who took simple mortgages and mortgages securities and other types of loans and securities and structured so many complicated and risky derivatives, then bet against some of them without clearly and specifically telling buyers they were doing so, and sold them worldwide). They weren’t the regulator of Fannie Mae and Freddie Mac, who were placed in conservatorship just weeks after IndyMac was seized by the FDIC and remain in conservatorship today (and would have become insolvent if not for a U.S. taxpayer bailout of well over $130 billion). They weren’t the overseer of FHA and its mortgage insurance fund which is currently insolvent (to the tune of over $15 billion). And they weren’t the regulator of the National Statistical Rating Agencies (who we now know through hindsight, incorrectly slapped AAA-ratings on hundreds of billions in mortgage and other securities; that would otherwise have not been sold/purchased by so many in the U.S. and around the world). With the benefit of hindsight, nearly everyone in government financial regulation (and monetary policy) and the private-sector finance’s judgments were proven to be mistaken, because the world experienced a highly unlikely (very-low probability) event; a once or twice-in-a-century global financial and economic crisis.

Click here for CAMELS Ratings Explanation

“Each of the actors: bankers, politicians, the poor, foreign investors, economists, and central bankers did what they thought was right”

I think Professor Rajan’s book “Fault Lines: How Hidden Fractures Still Threaten The World Economy” is one of the most thoughtful and logical accounts of the true root-causes of the recent financial and economic crisis. (Professor Rajan is the former Chief Economist of the International Monetary Fund and in 2003 was the inaugural winner of the Fischer Black Prize given by the American Financial Association to the best financial economist under forty.) I would strongly encourage you to read this book, as I believe it will change your mind if you are one of those who believe the mainstream media and liberal politicians overly simplistic view that “bankers are to blame” for the unprecedented worldwide financial crisis.

Professor Rajan states it best when he says:

“I do not seek to be an apologist for bankers…..But outrage does not drive good policy. Though it was by no means an innocent victim, the financial sector was at the center of a number of fault lines that affected its behavior. Each of the actors…..bankers, politicians, the poor, foreign investors, economists, and central bankers…..did what they thought was right. Indeed, a very real possibility is that key actors like politicians and bankers were guided unintentionally, by voting patterns and market approval respectively, into the behavior that led inexorably toward the crisis. Yet the absence of villains, and the fact that each of these actors failed to bridge the fault lines makes finding solutions more, rather than less, difficult.”

A common but mistaken view that I have often read in the mainstream press and other accounts of the financial crisis is roughly that: “The unsustainable housing price bubble was caused by U.S. banks and independent mortgage lenders lowering credit standards for mortgage loans”. This is neither economically logical nor factually correct. Professor Rajan makes clear (as have other economic experts) that asset price inflation comes first and credit naturally expands as a result. In other words, credit expansion is a byproduct not the initial cause of asset price inflation. Only in the later stages of an asset bubble does credit expansion reinforce this trend and cause asset prices to rise even higher. The point being, it wasn’t the bankers and mortgage lenders who started the housing bubble, it was central bankers, like our Federal Reserve, manipulating market rates too low for too long (for job-creation reasons), world trade imbalances between countries (that caused huge pools of unquestioning investor funds from developing countries seeking highly-rated debt instruments to flow into the U.S. and other developed countries), and government housing policies (most mention CRA requirements and Fannie and Freddie’s role, some mention the mortgage tax-deduction, few mention FHA’s role in setting lending standards for subprime loans and no one mentions that Congress, during the Clinton administration, passed a law to allow owner-occupants to sell their homes every two years and avoid capital gains of $500,000 each time! In hindsight, I believe, this law encouraged consumers to buy and flip owner-occupied homes and that as soon housing prices began to rise, this group of hidden real estate speculators exploded in size) that started the unsustainable housing bubble in the U.S. and many other developed countries. The expansion of private sector mortgage lending and the deterioration in lending standards (just as the fervor to buy homes by many individual Americans) were a symptom of these central bank/government actions and world trade/financial imbalances.

Another common misperception by the mainstream press and public is that this financial crisis was strictly centered in housing and mortgage lending in the United States. Not true. The U.S. mortgage market pre-crisis just happened to be the largest debt market in the world (larger even than the U.S. Treasury market) and homes were the largest asset that individual Americans owned, so it became the key (and almost only) focal point of the crisis; but before and during the crisis (and even today in countries like China and Canada) major bubbles and busts occurred in housing markets around the world, as well as many other types of asset classes (commercial real estate, private equity leveraged-buyouts, publicly-traded equities, bonds, commodities, etc.), and these asset price increases logically led to the deterioration in all types of lending standards and banking crises occurred, as a result, all over the world. The point being, U.S. mortgage lenders were not the only or even the primary cause of the worldwide financial crisis. Their activities were a logical byproduct of central bank/government actions and world trade/financial imbalances. Professor Rajan points this out:

“In addition, the promise (by the Federal Reserve) that liquidity would be plentiful over the foreseeable future meant that bankers were willing to make longer-term illiquid, and hence risky, loans. But with firms unwilling to invest, banks went looking for deals that would create demand for loans. One option was for private equity investors to acquire firms, relying on banks to finance the deals. Banks, in turn, packaged the loans they made……creating collateralized loan obligations (CLOs)….and sold debt securities against them, thus obtaining the funds to make yet more loans. The result was that larger and larger leveraged acquisitions were proposed to satisfy the seemingly insatiable investor hunger for debt claims. As the rush to lend increased, lending standards declined rapidly: the classic signs of the frenzy were ‘covenant-lite’ loans, bereft of the traditional covenants banks put in to trigger repayment if the borrower’s condition deteriorated, and pay-in-kind bonds, schemes by which borrowers who could not pay interest simply issued more bonds. As I argued earlier, the recent crisis was not caused only by lending to the poor!” (related to home lending, Prof. Rajan means primarily CRA through subprime, the GSEs, and FHA, when he says “poor”).

I think it is appropriate to note, that I detected a slight bias in some of Professor Rajan’s statements and conclusions and I believe that bias might emanate from his educational and professional background. He is an academic and professional economist (who I don’t believe has ever worked in the private, “for-profit” financial sector) and those who lead The Federal Reserve Bank are also academic and professional economists. Read Chapter Five “From Bubble to Bubble” for yourself. I give Professor Rajan credit for clearly laying out the facts and describing the Fed’s major policy mistakes, but I believe he fails to condemn them in the same way he does the “amoral” (his word not mine) private, for-profit financial sector, because in his heart and mind he is one of them and could see himself or anyone being under similar pressures and making similar mistakes. Take a look at this excerpt from Chapter 5:

“The danger is that monetary economists will try to wish away links between monetary policy, risk taking, and asset-price bubbles. Bernanke came close to doing so in his 2010 speech to the American Economic Association, where he argued that it was not the Fed’s defective monetary policy….which he considered entirely appropriate, given the Fed’s views on inflation…..but its inadequate supervision that helped trigger the crisis. He concluded: ‘Although the most rapid prices increases occurred when short-term interest rates were at their lowest levels, the magnitude of the house price gains seem too large to be readily explained by the stance of monetary policy alone. Moreover, cross-country evidence shows no significant relationship between monetary policy and the pace of house price increases.’”

“Of course, no one claims that the Fed alone was responsible for the housing debacle. Government policies favoring lowincome housing, as well as private-sector mistakes, contributed significantly. But to suggest that it had no role is disingenuous. Indeed, a detailed study published in the Federal Reserve Bank of St. Louis Review in 2008 presents evidence that ‘monetary policy has significant effects on housing investment and house prices and that easy monetary policy designed to stave off the perceived risks of deflation in 2002-2004 had contributed to a boom in the housing market in 2004 and 2005.’”

I looked it up, disingenuous means “not candid or sincere” and its synonyms are “false” and “devious”. In my opinion, Prof. Rajan, as a professional courtesy, underplays the fact he believes, “Bernanke made a false statement in 2010 when he denied that monetary policy had any role in housing debacle”. Doesn’t that false statement, by a top economic official of the government, cause us to continue to misunderstand the true root causes of the financial crisis (and therefore not take the correct steps to prevent a future one)? It wouldn’t be the first time. Ben Bernanke himself admitted in 2002, during a speech he gave at Milton Friedman’s 90th birthday celebration, that the Federal Reserve’s monetary actions did in fact cause the Great Depression (70 years after the fact and nearly 40 years after Milton and Anna Schwarz blamed the Fed in “A Monetary History of the United States”): “What I take from their work is the idea that monetary forces, particularly if unleashed in a destabilizing direction, can be extremely powerful…..Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re sorry. But thanks to you, we won’t do it again.” Isn’t being “disingenuous” about the Fed’s role in causing the most recent financial crisis, a lot worse than being a member of the “amoral” private, for-profit financial sector? Is it going to take the Fed another 70 years to admit their major role in causing the 2008 financial crisis?

As Prof. Rajan states (about the Fed’s pre-crisis, low-rate monetary policies):

“Low short-term interest rates pushed investors to take more risk, for a number of reasons. Some institutions, like insurance companies and pension funds, had contracted long-term liabilities. At the low interest rates available for safe assets, they had no hope of meeting those liabilities. Rather than falling short for sure, they preferred to move into longer-term riskier bonds, such as mortgage-backed securities, that paid higher interest rates. In addition, as long-term interest rates fell and the value of stocks, bonds, and housing rose, households felt wealthier and may have felt the confidence to take more risks.”

Count me with the conservatives (as Prof. Rajan describes them in his Epilogue); I strongly believe that the Federal Reserve Bank’s (“extremely powerful”, Bernanke’s words) politically-motivated and mistaken pre-crisis monetary policies and the strong, “markets are mostly right and efficient” economic culture they fostered throughout the entire financial system (as a result of Greenspan’s market philosophy and his then “infallible” aura as Chairman, and the Fed’s central financial role and then respected status) squelched any appropriate counter-cyclical banking regulation and are the primarily reasons for the 2008 financial crisis (a close second being government housing policies and world trade/financial imbalances, followed by private investors, bankers and consumers who responded to these economic incentives in what they believed at the time was a rational and appropriate way).

Lastly, I don’t think Prof. Rajan’s arguments about the “amoral” private, for-profit financial sector are quite logical? They don’t ring true to me, because they don’t explain the fact that the government-controlled, not-for-profit, FHA insurance fund made the same economic decisions as the private “for-profit” financial sector before the crisis (they were one of the largest subprime lenders in the Country before the crisis, with billions in zero down payment, subprime credit score, high debt-to-income ratio, and no income or asset documention home loans) and FHA was much slower to react during the crisis (than the private sector) to tighten its lending standards and increase its guarantee fees (only recently, around the time they became insolvent did they make significant changes) and today, they are the only subprime and no income or asset documentation (reverse mortgages) home lender in the nation; taking over major mortgage market share from the collapse of the private subprime mortgage market. It was always my view, and I know IndyMac’s management team, board, shareholders and regulators shared this view, that before this crisis, we felt like we were “doing good”. Sure, we were making a profit, but we were also just as importantly helping people buy homes, lower their mortgage payments, pull cash-out out of their home’s equity to make improvements, send their kids to college, buy a car, pay for unexpected medical bills, or start a business. In other words, we thought and felt strongly pre-crisis that we were “doing good” for our customers and also “doing well” for ourselves and our shareholders. I think FHA probably thinks they were (pre-crisis) and are (post-crisis) “doing good” too, despite their present high level of nonperforming loans, foreclosures, insolvent status, and recent negative press; including an LA Times OpEd by a resident fellow of the American Enterprise Institute entitled: “The FHA: A home wrecker”.

I believe that we (all of us) have allowed a double standard to develop in America, where citizens in the private sector are held to a higher standard of conduct and accountability than citizens in the public sector. And I believe it is getting worse over time (as the government expands) and it is eroding our individual rights and liberties and hurting the private sector’s ability and desire to take risks and innovate (succeeding sometimes, but more often failing and then trying again); the keys to a dynamic and vibrant economy. It is my view that Americans operating in the government sector (especially those in power, but even those who are not), must be held to a higher standard of duty and care than American’s operating in the private sector. Yet clearly today it is the opposite. Nearly all of our civil laws and regulations and the entire civil enforcement apparatus of the government is aligned against the private sector and private individuals. Nothing, other than our mostly disinterested and uninformed electorate, holds the government and its key officials to account for their conduct and mistakes. Why is it that because you seek to make your career in the “for- profit” sector (and help create jobs and taxpayers), some people think it is not possible to “do good” at the same time? And if something does go wrong (in an unprecedented financial crisis, say), it’s even worse. Your conduct and motives are immediately called into question and your reputation is unfairly besmirched. And years of your professional life are taken away being investigated by the government and sued (there are even calls in the press and among certain politicians for criminal prosecutions, without any knowledge of specific wrongdoing). However, if you are a government official and you are mistaken or fail, nothing happens. In fact, you get to have the financial reform bill named after you, you get reappointed as Chairman of The Federal Reserve Board, you get reappointed as Chairman of the FDIC (and retire to a D.C. foundation as a banking expert and write a narcissistic book that essentially says “if these boys had only listened to me”), or you retire as the head of OFHEO (Fannie Mae/Freddie Mac’s regulator’s name before it was changed) to a lucrative career with a private equity firm.

I will leave you with the following from Prof. Rajan:

“In structuring reforms, we have to recognize that the only truly safe financial system is a system that does not take risks, that does not finance innovation or growth, that does not help draw people out of poverty, and that gives consumer little choice. It is a system that reinforces the incremental and thus the status quo. In the long run…..settling for the status quo may be the greatest risk of all, for it will make us unable to adapt to meet the coming challenges. We do not want to return to the bad old days and just make banking boring again: it is easy to forget that under a rigidly regulated system, consumer and firms had little choice. We want innovative, dynamic finance, but without excessive risk and the outrageous behavior.”

Excerpts From Fault Line

More Excerpts From Fault Line

“Many People Like Cheap Moralizing…In the West, Intellectuals Like to Blame the Markets”

Mr. Balcerowicz’s views in this recent WSJ interview are roughly the same as mine.

Key Excerpts from Balcerowicz’s WSJ Interview:

“Why do some countries change for the better in a crisis and others don’t? Mr. Balcerowicz puts the ‘popular interpretation of the root causes’ of the crisis high on the list.”

“’There is a lot of intellectual confusion,’ he says. ‘For example, the financial crisis has happened in the financial sector. Therefore the reason for the crisis must be something in the financial sector. Sounds logical, but it’s not. It’s like saying the reason you sneeze through your nose is your nose.’”

“The markets didn’t ‘fail’ but were distorted by bad policies. He mentions ‘too big to fail,’ the Fed’s easy money, Fannie Mae and the housing boom. Those are the hard explanations. ‘Many people like cheap moralizing,’ he says. ‘What a pleasant feeling to condemn greed. It’s popular.’”

“’Generally in the West, intellectuals like to blame the markets,’ he says. ‘There is a widespread belief that crises occur in capitalism mostly. The word crisis is associated with the word capitalism. While if you look in a comparative way, you see that the largest economic and also human catastrophes happen in non-market systems, when there’s a heavy concentration of political power—Stalin, Mao, the Khmer Rouge, many other cases.’”

“’This idea that markets tend to fall into self-perpetuating crises and only wise government can extract the country out of this crisis implicitly assumes that you have two kinds of people. Normal people who are operating in the markets, and better people who work for the state. They deny human nature.’”

Leszek Balcerowicz: The Anti-Bernanke

Leszek Balcerowicz, the man who saved Poland’s economy, on America’s mistakes and the better way to heal from a financial crisis.



As an economic crisis manager, Leszek Balcerowicz has few peers. When communism fell in Europe, he pioneered “shock therapy” to slay hyperinflation and build a free market. In the late 1990s, he jammed a debt ceiling into his country’s constitution, handcuffing future free spenders. When he was central-bank governor from 2001 to 2007, his hard-money policies avoided a credit boom and likely bust.

Poland was the only country in the European Union to avoid recession in 2009 and has been the fastest-growing EU economy since. Mr. Balcerowicz dwells little on this achievement. He sounds too busy in “battle”—his word—against bad policy.

“Most problems are the result of bad politics,” he says. “In a democracy, you have lots of pressure groups to expand the state for reasons of money, ideology, etc. Even if they are angels in the government, which is not the case, if there is not a counterbalance in the form of proponents of limited government, then there will be a shift toward more statism and ultimately into stagnation and crisis.”

Looking around the world, there is no shortage of questionable policies. A series of bailouts for Greece and others has saved the euro, but who knows for how long. EU leaders closed their summit in Brussels on Friday by deferring hard decisions on entrenching fiscal discipline and pro-growth policies. Across the Atlantic, Washington looks no closer to a “fiscal cliff” deal. And the Federal Reserve on Wednesday made a fourth foray into “quantitative easing” to keep real interest rates low by buying bonds and printing money.

As a former central banker, Mr. Balcerowicz struggles to find the appropriate word for Fed Chairman Ben Bernanke’s latest invention: “Unprecedented,” “a complete anathema,” “more uncharted waters.” He says such “unconventional” measures trap economies in an unvirtuous cycle. Bankers expect lower interest rates to spur growth. When that fails, as in Japan, they have no choice but to stick with easing.

“While the benefits of non-conventional [monetary] policies are short lived, the costs grow with time,” he says. “The longer you practice these sorts of policies, the more difficult it is to exit it. Japan is trapped.” Anemic Japan is the prime example, but now the U.S., Britain and potentially the European Central Bank are on the same road.

If he were in Mr. Bernanke’s shoes, Mr. Balcerowicz says he’d rethink the link between easy money and economic growth. Over time, he says, lower interest rates and money printing presses harm the economy—though not necessarily or primarily through higher inflation.

First, Bernanke-style policies “weaken incentives for politicians to pursue structural reforms, including fiscal reforms,” he says. “They can maintain large deficits at low current rates.” It indulges the preference of many Western politicians for stimulus spending. It means they don’t have to grapple as seriously with difficult choices, say, on Medicare.

Another unappreciated consequence of easy money, according to Mr. Balcerowicz, is the easing of pressure on the private economy to restructure. With low interest rates, large companies “can just refinance their loans,” he says. Banks are happy to go along. Adjustments are delayed, markets distorted.

By his reading, the increasingly politicized Fed has in turn warped America’s political discourse. The Lehman collapse did help clean up the financial sector, but not the government. Mr. Balcerowicz marvels that federal spending is still much higher than before the crisis, which isn’t the case in Europe. “The greatest neglect in the U.S. is fiscal,” he says. The dollar lets the U.S. “get a lot of cheap financing to finance bad policies,” which is “dangerous to the world and perhaps dangerous to the U.S.”

The Fed model is spreading. Earlier this fall, the European Central Bank announced an equally unprecedented plan to buy the bonds of distressed euro-zone countries. The bank, in essence, said it was willing to print any amount of euros to save the single currency.

Mr. Balcerowicz sides with the head of Germany’s Bundesbank, the sole dissenter on the ECB board to the bond-buying scheme. He says it violates EU treaties. “And second, when the Fed is printing money, it is not buying bonds of distressed states like California—it’s more general, it’s spreading it,” he says. “The ECB is engaging in regional policy. I don’t think you can justify this.”

“So they know better,” says Mr. Balcerowicz, about the latest fads in central banking. “Risk premiums are too high—according to them! They are above the judgments of the markets. I remember this from socialism: ‘We know better!'”

Mr. Balcerowicz, who is 65, was raised in a state-planned Poland. He got a doctorate in economics, worked briefly at the Communist Party’s Institute of Marxism-Leninism, and advised the Solidarity trade union before the imposition of martial law in 1981. He came to prominence in 1989 as the father of the “Balcerowicz Plan.” Overnight, prices were freed, subsidies were slashed and the zloty currency was made convertible. It was harsh medicine, but the Polish economy recovered faster than more gradual reformers in the old Soviet bloc.

Shock or no, Mr. Balcerowicz remains adamant that fixes are best implemented as quickly as possible. Europe’s PIGS—Portugal, Italy, Greece, Spain—moved slowly. By contrast, Mr. Balcerowicz offers the BELLs: Bulgaria, Estonia, Latvia and Lithuania.

These EU countries went through a credit boom-bust after 2009. Their economies tanked, Latvia’s alone by nearly 20% that year. Denied EU bailouts, these governments were forced to adopt harsher measures than Greece. Public spending was slashed, including for government salaries. The adjustment hurt but recovery came by 2010. The BELL GDP growth curves are V-shaped. The PIGS decline was less steep, but prolonged and worse over time.

The systemic changes in the BELLs took a while to work, yet Mr. Balcerowicz says the radical approach has another, short-run benefit. He calls it the “confidence effect.” When markets saw governments implement the reforms, their borrowing costs dropped fast, while the yields for the PIGS kept rising.

Greece focused on raising taxes, putting off expenditure cuts. They got it backward, says Mr. Balcerowicz. “If you reduce through reform current spending, which is too excessive, you are far more likely to be successful with fiscal consolidation than if you increase taxes, which are already too high.”

He adds: “Somehow the impression for many people is that increasing taxes is correct and reducing spending is incorrect. It is ideologically loaded.” This applies in Greece, most of Europe and the current debate in the U.S.

During his various stints in government in Poland, the name Balcerowicz was often a curse word. In the 1990s, he was twice deputy prime minister and led the Freedom Union party. As a pol, his cool and abrasive style won him little love and cost him votes, even as his policies worked. At the central bank, he took lots of political heat for his tight monetary policy and wasn’t asked to stay on after his term ended in 2007.

Mr. Balcerowicz admits he was an easy scapegoat. “People tend to personalize reforms. I don’t mind. I take responsibility for the reforms I launched.” He says he “understands politicians when they give in [on reform], but I do not accept it.” It’s up to the proponents of the free market to fight for their ideas and make politicians aware of the electoral cost of not reforming.

On bailouts, Mr. Balcerowicz strikes an agnostic note. They can mitigate a crisis—as long as they don’t reduce the pressure to reform. The BELL vs. PIGS comparison suggests the bailouts have slowed reform, but he notes recent movement in southern Europe to deregulate labor markets, privatize and cut spending—in other words, serious steps to spur growth.

“Once the euro has been created,” Mr. Balcerowicz says, “it’s worth keeping it.” The single currency is no different than the gold standard, “which worked pretty well,” he says. In both cases, member countries have to keep their budget deficits in check and labor markets flexible to stay competitive. Which makes him cautiously optimistic on the euro.

“It’s important to remember that six, eight, 10 years ago Germany was like Italy, and it reformed,” he says. Before Berlin pushed through an overhaul of the welfare state, Germany was called the “sick man of Europe.” “There are no European solutions for the Italians’ problem. But there are Italian solutions. Not bailouts, but better policies.”

Why do some countries change for the better in a crisis and others don’t? Mr. Balcerowicz puts the “popular interpretation of the root causes” of the crisis high on the list.

“There is a lot of intellectual confusion,” he says. “For example, the financial crisis has happened in the financial sector. Therefore the reason for the crisis must be something in the financial sector. Sounds logical, but it’s not. It’s like saying the reason you sneeze through your nose is your nose.”

The markets didn’t “fail” but were distorted by bad policies. He mentions “too big to fail,” the Fed’s easy money, Fannie Mae FNMA -1.41% and the housing boom. Those are the hard explanations. “Many people like cheap moralizing,” he says. “What a pleasant feeling to condemn greed. It’s popular.”

“Generally in the West, intellectuals like to blame the markets,” he says. “There is a widespread belief that crises occur in capitalism mostly. The word crisis is associated with the word capitalism. While if you look in a comparative way, you see that the largest economic and also human catastrophes happen in non-market systems, when there’s a heavy concentration of political power—Stalin, Mao, the Khmer Rouge, many other cases.”

Going back to the 19th century, industrializing economies recovered best after a crisis with no or limited intervention. Yet Keynesians continue to insist that only the state can compensate for the flaws of the market, he says.

“This idea that markets tend to fall into self-perpetuating crises and only wise government can extract the country out of this crisis implicitly assumes that you have two kinds of people. Normal people who are operating in the markets, and better people who work for the state. They deny human nature.”

Gathering the essays for his new collection, “Discovering Freedom,” Mr. Balcerowicz realized that “you don’t need to read modern economists” to understand what’s happening today. Hume, Smith, Hayek and Tocqueville are all there. He loves Madison’s “angels” quote: “If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary.”

This Polish academic sounds like he might not feel out of place at a U.S. tea party rally. He takes to the idea.

“Their essence is very good. Liberal media try to demonize them, but their instincts are good. Limited government. This is classic. This is James Madison. This is ultra-American! Absolutely.”

Mr. Kaminski is a member of the Journal’s editorial board.

A version of this article appeared December 15, 2012, on page A15 in the U.S. edition of The Wall Street Journal, with the headline: The Anti-Bernanke.

FDIC Settlement Documents and M. Perry’s Comments Re. Settlement

Attached below you will find the key settlement documents (and my comments) related to the FDIC-R’s meritless, $600 million, civil negligence lawsuit against me.

Simply stated, I agreed to settle the FDIC-R’s lawsuit for the following reasons:

  1. I continue to “DENY” the FDIC-R’s allegations against me in the formal settlement agreement. This was important to me, because these allegations were not true.
  2. The settlement documents state clearly that the FDIC was not alleging that I caused IndyMac Bank to fail and/or the FDIC insurance fund to suffer a loss. This was important to me. I did not cause IndyMac Bank to fail or the insurance fund to suffer a loss.
  3. We had run out of insurance to cover legal defense costs, because the D&O insurers had improperly denied me (and others) coverage for various matters under a second “tower”/year of insurance. Unbelievably, more than four years after IndyMac Bank was seized by the FDIC, no factual discovery has yet occurred in this matter. As a result, a trial likely would have been six months to a year away and would have cost me millions more to defend against and untold hours of my time.
  4. The federal judge in this matter had ruled that because IndyMac Bank was a California-based firm, my judgments as CEO were not protected by the common law Business Judgment Rule, as they are in nearly every other state in the union, and therefore the FDIC-R could sue me for “ordinary negligence” (and the 9th Circuit refused to hear our appeal of this issue until after trial). Because of these rulings, it was my view that a jury’s judgments in this case could inappropriately be infected by hindsight and/or anti-banker sentiment; so there was a risk that I might not obtain a fair trial and/or a proper decision (I believe strongly that the recent home builder division management jury verdict was an improper decision).
  5. While I and my family had to personally pay $1 million to the FDIC-R to settle this meritless case, I am not financially responsible if the FDIC-R is unable to collect any or all of the remaining $11 million from the D&0 insurance carriers (a real risk given the D&O insurers’ actions to-date and related insurance litigation).

To obtain this settlement, the FDIC used its awesome government power to force me to accept a separate enforcement action that prohibits me from participating in the affairs of banks (my long-time profession). The bottom line is that the FDIC inappropriately leveraged the FDIC-R’s meritless $600 million civil lawsuit against me to obtain this banking prohibition.

At one point, we asked the FDIC to just settle the FDIC-R’s lawsuit (the FDIC-R, as a receiver of IndyMac Bank, has a fiduciary duty to settle to for the maximum amount it can obtain to minimize losses for the deposit insurance fund) and to sue me in a separate enforcement action, as required by banking law, in order to try and obtain a banking prohibition. The FDIC refused. Why? Because the federal law that allows the FDIC to obtain an enforcement action/”banking prohibition” requires that the FDIC prove that I “engaged or participated in unsafe and unsound banking practices” and that “such practices demonstrated a willful and/or continuing disregard for the safety and/or soundness of the bank”; a higher standard of proof than California’s “ordinary negligence”. Also, the five-year statute of limitations for such actions may have expired on November 1, 2012 (the last of the $10 billion in loans in question were funded in October 2007 and transferred to held for investment, and the credit mark-to-market loss was recognized on November 1, 2007; importantly, even after this loss was recognized IndyMac Bank remained well-capitalized at December 31, 2007 because we had prudently raised $676 million in capital in 2007) .

In the FDIC’s prohibition order, whose allegations I “neither admit nor deny”, I think the following excerpt says it all: “The FDIC considered the matter and has reason to believe:”….As I said, four and ½ years have come and gone since IndyMac Bank was seized by the FDIC and yet no factual discovery related to the FDIC-R’s litigation against me has occurred (and no lawsuit seeking an enforcement action against me was ever filed), so no detailed allegations were enumerated in this prohibition order; only a generic listing of phrases like “unsafe and unsound banking practices”. I am also confident that there was no evidence or sworn testimony during their pre-litigation, investigative phase, that would support the FDIC-R’s allegations against me (and much evidence and sworn testimony that would refute them).

The bottom line is that the FDIC used a meritless and frivolous typical plaintiff’s bar civil lawsuit (that cost me millions to defend myself against and where there was some minor yet significant financial risk to me and my family of an incorrect jury verdict) and their awesome government power to force me to accept an enforcement action/”banking prohibition”. I guess they were afraid that some bank might hire me, if left to their own free market decisions? Should branches of our federal government really be allowed to sue individual Americans civilly in this manner and take their assets, defame them and restrict their ability to make a living? I don’t think it is right and I think most American’s would be disturbed to learn how these (nearly unaccountable) bureaucracies within our government operate. In my view, they sure don’t seem to care much about the truth and individual American’s rights and liberties.

M. Perry’s Attorneys’ Press Release Re. FDIC Settlement

M. Perry and FDIC-R Settlement Agreement, Stipulation and Dismissal of Civil Suit

FDIC’s “Order of Prohibition from Further Participation” (barring M. Perry from banking)

M.Perry’s “Consent to FDIC Order of Prohibition from Further Participation”

M. Perry’s Activities Not Prohibited by FDIC Order

IndyMac’s (Credit Quality) Performance as a Loan Originator

Attached you will find the spreadsheet that shows IndyMac’s loan performance by vintage/year, during its entire history as a loan originator, 15 years from 1993 through 2007, as of May 31, 2008 (about a year after the housing bubble had burst, the private MBS market had collapsed, and the financial crisis had been well under way); the latest available date before being seized by the FDIC on July 11, 2008. The 2008 loan originations were not on this report, because they were not a full year’s vintage. (Nearly all of the 2008 originations would have been current as of May 31, 2008, as they on average had only made a few payments by then.)

During this 15-year timeframe, IndyMac originated 1,663,511 mortgage loans, with an original principal balance of $351.3 billion.

Of this amount, $172.8 billion (or 49.2%) remained outstanding as of May 31, 2008. As of this date, $170.5 billion (or 48.5% of original balances) were paid off in full, paid down or sold (as whole loans; where the servicing rights were not retained by IndyMac), and $8.0 billion (or 2.3% of original balances) were cumulatively foreclosed on and sold as REOs over 15+ years.

IndyMac and its securities investors’ (both private MBS investors and Fannie Mae, Freddie Mac, and FHA) cumulative losses over 15+ years were less than 1% (0.72%) through May 31, 2008. That is an average annual loss rate over those years of less than 0.05%.

The lowest vintage for cumulative losses was 2003 with 0.14% and the highest vintage was 2006, with 1.39%, to-date through May 31, 2008. The highest vintage cumulative losses, prior to the unprecedented housing bubble-bust period (2005-2008), was 1999, were cumulative losses were 1.33%, to-date through May 31, 2008.

$6.9 billion (or 2.0% of original balances) remained in foreclosure, as of May 31, 2008. 94% of this amount is related to housing bubble/bust years 2005-2007.

In other words, as of May 31, 2008, and over a 15+ year history (including more than a year of an unprecedented housing bubble-bust, total collapse of the private MBS market, and related financial crisis), roughly 95% of IndyMac’s borrowers had either successfully paid off their loans or were not currently in foreclosure or had never been foreclosed upon. It is an oversimplification, but you could roughly say that this equated to a 95% borrower success rate (and it was a much higher success rate for pre-bubble/bust years 1993-2004), as of May 31, 2008.

While I don’t have access to any data beyond May 31, 2008, I am sure (like all home lenders) IndyMac’s credit quality performance deteriorated substantially as the housing, mortgage, and financial crisis worsened in 2008 and 2009 (especially for the home loans originated in the bubble/bust years of 2005-2008). However, IndyMac’s historical loan performance data always compared more favorably than FHA’s home lending program (as documented in IndyMac’s historical SEC filings) and I believe this data objectively documents that substantially increased future losses were not predictable entering 2007 (based on historical loss trends by vintage) and were caused by an unprecedented housing bubble and bust, not IndyMac’s loan origination practices.

Please Note: Most of the mortgage industry delinquency, foreclosure, and loss statistics I have seen in the press are not correctly analyzed and/or presented. These statistics must be analyzed by vintage/year, because typically newer vintages and growing originations in newer vintages (where delinquencies tend to be lower in normal, non-bubble/bust times) can mask true credit quality performance (like they have at FHA). And these statistics must be compared to total originations (not current loan balances outstanding), because loan prepayments can significantly distort these statistics. By way of a simple example, assume that in Year 1, 100 loans are originated and now it is Year 5 and because rates declined, 90 of the 100 loans paid off (refinanced to a lower rate) and only 10 remain outstanding and assume 2 of these loans are now in foreclosure. That is a 2% “failure rate” in my book based on the origination of 100 loans…..but you might see the press say that 20% of the loans from Year 1 are currently in foreclosure. Clearly, the correct figure is 2%. Finally, because of the wide press coverage of the mortgage and financial crisis, including “underwater” mortgages and various government programs that mostly benefited delinquent borrowers (and even worse in IndyMac’s particular case, because borrower’s were aware of IndyMac’s failure and the buyer of IndyMac’s assets received a substantial discount and loss protection from the FDIC and could therefore sell or restructure borrower loans at a loss to the original UPB, but still a strong profit to them), borrowers’ and lenders’ historical behaviors changed significantly and, as a result, delinquency and loss trends were exacerbated to unprecedented levels.

IndyMac Loan Performance by Vintage (Original Report)

IndyMac Loan Performance by Vintage (Reformatted for Readability Only)

IndyMac Bank OMG Not TBTF

Below you will find a link to a (unedited) paper that I wrote entitled “IndyMac Bank OMG Not TBTF” on July 27, 2008, a few weeks after IndyMac Bank’s failure.

It has not seen the light of day until now, because my attorneys advised me not to publish it or say anything publicly given that I would soon be the target of government investigations and litigation. Now that I have settled the FDIC’s civil matter against me, I have decided to make this paper available to the public.

It is important to note that this paper was written before the apex of the 2008 financial crisis, where many larger financial institutions and even non-financial institutions (like Lehman, Fannie Mae, Freddie Mac, Citi, AIG, GM, Chrysler, the money market fund industry, and many others) failed or likely would have failed if they had not been bailed out by the government; through TARP, government guarantees and/or other measures. So, this paper does not have the benefit of over four plus years of hindsight judgment regarding the global financial and economic crisis. Interestingly, in this paper I briefly describe a TARP-like program and its economic rationale for the FDIC (deposit insurance fund) before TARP was conceived.

IndyMac Bank OMG Not TBTF

Informal Mortgage Industry Talk By Michael Perry

Attached below is the text of an informal talk that I gave at a mortgage industry dinner in San Francisco on November 15, 2012.

Along with Statement 32; the paper I wrote on July 27, 2008, this informal talk helps give some context to the decisions IndyMac made, to IndyMac’s failure, and to the financial crisis generally.

Please note that this talk was given before I settled the FDIC’s $600 million civil lawsuit against me.

Informal Mortgage Industry Talk by Michael Perry