In 1933, given bank failures en masse from the 1920s to the early 1930s, the U.S. government created America’s Federal Deposit Insurance Corporation (FDIC).
The FDIC was given fiduciary responsibility as a watchdog over America’s banks and promises to pay $250,000 to each depositor of a failed FDIC insured bank.
“We do not want and will not have another epidemic of bank failures,” said former President Franklin D. Roosevelt on March 12, 1933.
To underline President Roosevelt’s words, the FDIC said on its website that it “preserves and promotes public confidence in the U.S. financial system … by identifying, monitoring and addressing risks to the deposit insurance funds; and by limiting the effect on the economy and the financial system when a bank or thrift institution fails.”
Searching for Investors
On Sept. 7, “the Federal Deposit Insurance Corporation (FDIC) announced the launch of a new program to encourage small investors and asset managers to partner with larger investors to participate in the FDIC’s structured transaction sales for loans and other assets from failed banks,” according to a FDIC press release.
In the search for innovative ways to rid itself of failed banks under its receivership and reduce losses, the FDIC is calling on small investors or asset managers, but especially minority and women-owned firms, to join with larger-sized investors and jointly buy the assets of failed banks.
By joining investors with limited funds with those who are wealthier, this program, called the Investor Match Program, gives smaller investors a chance to play with those in the bigger league. At the same time, it gives the FDIC a larger pool of investors willing to take failed banks off its hands.
“The Investor Match Program opens the door to investors who otherwise would not have the resources necessary to participate in such sales,” according to the FDIC press release.
Snapshot of FDIC Inner Workings
“The First National Bank of Florida [FNB], Milton, Florida, was closed today by the Office of the Comptroller of the Currency, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver,” according to a Sept. 9 FDIC press release.
Although the total cost of the FNB failure to FDIC’s Deposit Insurance Fund (DIF) amounts to $46.9 million, the unloading of FNB to CharterBank, based in West Point, Ga., was considered the least costly alternative.
“Customers can be confident that their deposits are safe and readily available. CharterBank is firmly rooted in small town banking and has a rich history of serving and bringing out the best from its communities since its founding in 1954,” said Robert L. Johnson, CEO at Charter Financial, CharterBank’s parent company, in a Sept. 9 press release.
In the event of bankruptcy, depositors of failed banks receive up to $250,000 out of the DIF, the standard maximum since 2010. The DIF’s sole purpose is to pay depositors the aforementioned amount in case of bank failure.
The DIF is intended to prevent runs on banks by panicked depositors who fear an imminent bankruptcy and subsequently the loss of all their deposits, as it happened in the 1930s.
Funding for the DIF comes from insurance premiums paid by financial institutions, as well as the interest received by investing all unused DIF funds. The fund may borrow from the U.S. Department of the Treasury, the Federal Financing Bank (FFB), Federal Home Loan Banks, and its insured members.
“The FDIC has borrowing authority of $100 billion from the Treasury and a Note Purchase Agreement with the FFB not to exceed $100 billion to enhance the DIF’s ability to fund deposit insurance obligations,” according to the FDIC 2010 annual report.
In 2010, the DIF received $13.5 billion in insurance premiums from 7,657 members, compared to $24.7 billion in earnings in 2009. The fund also received $13.6 billion in dividends and other payments in 2010.
With 157 bank failures in 2010, the DIF shrank to $46.2 billion, as it needed $28.8 billion to fund the 2010 bank failures.
In 2010, the DIF member pool shrank by 4.43 percent from the 8,012 members in 2009 and 7.8 percent between 2008 and 2010, given the bank failures.
Bank failures appear to have leveled off, as by Sept. 9, 71 banks were taken into receivership by the FDIC in 2011 compared to 118 banks in 2010.
Since 2000, a total of 419 banks have failed, with close to 89 percent having failed since 2009. There were no bank failures in 2005 and only two in 2000, three in 2007 and 2003, four in 2001 and 2004, 11 in 2002, and 25 in 2008.
By June 30, there were a total of 7,513 commercial bank and savings institution members in the DIF system. About 11.5 percent or 865 banks, with total assets of $372 billion, were considered troubled institutions.
The total DIF fund balance amounted to negative $7.4 billion in 2010 versus negative $20.9 million at year-end 2009, as liabilities exceeded the revenue during both years.
“During 2009 and 2010, losses to the DIF were high. As of December 31, 2010, both the fund balance and the reserve ratio were negative after reserving for probable losses for anticipated bank failures,” according to the FDIC’s 2010 annual report.
Going After Insiders and Outsiders of Failed Banks
“As receiver for a failed financial institution, the FDIC may sue professionals who played a role in the failure of the institution in order to maximize recoveries. … Professionals may be sued for either gross or simple negligence,” according to the FDIC website.
The FDIC does not have to limit itself to taking on bank insiders; it can also go after appraisers, brokers, insurance carriers, and anyone else who had a hand in the respective bank’s failure.
However, “lawsuits brought by the FDIC against former directors and officers of failed banks are instituted on the basis of detailed investigations conducted by the FDIC. Suits are not brought lightly or in haste,” states the FDIC on its website.
The failed bank investigation generally takes about one and a half years and before filing a lawsuit, the FDIC tries to reach a settlement.
Between 1985 and 1992, the FDIC took court action against employees of 24 percent of all failed banks.
Within a 23-year span and up to 2009, the FDIC hauled in $6.2 billion, versus a cost of $1.5 billion, in going after those neglecting their fiduciary responsibility that comes with being involved in the banking sector.
During the recent economic meltdown, the FIDC went after 266 individuals—109 persons in 2010 and 157 since the beginning of 2011. Charges included attorney and appraiser malpractice as well as mortgage fraud, involving 30 failed banks with $6.8 billion charged for losses.
“Professional liability suits are only pursued if they are both meritorious and cost-effective. Before seeking recoveries from professionals, the FDIC conducts a thorough investigation into the causes of the failure,” according an entry on the FDIC website.
Taking the Court Route
On Aug. 22, the FDIC filed a lawsuit against Silverton Bank of Georgia, one of the largest failed banks in that state, seeking to recover $71 million for losses due to fiduciary irresponsibility.
Among the defendants are 16 former directors and three former officers, as well as the Chubb Group of Insurance Companies and the Westchester Fire Insurance Company.
In its court filings, the FDIC accused the bank of disregarding the economic downturn in the real estate market beginning in 2007 in their quest for accelerated growth of the bank.
Most troubling to the FDIC was that the failed bank’s board of directors consisted of seasoned CEOs and presidents of Georgia’s community banks.
“This case presents a text book example of officers and directors of a financial institution being asleep at the wheel and robotically voting for approval of transactions without exercising any business judgment in doing so,” accuses the FDIC complaint.
Lloyd’s of London Refusing to Pay
Within days of filing a lawsuit, the FDIC filed a Joint Motion for Entry of Judgment at the United States District Court District of Arizona, settling with defendants Gary A. Dorris and Philip A. Lamb, both former executives of the failed First National Bank of Nevada, for “breaches of fiduciary duty and acts of negligence and gross negligence.” Both agreed to settle for $20 million each, without admitting guilt.
The two defendants were insured by the Lloyd’s of London Catlin Syndicate 2003 (Catlin), which denied any coverage, being part of any lawsuit, and providing funds for the defense. Both defendants gave the FDIC the right to go after Catlin.
Catlin, with its refusal to be involved in any settlement, “cannot intervene in this lawsuit to challenge the terms of the stipulated judgment,” according to the court filings, which can be found on the D&O Diary website, owned by the OakBridge Insurance Services of Ohio.
