THE WARNINGS THE FDIC IGNORED
As is more fully described in "Follow the Money: What Happened to PSFS and Why", in late 1992, the shoe was on the other regulatory foot, so to speak: The Philadelphia Savings Fund Society ("PSFS"), having been founded in 1816 and at the time still the nation's oldest savings bank, had sold, in order to comply with heightened FDIC capital requirements which were later found to be unlawful, most of ts best assets so as to shrink from the $25 billion institution it had been just a few years earlier. By then reduced to $3.5 billion in size, PSFS remained the premier savings bank in Philadelphia and was led by Roger Hillas, the dean of Philadelphia bankers to whom even the FDIC's own examiners gave the very highest marks. PSFS (also known by the name Meritor Savings Bank, its parent) had an extremely loyal customer base, with numerous generations of Philadelphians having deposited their savings there since the presidency of James Monroe. Although, like most other savings banks during what came to be known as the "S&L crisis", PSFS was losing money, it still had nearly $400 million in tangible equity and reserves and had a branch and depositor network that was the envy of its competitors.
The FDIC, on the other hand, was the financially troubled insurer of PSFS's deposits. Just a year earlier, it had been declared technically insolvent by the General Accounting Office ("GAO"). For the first time since its founding in 1933, the FDIC -- a self-supporting agency which had up until then boasted of never having had to use a dime of government money -- was forced to go to Congress hat-in-hand for a bailout. During 1992, the FDIC had aggressively worked its deficit down from $7 billion to just under $1 billion. But the end of the year was fast approaching, and officials at the FDIC -- unused to the degree of Congressional scrutiny which comes with the receipt of federal aid -- were determined to close the gap by December 31. (See chart showing history of FDIC's net worth 1933-2006).
Despite PSFS/Meritor's attractive franchise value, the FDIC had been carrying an $864 million reserve on its books as part of a larger reserve it had taken in 1991 at the insistence of the GAO. As was brought out at the subsequent trial of Frank P. Slattery v. the United States, recovering that reserve became a very attractive option for the FDIC in the waning days of 1992, but one that could only be accomplished were the bank to be seized and closed at a profit -- and by mid-December at the latest. (In the meantime, a number of other S&Ls in similar or worse shape than PSFS were allowed to remain open. None, however, had reserves anywhere near the magnitude of that which the FDIC could recover by seizing Meritor. All survived and prospered in the ensuing years; as an example, the nearby Wilmington Savings Fund Society ("WSFS"), whose stock was then trading in the $1.50 - $2.00 per share range, now sells at over $60.
The rest, of course, is history. Late in the afternoon of December 11, 1992, the Pennsylvania Secretary of Banking, Sarah W. Hargrove, acting, as the Court of Claims later held, at the behest of the FDIC, closed Meritor, whereupon the FDIC immediately sold the PSFS branch and depositor network to its arch-competitor, Mellon Bank. (Some years later, Mellon sold the PSFS branches -- at yet another substantial profit -- to Citizens Bank). The FDIC also announced that the Meritor/PSFS takedown would be one of the very few times in its 60-year history that it had been able to close a bank without having to make good on even a penny of its insurance obligations. Accordingly, the $864 million reserve on the FDIC's books was eliminated, thus wiping out virtually all of what remained of the FDIC's deficit. Six months later, Frank P. Slattery, Jr., a former member of the Meritor board of directors, filed suit against the FDIC for breach of contract on behalf of all Meritor shareholders. Almost 10 years later, in August of 2002, the U.S. Court of Federal Claims ruled that the seizure of Meritor/PSFS was illegal and in February of 2006 -- nearly 14 years after PSFS was closed -- the court awarded $371.7 million in damages. Both sides are expected to appeal.
Damages to be paid by the FDIC - not the taxpayer
Unlike all other supervisory goodwill (i.e., "Winstar") cases -- for which Congress some years ago provided a blanket appropriation to pay damage awards with taxpayer money -- it appears from government court filings that any damages for Meritor's wrongful seizure will ultimately come out of the FDIC's own budget. This would appear to be because, unlike any of the other Winstar cases, the Court of Claims ruled that Meritor's demise was not caused by Congress' enactment of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 -- ("FIRREA"), but instead by the FDIC's own independent business decisions. As a matter of fact, the court found that the FDIC had improperly breached the terms of its 1982 contract with Meritor long before FIRREA came into being. So, ironically, by seizing Meritor in order to re-capture what basically was an artificial reserve, the FDIC appears to have ended up exposing itself to what could very well be a real economic loss of $372 million or more.
But it didn't have to be. As shown by the subsequent performance of WSFS and the other S&Ls which were left alone, had the FDIC simply kept its word, there would have been no cost to itself. However, FDIC management at the time appears to have fallen victim to a malady which publicly-traded companies often suffer: pursuing short-term earnings gains at the expense of doing what is best in the long run. Indeed, the FDIC could have left Meritor alone -- and most likely would have been able to substantially eliminate, if not fully recover, its reserve in fairly short order due to the rapidly-improving conditions which were occuring in the S&L industry at the time. However, someone at the FDIC apparently wanted the $864 million off the books before the year ended three weeks later. While seizing Meritor and immediately selling most of its assets at a hefty premium effectively balanced the FDIC's books for 1992, it left the problem of paying whatever damages might later be assessed to whomever was running the agency when that happened. (It also allowed a number of key FDIC employees to collect substantial performance bonuses for 1992).
Warnings are ignored
And it is not as if the FDIC was not warned that what it was doing was wrong -- and could prove costly in the future. In the weeks and days leading up to the seizure, Andrew C. "Skip" Hove, the chairman of the FDIC, received numerous communications from, among others, Gary Hindes, who had chaired a committee of Meritor bondholders which had earlier agreed to swap bond debt for 38 percent of the bank's stock in order to assist Meritor in complying with the FDIC's heightened capital requirements, and Wilbur L. Ross, Jr., then an investment banker who had served as financial advisor to the bondholder committee. All of their letters, faxes and phone calls were ignored. Ironically, it was not until after Meritor had already been seized that Mr. Hove, in a letter dated December 11, 1992, responded: "all communications we may have with Meritor in our role as insurer and primary federal regulator will be directly with that institution. We are not at liberty to discuss such matters with individual creditors, shareholders, depositors, nor the general public." (Read the letters).
Even a fellow regulator had concerns
It is also important to note that at the time of Meritor's seizure, the FDIC was largely being run by the staff. Due to the death of its former chairman, as well as vacancies created by the recent change in administrations, Stephen R. Steinbrink, the acting comptroller of the currency, had to be deputized to serve on the FDIC board in order for there to be a quorum for the various meetings which culminated in the decision to close Meritor and sell PSFS. Indeed, as was evidenced at trial, Mr. Steinbrink, at the December 9, 1992 board meeting, was clearly taken aback by what the FDIC was proposing to do. According to a recorded transcript of the meeting presented in evidence at trial, he questioned "why would we issue an 8(a) today?, referring to the proposed issuance of a formal Notice of Intent to Terminate Deposit Insurance. "I mean," he continued, "there's got to be some reason that's not in the case (memorandum)". In response, Paul G. Fritts, executive director of the FDIC for supervision and resolutions, told Mr. Steinbrink that sending the Notice would give the Pennsylvania Secretary of Banking the reason she needed to immediately close Meritor. "I was hoping to avoid saying that, but you've asked me," Fritts added. Quoting from one of the plaintiff's liability trial briefs (which, again, quotes from a verbatim transcript), "Director Steinbrink repeats his concern that the section 8(a) procedures are being misused: Dir. Steinbrink: 'Does this -- does this -- I mean, I don't know if I even ought to ask this kind of question on the record. I mean, does this -- this appears, if I were sitting and looking at this in my own agency, that this is a CY - CYA 8(a)'." (Ed. note: After an eight-month trial on the issue of liability, the existence of these transcripts did not come to light until just three days prior to closing arguments, notwithstanding the FDIC's obligation to have disclosed their existence to plaintiff's counsel during discovery many years earlier. For further details, see "FDIC: Cover-up or Screw-up?")
Bonuses for its employees; more interest income for the FDIC
But do not cry too much for the FDIC -- it is making money all the while, for the FDIC's assets are all invested in interest-bearing U.S. government securities. On top of having had the free use of Meritor's money for 14 years now, the FDIC continues to earn interest for its own account while the Meritor estate -- still open and functioning under the control and administration of the very same FDIC which illegally closed the bank -- earns none. A simple mathematical computation would indicate that even if the FDIC is finally forced to pay out $372 million in damages, it has most likely already earned at least that amount in interest over the past 14 years. And despite convincing evidence to the contrary (and two adverse court judgments against it), to this day, the FDIC refuses to admit that it did anything wrong. Though facing the very real possibility that it will have to pay out $372 million in damages, to our knowledge, not a single policy at the FDIC has been changed nor has a single person been held accountable for the wrongful seizure of America's first and oldest savings bank. Mr. Hove has since retired to Nebraska -- and Mr. Fritts and many other career FDIC employees who collected bonuses for what they did to Meritor have since retired and are collecting FDIC pensions.
TO READ THE 1992 CORRESPONDENCE, CLICK ON THE ITEMS BELOW: