In the absence of a serious scandal, there is a ritual when the administration appoints a chairman to succeed its prior appointee. The outgoing chairman praises his successor at the ceremony where the new chairman takes the oath of office. The successor praises his predecessor’s accomplishments and speaks of how they have made his own task much easier. The president lauds both of his appointees. But President Reagan did not invite Gray to the podium or praise him, and Wall did not mention him in the speech he made at the ceremony (Binstein and Bowden 1993, 298). The administration and Wall signaled a complete break with Gray’s policies, not continuity. They also signaled the severity of their displeasure with Gray. The process inflicted a last bit of humiliation on him.
Wall sincerely believed that Gray’s policies were disastrous for the Bank Board, the industry, and Gray. Mayer (1990, 242) sums it up: “For Danny Wall, Ed Gray was the enemy.” Wall knew that Gray’s status as the most unpopular regulator in the nation offered him an opportunity to gain by making clear his break from Gray’s policies. Initially, Wall played this very well. He picked a symbolic change that was sure to receive favorable publicity. Gray had placed an unarmed guard at the door leading to the portion of the headquarters in which the Bank Board members’ offices were located. Wall removed him and ensured that the act gained wide publicity, “spun” as a break with Gray’s legacy of distrust and paranoia. It earned him prominent, glowing stories in the Washington Post and the trade press.
Wall believed that Gray had far too many officials reporting to him (over fifteen). He created a new layer of “executive directors,” managers above the level of office director, to reduce the number of direct reports. Wall did not retain anyone involved in making policy during Gray’s term as a direct report. The president also appointed Roger Martin to the Bank Board. He was a real estate developer, a Republican donor, and a friend of one of Keating’s closest allies.
Wall appointed Darrell Dochow as executive director of the Office of Regulatory Policy, Oversight and Supervision (ORPOS). Dochow had spent most of his career at the Office of the Comptroller of the Currency (OCC) until being recruited to be the director of agency functions at the FHLB-Seattle. His specialty was electronic data processing. Despite the name “Policy” in the title, ORPOS did not take a lead role in setting regulatory policy under either Gray or Wall.
Wall recruited Jordan Luke to serve as his executive director for legal functions. Luke was a commercial lawyer. He promptly barred bringing any new suits against accounting firms. Wall and Luke were not close. Wall had a dim view of lawyers (a common view). Wall generally did not seek to manage the legal function. Luke saw his role primarily as that of a technician providing support to policy makers.
Wall understandably considered himself an expert in congressional relations. He brought Karl Hoyle, a PR specialist, to the agency as executive director for congressional relations and PR. Hoyle was close to Wall, but generally was not involved in policy.
Jim Boland, Wall’s chief of staff, was his closest advisor at the agency. Boland was a congressional staffer and friend. The other individuals that influenced Wall’s policies were his closest friend, Rick Hohlt, and to a lesser extent “Snake” Freeman. Both men were senior league lobbyists.
Roy Green, president of the FHLB-Dallas, retired soon after Wall became chairman. Wall chose George Barclay, a senior official on the banking side of the FHLB-Dallas, to replace him. Barclay had no experience as a supervisor. Barclay and Wall then forced Selby to resign (Mayer 1990, 211).
Wall advanced two interrelated policy changes. He dramatically adopted forbearance, and he wanted the GAO to declare the FSLIC solvent. Both of Wall’s top priorities focused on changing the behavior of government, not the industry. Like President Reagan, Wall believed that government was the problem. He believed that Gray and his key appointees, working together with the GAO, had created an unnecessary S&L crisis.
Wall believed in forbearance. He implicitly endorsed the industry’s primary charge against Gray by pledging that he would usher in a new approach that would never “regulate to the lowest common denominator.” He ended reregulation.
Recall his support for removing Scott Schultz and for preventing any suit against Craig Hall; recall also the statement he made to Speaker Wright soon after becoming chairman:
We did have a clown in the Craig Hall thing. He would have brought down the daisy chain [of S&Ls in Texas]. (Barry 1989, 218)
His statement to Wright was in private, but Wall publicly stated, “By definition, we don’t shut down Texas institutions” (Mayer 1990, 235). Takeovers of Texas S&Ls soon slowed to a trickle. Growth rates of high fliers in the Southwest, particularly in Texas, increased sharply as enforcement actions against those who broke the rules fell markedly and Jordan Luke stated publicly that he hoped that the Bank Board would continue to decrease the number of enforcement actions in 1988 (U.S. House Banking Committee 1989, 2:599; 5:307).
Wall embraced forbearance in several other ways. Gray had proposed a rule that would have ended the last vestiges of creative RAP. The Bank Board delayed that rule for over a year (U.S. House Banking Committee 1989, 2:321).
The FSLIC recap bill, as passed, required changes in the agency’s net-worth requirements that would allow S&Ls to overstate their true net worth. The Bank Board adopted a rule with statutory forbearance provisions that went well beyond those required by the new law.
It appeared to me that this might have been unintentional or that the drafters had not understood the supervisory implications, so I asked Jim Barth, the new chief economist, to find out how many S&Ls would fail their net-worth requirement under the statute and under the proposed rule. Barth ran the numbers and found that a material number of S&Ls that would have failed their net-worth requirement under the statutory standard would meet it under the proposed rule. Barth understood the significance of the data. The Bank Board had far greater supervisory powers over S&Ls that failed their net-worth requirements. The proposed rule would reduce the agency’s power to prevent abuses at the S&Ls that posed the greatest risk. He told his superiors at the Bank Board what he had found and, being an honorable scholar, gave me credit for sparking the research.
Wall was unhappy that Barth had performed this analysis. Richard Haas, the executive director whom Barth reported to, called him into his office and questioned Barth sharply about it. Then Haas questioned him about why I had wanted the analysis done. Barth responded that the data showed why I wanted the analysis: we were unnecessarily and sharply limiting our supervisory powers over S&Ls we badly needed to get under control. Haas made clear to him that he was never to do a study again at my suggestion, at least not without his bosses’ express approval. Wall was deeply upset that this study had been done, even though it was never released to the public and remained a secret. Barth told me how he had been called on the carpet, warned me about how Wall viewed me, and explained why he could not be seen as being close to me.
The new statute also required the Bank Board to revise the classification-of-assets rule; it now had to comply with the forbearance provisions barring the agency from requiring loss recognition greater than that required under GAAP. This forbearance clause was the gravest threat to our supervisory powers, and the inclusion of the “except for supervisory purposes” phrase had been our top priority. The preceding chapter explained how Representative Leach and Senator Gramm led the successful effort to include our language. Wall decided not to take advantage of the supervisory exception in the revised rule. As a result, the rule resulted in much greater forbearance than that required by the statute.
Wall’s highest priority was to change the FSLIC’s internal accounting so that it could report its own solvency. Wall believed that the FSLIC’s acknowledgment of its insolvency was responsible for the industry’s difficulties (as opposed to the industry’s problems having caused the FSLIC’s insolvency). He believed that the FSLIC’s insolvency caused every S&L to pay substantially higher interest rates in order to attract deposits. Wall thought that the public would believe the FSLIC if it declared itself solvent and if the GAO “blessed” that claim.
Wall was incredulous that Gray had acknowledged that the FSLIC was insolvent. He complained years later in an interview:
Ed Gray sat at this table with Charles Bowsher [the comptroller general], and they had a bidding war about how big the losses were at the FSLIC. And Gray’s numbers were bigger than Bowsher’s. To the visitor, that made sense: Gray knew more about it than Bowsher. To Wall it was the essence of disloyalty. As late as the summer of 1987 he was insisting to Bowsher that “you only have a $2 billion problem here.” (Mayer 1990, 244; emphasis in original)
The FSLIC’s enormous contingent liabilities (insurance obligations to depositors of hopelessly insolvent S&Ls) caused the FSLIC and the GAO to recognize that the FSLIC was insolvent. Wall’s problem was that there were even more insolvent S&Ls—and they were far more deeply insolvent—in fiscal year (FY) 1987 than there had been in FY 1986 when Gray recognized that the FSLIC was insolvent. The FSLIC’s contingent liabilities were therefore larger, and the FSLIC was more insolvent, in FY 1987 than in FY 1986.
Wall could use forbearance, however, to reduce dramatically the FSLIC’s contingent liabilities. He simply assumed that forbearance would work and that far fewer S&Ls would fail than Gray had predicted. The result was a sharp fall in the FSLIC’s estimate of its contingent liabilities.
There were other ways the dramatic increase in forbearance could help Wall declare the FSLIC solvent. The money the FSLIC typically needed to resolve failed S&Ls was vastly greater than the amounts estimated by GAAP. GAAP underestimated losses particularly badly for control frauds and did worst of all for Texas control frauds. Every government takeover of a failed S&L directly increased the FSLIC’s estimate of the cost of resolving that S&L. The FSLIC’s predictions of the cost of resolution (prior to takeover) consistently underestimated actual losses, so it seemed as if the GAO should require the FSLIC to recognize dramatically greater contingent liabilities for future losses.
Wall had a five-part plan for getting the FSLIC declared solvent. I have explained the first three steps: designing accounting and regulatory changes that would make the industry report that it was healthier, stopping virtually all expensive takeovers, and revising the FSLIC’s financial statements (to indicate that forbearance would substantially reduce the FSLIC’s contingent liabilities). The fourth step was an ancillary benefit of stopping the takeovers. It allowed Wall to dramatically increase the amount of money in the FSLIC fund. He took the $2.3 billion in annual FSLIC insurance-premium income and the slightly larger annual funds received from FICO bond sales under the FSLIC recap and left them in the FSLIC fund. This allowed the fund to grow at an annual rate of roughly $5 billion. Wall told us that he was greatly increasing the FSLIC’s cash reserves in order to convince the GAO that the FSLIC was solvent. Wall was running a negative arbitrage: the interest expense on the FICO bonds was far greater than the interest rate the treasury paid the FSLIC on its reserves. This waste, though enormous, was dwarfed by the opportunity cost of not using the fund to close the worst control frauds.
Wall’s belief—that if the FSLIC fund had more cash in it, then it must be solvent—had no support under accounting theory, but he believed that politics, not accounting principles, would determine whether the GAO blessed the FSLIC’s revised financial statements and reported that it was now solvent. Wall built up the liquidity of the FSLIC fund to provide the GAO with the political cover he believed it needed. His fifth step was to put political pressure on the GAO to provide that blessing.
The effort failed. The GAO was livid that Wall would try to damage its professional reputation (Day 1993, 289).
Wall was convinced that Gray had deliberately gamed the numbers to make the FSLIC appear insolvent to get the recap passed. He said this at a lunch in San Francisco where we shared a table. He sounded strikingly similar to Senator Proxmire (in the passage quoted in the last chapter) predicting that the FSLIC would create false publicity about an S&L crisis in order to induce Congress to pass an excessively large FSLIC recap bill. Proxmire, a prominent Democrat who had long chaired Senate Banking, was Wall’s chief opponent on myriad issues for many years. The similarity of Proxmire’s and Wall’s views adds to the likelihood that when Wall became chairman he really believed that there was no S&L crisis and that forbearance was the key to preventing a crisis from developing. The industry and the administration had pushed this view since 1981, so it is understandable that Wall shared their beliefs. Congress had just voted overwhelmingly to mandate greater forbearance, and a majority in both parties had supported it. Gray was the outlier, not Wall. The administration, Congress, the industry, and Wall all agreed on three things. There was no real crisis, Gray was the problem, and forbearance was the solution.
The claim that Gray knowingly manufactured a false crisis to get the FSLIC recap passed required an explanation of why Gray made its passage his top priority. If he knew there was no crisis, he had little to gain from passage of the bill and a great deal to lose from Speaker Wright’s extortion. Why would Gray have reintroduced the bill in 1987, a move likely to provoke further extortion from Wright? The control frauds offered the only logically coherent explanation: Gray was vindictive. He wanted the extra money to punish his political opponents. (In a classic example of “too many c(r)ooks spoil the soup,” this logical coherence was destroyed because the control frauds offered two contradictory theories of Gray’s vindictiveness. The California control frauds said that Gray was out to destroy Republican contributors; the Texas control frauds said that Gray was out to destroy Democratic contributors.) From Wall’s perspective, however, the point was that everyone he talked to agreed that Gray was vindictive. Wall’s view of Gray as a man who had undercut the administration’s deregulatory policies, artificially created a crisis, and vindictively targeted S&Ls for closure was a common view in 1987. The control frauds and the league had spent lavishly to spread that message for years.
One testament to the success of this big-lie technique was the reaction of Larry White, the new Bank Board member, to the campaign. He began his term by soliciting complaints against Bank Board supervisors, and he insisted on hearings on whether to renew the direct-investment rule. Documents we discovered after Lincoln Savings was finally closed confirmed what I told White at the hearings: Keating had stacked the Bank Board hearing. He arranged to have a dozen prestigious (and purportedly independent) entities support his criticisms of the direct-investment rule and the agency. He secretly coordinated the testimony.
All the witnesses claimed that the Bank Board frequently acted abusively: the proof was that institutions were so afraid of reprisals that none of them would come forward to complain. I told White that this was absurd: we were guilty because no one would provide an example of our guilt. It was logically impossible to refute their claim, and an assertion that cannot be falsified is a statement of faith, not fact. I added that the truth was that Bank Board regulation still remained far weaker than banking regulation. White told me, “Bill, they can’t all be lying.” I lost credibility with him when I responded, “Yes, Larry, they can and they are.” He said that my response showed that I was acting like an advocate.
White’s view, and his conclusion that I lacked objectivity, was a natural human reaction. Consider the effect of 150 people saying the same thing—that is how many people met with Wright at Ridglea to attack Gray. The Bank Board member heard the same message from the administration, the league, S&L CEOs, and real estate developers. Surely they couldn’t all be lying? White knew that Gray was not a monster, but their personalities and approaches to decision-making were so different that they were never close. White was always wary of Gray. The charges of abuse created smoke, and White feared that though he never saw it himself, there might be fire. The control frauds advanced under cover of the smoke screen they laid down.
The newest Bank Board Member, Roger Martin, adopted the views of his fellow real estate developer, Charles Keating, even more completely than Wall did. As Mayer (1990, 242) notes, for Wall, Gray was the enemy. Martin shared that view, but added fervor.
Just like Wright and the Keating Five, the Bank Board members heard that Selby and Patriarca, the directors of agency function at the FHLB-Dallas and the FHLBSF, were vindictive. Gray had personally selected them, so their vindictiveness confirmed Gray’s. The leader is normally decisive in establishing group culture, so it followed that the industry complaints that the FHLB-Dallas and the FHLBSF staffs were vindictive and overly aggressive were credible. Forbearance requires passivity, not aggressiveness. I also had a reputation for being aggressive and close to Gray.
Wall never had much success converting the field to his type of agency culture. The central problem was that Gray put in place a normal financial regulatory culture: he personally recruited many of the best banking regulators and put them in charge of supervising the most troubled field offices. They, in turn, raided their former agencies for many of the best up-and-coming staff and hired new, professional staff that emulated their bosses. Other FHLB presidents, at Gray’s urging, recruited banking regulators as their own top supervisors. These officials were chosen because they were thought to exemplify the strengths of banking regulatory culture: good judgment and no-nonsense supervision. The banking regulatory agencies were much more prestigious than the Bank Board. The FHLB field officials thrived under the influence of the banking regulatory culture. Danny Wall, a minor political figure with no experience in supervision, could not make them repudiate that culture.
A related problem was that the top people who joined the Bank Board from the OCC, Selby and Patriarca, were considerably more prestigious and accomplished than Wall. Selby had served in about every senior position at the OCC and had then run it. Patriarca was the wunderkind whose career was an improbably meteoric rise from the most junior of enforcement attorneys to the head of the most difficult and prestigious job: head of the multinational group supervising the largest, most complex banks in America. How was Wall supposed to convince other field supervisors, Selby’s and Patriarca’s former subordinates at the OCC, that they should ignore Selby’s and Patriacrca’s advice and follow his?
In a sane world, Wall would have welcomed the presence of Selby and Patriarca in the two most troubled regions, sought their advice, and learned from them. Unfortunately, in Wall’s eyes Gray had tainted Selby and Patriarca by selecting them. By doing their jobs well, Selby and Patriarca had angered ultrapowerful politicians. Wall wanted to avoid confrontation.
Wall could fire FHLB officials only “for cause.” This was a major limitation on his managerial sway because the field did all the direct examination and supervision. Wall potentially had leverage with the principal supervisory agents (PSA). Each FHLB CEO was also the PSA for his (they were all male) district. The Bank Board chairman, not the FHLB, determined the PSA designation. This meant that the chairman had substantial leverage over the choice of a successor when an FHLB CEO resigned. He could block any candidate by refusing to designate him as the PSA. Gray caused shock waves when he removed the PSA designation from Joe Settle (which effectively forced him to resign as FHLB-Dallas CEO). The FHLBs and their presidents formed powerful duchies that the Bank Board could interfere with only in egregious circumstances.
There were, however, important people on the Bank Board staff who supported the views that forbearance was desirable and that Gray, Selby, Patriarca, and I were too aggressive. The most important of these was Rosemary Stewart, OE’s head. Stewart believed that all four of us were too aggressive, and she eventually came to believe that Gray and I had a “vendetta attitude” against Charles Keating (U.S. Senate Committee 1990–1991a, 4:153–156, 324; 5:19). Stewart’s views lent great credibility to the complaints about the Bank Board under Gray. Gray, Selby, Partriarca, and I were upset with Stewart’s performance; this further testified to her rightness when Wall accepted her view that we criticized her because she had blocked our misuse of the agency’s enforcement powers to punish innocent S&L owners, principally Charles Keating. Stewart eventually came to believe that Gray wanted to punish Keating for opposing reregulation. She was the only Gray-appointed office director (in a nonadministrative capacity) that Wall left in charge of a department. Stewart played a vital role in confirming Wall’s and Martin’s conclusion that Gray, Selby, Patriarca, and I were the problem and that Keating was the solution.
Wall and Martin had, from their perspective, inherited control of a dangerously flawed agency. If their plan had been to regulate aggressively but fairly, then having two key field offices under the control of vindictive leaders would have been an almost insuperable problem, because the Bank Board could regulate aggressively only through the field. Because, however, Wall and Martin believed that the answer was to end aggressive regulation, they had a real chance of success. The Bank Board could block any aggressive action by its field offices. The only vital change needed at headquarters was to remove Robertson’s control over ORPOS. Wall achieved that goal by appointing Dochow as ORPOS’s executive director.
The field could not take any enforcement action or close any S&Ls without the Bank Board’s approval. Green’s resignation as president of the FHLB-Dallas allowed Wall to remove Selby and dramatically change the culture of the FSLIC’s most important district. If Cirona were to resign as FHLBSF president, Wall could do the same at the FHLBSF, the FSLIC’s second-most important district. Wall could make life sufficiently unpleasant for Cirona that he was likely to resign.
If Wall were wrong about forbearance, he would increase the eventual bailout costs to the taxpayers by tens of billions of dollars. Wall and his team assumed that control frauds were rare. They also assumed that they could distinguish those rare frauds from honest but troubled S&Ls. If Wall’s team were not able to distinguish the control frauds, and if the frauds were not rare, then the team would be extraordinarily vulnerable to being manipulated by the frauds. One reason that Reagan appointed Wall was that both believed government to be the problem. This predisposed Wall to believe industry complaints about aggressive regulators. Because Wall’s team viewed Gray and his people as the enemy and as vindictive, they believed control frauds’ claims about vindictive field regulators. The control frauds’ only expertise was in manipulating people. Wall’s team would be lambs to the slaughter if control frauds existed in huge numbers. Wall’s efforts at deregulation and creative accounting, like Pratt’s, improved the environment for control frauds and weakened the Bank Board’s ability to fight them.
Wall’s actions exposed the nation and his reputation to two other risks. He weakened supervision by removing the nation’s top financial regulator (Selby) from the region that most needed tougher supervision and placing Barclay in charge. The loss of supervisory talent would have been enormous in any case, but Wall greatly compounded the loss by removing Selby in an attempt to placate Speaker Wright. The message to the supervisors was clear: do not upset the politically powerful. If Selby and Patriarca were right, if control frauds were important, and if they routinely developed political patrons, then this was the worst possible message Wall could have sent. If Wall succeeded in sending a similar message to the FHLBSF staff, the control frauds’ victory would be complete. The losses to the taxpayers would mount tremendously.
Wall would suffer personally if he failed to change the culture of the FHLBSF and if he were wrong about the importance of frauds and the presumed vindictiveness of the FHLBSF. If the FHLBSF were fair and professional as well as correct about the nature of the control frauds, then Wall would have to block takeovers and enforcement actions supported by well-researched and well-reasoned memoranda and data. The FHLBSF led the nation in closing failed S&Ls, particularly control frauds. It had recommended thirty-five closures; the Bank Board had closed all thirty-five; and the Bank Board had never lost a case that challenged a closure recommended by the FHLBSF (U.S. House Banking Committee 1989, 5:159). All the recommendation memoranda passed my desk for review when I was the Bank Board’s litigation director. The FHLBSF had, by far, the best-documented memoranda of any district.
It should also have been clear that the FHLBSF would continue to recommend closures even if Wall did not want to close failed S&Ls. Indeed, Cirona explicitly told Wall that when he visited San Francisco early in his term. Wall complained that we recommended actions even when we knew he would reject them: this, he said, could make him look bad. Cirona told him that our job was to give him our best advice; he would decide whether to take it. Wall glared back but said nothing.
Cirona and Patriarca shaped the FHLBSF’s culture. The FHLBSF made possible Gray’s reregulation by closing so many control frauds more quickly than the FHLB-Dallas district could. These closures provided the facts to support a strong rationale for reregulation. An FHLBSF senior supervisor, Chuck Deardorff, conducted a study of fraud and abuse that helped the Bank Board identify the pattern of control frauds. The FHLBSF recommended that conservators be appointed for control frauds before they had been proven insolvent. The law allowed this, and courts upheld the takeovers, but this required very well-supported recommendations. Cirona, Deardorff, and Dirk Adams provided the leadership for this policy of earlier—and it was still far too late—intervention, and Rod Peck and Bruce Ericson of Pillsbury, Madison and Sutro, the FHLBSF’s outside counsel, were critical to the implementation of the strategy. Patriarca inherited this strong team and honed the regulatory culture into an even more effective strike force against the control frauds. The senior FHLBSF managers had the freedom that comes from knowing that we could double our salaries and reduce our workweek by going to the private sector if Wall found a way to force us out. No one was willing to endanger her reputation by being intimidated by Wall, and Wall had no leverage over Patriarca.
If the FHLBSF’s recommendations were correct, the frauds would fail and cause far greater losses. Wall would have to explain why he had ignored the recommendations. In this scenario, the FHLBSF would be vindicated and Wall’s reputation could be ruined. Wall seems to have been so convinced of Gray’s (and his top lieutenants’) perfidy that he never considered this possibility.
The first sign of the difficulties that the FHLBSF would have with Wall involved the town in which my family lives, San Carlos, California. San Carlos had a large S&L, Eureka Federal, that failed because of its investments in mob-related real estate in Las Vegas (Pizzo, Fricker, and Muolo 1991, 221–227). It was placed in the MCP program. The FHLBSF’s goals for MCPs were to stop ongoing frauds, clean up the files and record keeping, stop all new risky investments, and shrink the S&Ls. The MCP teams came from S&Ls thought to be well managed. The MCP program reached these goals, particularly in California, where the FHLBSF exercised real oversight of the MCP managers. The FHLBSF had only one serious problem: the MCP team leader guiding Eureka Federal. Despite warnings, he continued to violate directives to stop risky investments and growth. The FHLBSF removed him in mid-1987.
Within days, we received a letter from the Bank Board directing us to rescind our removal. We were stunned that senior Bank Board officials even knew this person existed. It turned out that he was a contributor to the Republican Party. When we fired him, he flew on his private plane to Washington, D.C., where he immediately got a personal meeting with Danny Wall. Wall heard his complaint without informing the FHLBSF of the meeting or arranging for the FHLBSF to join the meeting by telephone conference. Wall did not even ask the FHLBSF to respond to the complaint; he simply ordered the FHLBSF to rescind its decision.
At the time, Wall’s action seemed inexplicable to the FHLBSF. No one in the industry or in academia thought that MCPs should grow and invest in risky assets. The only industry complaints were that the FHLBSF had not forced the MCPs to shrink even more quickly. It was (and remains) impossible to know what the S&L executive told Wall, because Wall never informed the FHLBSF of the complaint or of the reasons he was ordering that the man be rehired. The only logical possibility is that the executive convinced Wall that Eureka could eliminate its losses by “growing out of its problems.”
The MCP manager was a Republican, a minor politico like Wall (who shared his love for talking politics), and an innovative “can do” type with a private plane. This was exactly the kind of manager Wall wanted in the industry and the kind of man he instinctively trusted. The FHLBSF was biased against high-risk investments. Wall supported deregulation and greater asset powers, especially for sophisticated managers like the man before him. Boland, Wall’s chief of staff, had a favorite analogy for describing Wall’s views of why deregulation was desirable. He said that if he were to drive 80 mph down a well-known (and dangerous) parkway in the Washington, D.C. area, doing so would be unsafe, but it would be safe for a professional race car driver to do it. It was critical to avoid “regulating to the lowest denominator” so that the Bank Board did not exclude the racing pros. Plainly, the FHLBSF’s decision was the product of Gray’s policies; Wall’s policies required the reversal of the FHLBSF decision. No input was needed from the FHLBSF, because the issue was what policy to follow and Wall knew his policies.
Wall’s actions violated normal management principles. But Wall knew that the FHLBSF shared Gray’s views about reregulation and forbearance. That made the FHLBSF Wall’s enemy. Wall had nothing to learn from the enemy, and if the incident humiliated the FHLBSF, that was a side benefit. It would show his displeasure, serve as a warning against future acts of regulatory zeal, and increase the chance that the senior staff would leave.
What Wall failed to understand was that these actions would upset not only the FHLBSF, but every other FHLB and a good part of the Bank Board’s staff as well. Wall was the leader of the entire Bank Board system. The FHLBSF was part of that system. We were his agents. Wall went out of his way to signal the industry: I do not trust my field staff, and if they displease you, please meet secretly with me and I will reverse their actions. As President Reagan said, “The government is not the solution; the government is the problem.”
The FHLBSF initially found Wall’s actions incomprehensible. We did not know the depth of the distrust and animus Wall had for us when he became chairman. Cirona, Patriarca, and I had had professional and amicable dealings with Wall when he was on the Senate Banking staff. We were baffled at the change.
The FHLBSF tried to implement Wall’s order to reinstate the MCP manager, but was overjoyed when his greed posed an obstacle. He demanded a long-term contract and a substantial raise! This was a golden opportunity to put our side of the matter before Wall. We explained the normal restraints on growth and risky investments by MCPs and why the rules were desirable. We explained the efforts we had made to get the manager to comply. We explained that he was already unusually well-compensated, that the raise he was demanding was excessive, and that a long-term contract made no sense since MCPs were supposed to be temporary. We were sure that Wall’s order had been some snafu and that now that he knew the facts, he would use the manager’s greed as a graceful way to climb down from his prior order. We were wrong. Wall ordered that we give the manager the raise and the long-term contract and that we let him expand the S&L by investing in risky investments. This sent a chill throughout the FHLBSF.1
Years later at a FHLBSF conference, the CEO of the S&L that acquired Eureka Federal told us what a bad job we had done during the MCP because we had permitted the S&L to grow and invest in risky assets that had had horrible default rates.2
Eureka’s MCP manager proposed a silver bullet to Wall. If Eureka Federal were allowed to “grow out of its problems,” there would be no need for FSLIC assistance. Wall never saw a “silver bullet” he did not want for his bandolier. He adopted the same silver bullet, but with a magnum load, for the largest S&L, American Savings, at the start of his term (again, over the objections of the FHLBSF). That silver bullet missed, and the ricochet would have taken out Wall but for the most improbable stroke of luck.
Wall would later testify that when he became chairman he discovered that the largest S&L, American Savings, was “being run out of the Chairman’s office” and that he promptly put an end to that. American Savings was run by its CEO, Bill Popejoy, under both Gray and Wall. Gray and Wall both failed, in part, because they ignored the FHLBSF’s views and adopted Popejoy’s plan to grow American Savings out of its problems.
What was run “out of the Chairman’s office” by both Gray and Wall was the FHLBSF’s efforts to supervise the S&L. Ann Fairbanks, Gray’s chief of staff, intervened to quash the adverse findings of the FHLBSF examiners led by George Kodani. Fairbanks even threatened Kodani’s job. After Gray acceded to Patriarca’s pleas, which I had endorsed and forwarded to him in January 1987, to allow the FHLBSF to regulate American Savings, the examiners found additional losses. Gray decided that he had made a mistake in approving Popejoy’s plan to grow American Savings out of its problems, and he put the S&L on a fast track for a FSLIC-assisted merger. That was the situation that Wall inherited.
American Savings’ management now drafted a “doomsday” letter to its outside auditors suggesting that the S&L was no longer a “going concern.” This is accounting jargon meaning that the firm has failed, and it triggers the most adverse accounting “basis” and results in substantial write-downs of asset values. The S&L management said that it would send such a letter to the auditors unless the Bank Board backed off and stated that American Savings would not be taken over. In substance, the S&L was holding a gun to its own head and threatening to shoot.3
Washington headquarters and the Corporate and Securities Division of the Office of General Counsel informed Mike and me of this shortly after Wall became chairman on July 1, 1987. I must confess that when we first heard this, we began to consider what sort of letters we could send to American Savings to prevent them from sending such a letter to their auditors. Fortunately, the securities attorney pulled us up short by asking why we would do anything of the kind. The attorney reminded us that the Bank Board was a securities-law regulator of S&Ls and that the S&L managers’ underlying purpose was to avoid disclosing losses that they should, in fact, reveal. Mike and I, quite embarrassed, said that we were wrong and that the Bank Board should refuse to send any letter.4 This appeared to be the consensus staff view.
The next day, Mike, his deputy Eric Shand, Shand’s supervisory team, and I were on a telephone conference with Wall and his senior staff about American Savings’ request. Mike and I explained why we opposed sending any letter. To our surprise, we were now alone in supporting that position. Wall was the most insistent on the need to send the letter in order to avert a run on American Savings that could take down the FSLIC and lead to a nationwide run. Everyone at the Bank Board feared a nationwide run, but we felt confident that we could put American Savings in the MCP program and promptly stop any run, even if Popejoy made good on his threat.
I tried to talk Wall out of sending the letter. I noted that Congress had been quite adversarial in its hearings on the Bank Board, that Dingell would claim jurisdiction over any securities-law matter, and that he opposed the Bank Board’s securities-law jurisdiction. I cited the securities attorney’s argument that the Bank Board’s only reason for sending the requested letter would be to prevent appropriate disclosures, and that acting in this manner would undercut our moral, political, and legal authority. How could we take enforcement action against others for failing to disclose losses if we acted to prevent the disclosure of similar losses at American Savings?5
The securities attorney, to our confusion and consternation, compounded our difficulties by speaking up and saying that we had been prepared to countenance a Bank Board letter last night. That was quite true, but we had promptly reversed ourselves in response to his arguments. The staff consensus had evaporated; the FHLBSF was the only one opposing the letter. Wall ordered it sent.
An analogous dispute soon arose. The FHLBSF had found evidence of pension-law violations by American Savings while it was under Charles Knapp’s leadership. Knapp was the most infamous of the high fliers who had caused American Savings’ insolvency. In such a case, the field office would refer the matter to the Washington office, which would forward it to the Department of Labor. The problem was that Washington sat on the referral for months. We pointed this out to Wall, in writing, and urged action. To my knowledge, Washington never made the referral. I know of no other S&L which received such favorable treatment on a pension-law violation.
Wall continued to direct the supervision of American Savings from his office. He made a major change almost immediately. Gray had urgently directed the FSLIC to find an acquirer, and the FSLIC had selected Ford Motor Co., which already owned First Nationwide, a large S&L based in San Francisco. Wall now reversed course and endorsed Bill Popejoy’s plan to grow rapidly by borrowing in the short run and investing in long-term assets.6 This, of course, exposed an insolvent S&L to severe interest-rate risk, which is what started the debacle! The FHLBSF vehemently opposed this plan as being imprudent. (Actually, it was insane, but you have to be polite even when your boss seriously proposes jumping off a cliff.)
With Wall’s blessing, American Savings increased its interest-rate-risk exposure in the summer of 1987—and interest rates shot up. Soon, the S&L had an unrealized loss of over $2 billion from this failed interest-rate gamble. It was already seriously insolvent from fraud losses, so every penny of the new losses would be borne by the taxpayers. American Savings funded its purchase of longterm securities with very short-term Reverse Repurchase Obligations (REPOs). REPO loans are collateralized by high-quality fixed-rate bonds. When interest rates increase, those bonds lose value and the REPO contract imposes a “margin call” that requires the borrower to immediately post enough new high-quality bonds to protect the lender against any loss. This means that American Savings faced a double whammy: the increase in interest rates both reduced the value of its huge bond portfolio by over $2 billion and produced repetitive margin calls that created a severe liquidity problem. This same dynamic later caused Orange County’s bankruptcy.
Wall and his top advisors met one weekend that fall. American Savings would collapse on Monday when it could not meet its margin calls. That was inevitable. Wall’s staff was in emergency meetings with the Federal Reserve to try to get large amounts of cash in order to fend off any runs that might be triggered by closing the nation’s largest S&L in a liquidity-and-solvency crisis. The FHLBSF was suddenly (and temporarily) back in Wall’s good graces. I was leading an emergency effort to prepare the legal and factual grounds for a takeover. Wall faced imminent disgrace.
Then Monday came—“Black Monday,” October 19, 1987. The largest stock market loss in American history occurred that day. Frightened investors sold stocks and bought bonds, which caused interest rates to fall. American Savings did not have to meet any margin calls, and over half the losses on its interest-rate-risk gamble were made good. Black Monday brought gloom worldwide, except in a tiny pocket at the Bank Board’s headquarters, which found renewed faith in God. It was the miracle on 1700 G Street. Proposed as a movie plot, the story would be rejected as too contrived.7
After the February 10, 1987, meeting, and after my criticisms of the Speaker began appearing in the press, he added me to his “to fire” list.
On July 29, 1987, Wall paid a courtesy visit on Wright. While Wall was waiting in Wright’s offices, some of Wright’s staff asked whether William Black was still employed by the Bank Board…. Wall said he responded that Black was no longer on the staff of the Bank Board, but was on the staff of the FHLB-San Francisco, an independent entity. When Wall entered Wright’s office, Wright asked the same question about Black and Wall gave the same answer.
According to Wall, sometime after November 20, 1987, and perhaps as late as early 1988, Wright’s aide Phil Duncan called [K]arl Hoyle, the Bank Board’s director of Congressional and Public Affairs. According to Wall, Duncan told Hoyle that Wall’s response that Black was now employed by the FHLB-San Francisco, and thus out of the Bank Board’s responsibility, was not satisfactory. Duncan did not accept that. He wanted Black fired. (U.S. House Conduct Committee 1989, 274; transcript citations omitted)
Wall personally passed on to Cirona, the president of the FHLBSF, Wright’s desires that I be fired. Cirona, however, supported me. He simply warned me that Wright was trying to get me fired and to avoid giving Wall any pretext of “cause” for firing me. Wall did the only thing he could: he ordered me not to talk to the press. Charles Babcock, a Washington Post reporter, was amused to hear Wright use obscenities in his attack on me during their interview (May 1, 1988, memorandum memorializing telephone call with Charles Babcock).
Wall also suggested that his general counsel, Jordan Luke, tell me that Wright wanted me fired. I asked Luke why Wall was so upset with me, particularly because we had never had any problem before he became chairman. Luke said Wall was upset that I had taken on Wright. Wall felt that Wright was so powerful and vindictive that I had endangered the entire agency by criticizing him. Wall also felt that I had acted in a manner so contrary to my own interests that he did not trust my judgment. If I criticized Wright, I would surely have no compunction in criticizing Wall if I felt he acted improperly. Both of Wall’s reasons were logically coherent.
Wall made serious mistakes after taking advice from people who believed in silver bullets, including Eureka’s MCP manager and Bill Popejoy, but at least none of them were evil. Within weeks of becoming chairman, Wall began committing the mistakes that would force him to resign. Wall took Charles Keating’s advice about how to solve the Bank Board’s problems with Lincoln Savings and the FHLBSF. The same silver bullet would slay both problems. The Bank Board’s problems with Lincoln Savings and Wall’s problems with the FHLBSF were, as Wall perceived them, the same. The FHLBSF enraged Keating and his political allies in the White House and Congress. The “silver bullet” was to remove the FHLBSF’s jurisdiction over Lincoln Savings.
The difficult thing, given that the reader knows the story will end badly, is to recreate how Keating could induce Wall to reach decisions that now seem suicidal. It appeared the opposite to Wall in 1987 and 1988. In 1987 and 1988, Wall considered Gray’s actions suicidal. Keating was someone who top politicians strove to meet at parties. He had close ties to the White House, the House and the Senate, and top state officials in Arizona and California. He was a major subject of a 60 Minutes segment about the “New Southwest” that focused on his novel way of doing business and suggested that Lincoln Savings must be enormously profitable. Top-tier audit firms gave his financials “clean opinions” and decried the FHLBSF’s criticisms. Lincoln Savings reported at times that it was the most profitable S&L in the country. Again, Boland is the one who had the telling phrase to describe Wall’s perspective. Keating was so powerful and so nasty that, in Boland’s catchphrase, “he can get you in ways you’ll never know you’ve been got.” Keating was a political force of nature the likes of which none of us, including Wall, had ever seen.
Years later, William Seidman, the FDIC chairman, told us that he had met Wall shortly after his term began and inquired how he was going to deal with the problems at Lincoln Savings. Wall replied that there were no problems; he had taken care of the whole matter. Wall inherited an FHLBSF recommendation to appoint a conservator for the S&L when he took office on July 1, 1987. The Bank Board’s power to appoint a conservator for a California-chartered S&L was restored on August 10, 1987, when President Reagan signed the FSLIC recap bill into law.
By late July 1987, it was clear that the FSLIC recap bill would soon become law. Bill Robertson, the director of ORPOS, wrote a memorandum to the Bank Board on July 23, 1987, in which he recommended that a conservator be appointed for Lincoln Savings. He was particularly disturbed by the evidence of efforts to deceive the examiners that Anne Sobol had gathered in her enforcement investigation. He asked for an opportunity to brief the entire Bank Board (U.S. House Banking Committee 1989, 5:598–615).
Robertson’s staff made the routine scheduling calls to Wall’s assistant to arrange a briefing on the FHLBSF’s recommendation to appoint a conservator. Wall’s assistant did not respond to their calls, so they e-mailed him. He did not respond to the e-mails (the Bank Board system allowed the sender to know whether the message was ever opened; the ORPOS e-mails were opened but never responded to [U.S. Senate Committee 1990–1991b, Special Counsel Exhibit 238]). This was unprecedented. (That is a phrase that is going to recur in this discussion of Lincoln Savings.) The FHLBSF’s recommendation to appoint a conservator for Lincoln Savings was never heard by the Bank Board under Wall. The FHLBSF was never permitted to brief the Bank Board on Lincoln Savings. That was unprecedented.
While the Washington and FHLBSF supervisory staffs moved to try to put Lincoln Savings into conservatorship, Keating raced to cut off those attempts. On the same day, July 23, 1987, that Robertson sent a memorandum to Wall recommending that a conservator be appointed, Wall’s closest aide, Jim Boland, accompanied by Dorothy Nichols, my former deputy and now my successor as litigation director, met with counsel for Lincoln Savings. Lincoln’s lawyers withdrew their suit against the agency, expressing their confidence that Wall would stop the abuses they claimed Gray committed. This was clever: prosecuting the lawsuit would have led to an embarrassing loss. Dropping the suit cost Keating nothing and allowed him to appear reasonable.
Earlier, on July 1, 1987, Lincoln Savings had filed the most massive response to an examination report in history. Over 750 pages long, it had many boxes of exhibits in support. Keating boasted that Lincoln Savings had spent millions of dollars preparing the response. The cost was primarily for Kaye, Scholer’s legal fees, since they authored the response. It was, superficially, quite good, but disingenuous.
Kaye, Scholer’s response triggered a large number of questions at the FHLBSF. The firm represented, on Lincoln Savings’ behalf, that a series of facts the examiners had found were not facts. For example, the examiners found that the loan files contained no credit checks or appraisals. Kaye, Scholer represented that the loan files contained both. In fact, both statements could be literally true. When the examiners reviewed a particular file, it had no credit check or appraisal; later, when Kaye, Scholer wrote its response, it represented that the file then had both documents. The FHLBSF’s newly acquired knowledge that Lincoln Savings was stuffing the files with documents created after the loan had been made suggested a need to check for even more widespread deception. Had the FHLBSF known that Jones, Day’s “regulatory audit” confirmed all the examiners’ key findings about the total lack of appropriate underwriting, and that Lincoln Savings used the the Jones, Day write-ups of document deficiencies as a road map for creating new documents and engaging in additional file stuffing, its concerns would have been even deeper.
The FHLBSF staff, outside counsel, and accounting experts reviewed the response. They found other things that made no sense and suggested that the responses were structured to mislead the examiners. Dividing the review of the examination response among us, we analyzed its errors and made a list of the most serious concerns; these needed to be reviewed immediately during a two-week “field visit” (jargon for a short, focused examination rather than a “full scope” examination). The topics to be covered by the examiners in the field visit and the timing were provided to the S&L in writing on August 28, 1987 (U.S. House Banking Committee 1989, 5:508). The OE and ORPOS concurred in providing this notice—which was standard procedure—to Lincoln Savings.
Among the topics for the field visit was the “tax sharing” agreement between Lincoln Savings and its parent holding company, ACC (U.S. House Banking Committee 1989, 5:621). Another topic was a suspicious transaction involving a property with a large loss that was suddenly sold for an enormous gain. For reasons that were not known by either the Bank Board or the FHLBSF in fall 1987, Keating could not allow the agency to learn of the extraordinary abuses involving either the agreement or the real-estate transaction. It was imperative that he prevent the field visit if he were to avoid a Bank Board takeover. I explain why in the next chapter.
Thereafter, nothing was ever normal again about the supervision of Lincoln Savings. On July 31, 1987, Wall made Darrell Dochow, the lead supervisor of the FHLB-Seattle, the “executive director” of supervision, which effectively demoted Bill Robertson to an ill-defined deputy position (U.S. House Banking Committee 1989, 5:507).
On September 2, 1987, only five days after the FHLBSF sent its letter to Lincoln Savings about the field visit, Lincoln Savings’ counsel met with Boland and Jordan Luke, Wall’s new general counsel (ibid., 5:521). The purpose of the meeting was to hear Lincoln Savings threaten to sue the Bank Board if the field visit took place. No one from the FHLBSF was informed of this request for a meeting with the Bank Board; no one at the FHLBSF was informed that senior Bank Board managers would meet with Lincoln Savings; obviously, the FHLBSF did not participate in the meeting; and the Bank Board did not request the FHLBSF’s views prior to making decisions in response to the threat to sue.
Jordan Luke was not a litigator, yet he did not alert the Litigation Division about the meeting, brought no litigator with him to the meeting, and did not ask his Litigation Division for its views prior to reaching a decision, even though the issue (ostensibly) threatened litigation. Boland and Luke did not consult Dochow prior to reaching their decision or alert him to the meeting. Dochow was Wall’s newly minted executive director of ORPOS (i.e., their colleague whose office presumably should have had the lead on matters involving examinations). Then, adding insult to injury, they made Dochow call the FHLBSF the next day and halt the planned field visit. All of these actions were unprecedented (unless you count the end run by the MCP manager of Eureka as an analog). Boland and Luke recommended to Wall (and there is every reason to believe that they recommended what they knew Wall wanted) that he prevent the field visit. Wall ordered that the scheduled field examination not go forward. At this point, Dochow was informed of the decision, and he communicated it to the FHLBSF. No examination had ever been halted in American financial regulatory history because of a threat of suit.
The violations of good management practices are so obvious that they do not require discussion. The incident shows how quickly Wall was able to transform the headquarters culture. By creating another layer of management and recruiting non–Bank Board staff to fill it, he could be sure that those who reported directly to him were strong supporters of his policies and mode of operating and that they could keep in check any holdovers from Gray’s regime.
The incident also shows the types of staffers Wall favored: technicians who defined their job as trying to implement smoothly their boss’ policies. They were dedicated to getting the trains to run on time; where they ran and what they carried were not their department. They also shared Wall’s obsession with secrecy.
Wall’s success in creating a supportive headquarters culture so quickly was all the more remarkable because the actions he needed support for were so antithetical to every normal supervisory reflex. The normal response of an agency lawyer, when a regulatee’s lawyer threatens suit if your client acts within its statutory mandate, is to make it unmistakably clear that the effort to intimidate will fail. Few things could be more clearly within the Bank Board’s mandate than the examination of an S&L. If he had sued, Keating would have lost, which would have created a desirable precedent for the Bank Board. Indeed, his lawyers could have been sanctioned for bringing a frivolous suit. More to the point, Keating could not sue to halt the examination, because the suit would be public, and depositors, bondholders, and shareholders of Lincoln Savings and its parent holding company, ACC, would have asked what Keating was trying to hide from the examiners. The Bank Board would have answered that question, in court, with the findings of the FHLBSF examination that demonstrated how badly mismanaged and abused the S&L was. The “short” selling alone (jargon for investments made in the belief that the share price will soon fall sharply) would have tanked ACC’s stock and Keating’s wealth. The Bank Board knew exactly how specious Keating’s claims were likely to be because he had recently filed his claim of purported bias by Gray, and that motion contained many pages of invective against Gray, but not a single act or statement of bias against Keating. Moreover, Gray had had no involvement in the FHLBSF’s examination—and he was gone. Keating’s legal claims, therefore, were frivolous.
General counsels normally respond to threats of litigation by energizing their staff to work tenaciously to ensure that the agency wins in court. New general counsels are normally eager to establish that no outside lawyer can push them around. Every natural instinct, honed by law school, should have driven Luke to respond to Keating’s litigation threats with the Clint Eastwood line “Go ahead. Make my day!” Instead, Luke went along with Wall’s decision to spike the field visit. Luke did not even make the most minimal effort to learn the facts before recommending capitulation. Again, this goes against every legal instinct and practice.
Dochow’s actions were even more inexplicable. Luke was brand new and had never been a supervisor. It was conceivable that he did not understand how much damage he was doing to all Bank Board regulators, indeed all financial regulators. Dochow was personally chosen by Wall to serve as executive director of the Office of Regulatory Policy and Supervision (ORPOS), yet Wall had excluded him and his people (both in the field and at headquarters) from any role in an unprecedented decision that could do incalculable harm to all financial regulators. They did not even inform him of the meeting in advance. The normal instinct of any supervisor upon hearing that the regulatee is desperate to avoid being examined is to assume that there must be a very good reason for the desperation. The normal response is to put the examiners in the shop immediately, beef up the team, and tell them to look intensively to find what the S&L or bank is trying to hide. The obvious suspects were the topics the FHLBSF had informed Lincoln Savings would be the subject of the field visit. This was a dispute whose resolution was of transcendent importance for the continued survival of the Bank Board. In any normal world, Dochow would have taken the lead in the meeting and insisted that the field visit go forward.
Any normal top supervisor treated the way Wall treated Dochow on this secret meeting with Lincoln Savings would have made clear that he would resign if the decision were not reversed forthwith. Wall’s deliberate exclusion of Dochow was a slap in the face. It was also a slap in the face of Dochow’s largest single group of supervisors, the FHLBSF. Dochow could not keep any credibility with his troops in the field if he allowed this kind of end run and surrender. Dochow, however, appears to have taken the way he was treated as proof of his need to get into Wall’s good graces. Wall obviously viewed the FHLBSF as the enemy. If Dochow stood with the FHLBSF, Wall would treat him like the enemy.
The substance of the September 2 agreement was that the field visit was postponed indefinitely. The Bank Board would rereview the examination report and Lincoln Savings’ massive response to it, and would then independently determine whether a field visit would be appropriate. Such a rereview by headquarters was unprecedented. If the re-review concluded that the FHLBSF had acted properly, our normal supervisory powers would be restored. Again, this was unprecedented.
Lincoln Savings, at a minimum, had bought itself many months in which it could not be examined. It reacted, of course, by speeding up its growth and frauds. Keating, knowing that no examiners would be permitted into the S&L, used this period of immunity to commit his most intense looting, adding massively to Lincoln Savings’ ultimate losses.
The FHLBSF was dumbfounded by the order not to examine Lincoln Savings. It was startling to see how quickly and totally the emerging agency culture of regulatory vigor and courage had been ended at headquarters. (It is a measure of Wall’s ability to select true toadies that not one of them ever opposed his policies on Lincoln Savings.)
Dochow told the FHLBSF that he was looking for some “middle ground” in the dispute about the field visit. This may appear innocuous, but it reveals how Dochow saw his role and the relationship between the FHLBSF and the Bank Board. Another quotation from Dochow may help illustrate the point. This quotation is from much later, on November 21, 1989, at the House Banking Committee hearings on the Lincoln Savings fiasco. It is important to emphasize that this testimony came after Lincoln Savings’ collapse was known to be the most expensive S&L failure in history and Keating was known to be a fraud. Dochow was answering a hostile question about why he had agreed to Keating’s demand that I be excluded from any meetings with Lincoln Savings’ representatives.
In one last effort to try to come to resolution between the institution and the [FHLBSF], with me quite frankly trying to serve as the referee, I decided that it was appropriate to go ahead and see if we could get Mr. Keating in the room with Mr. Patriarca and with myself. (U.S. House Banking Committee 1989, 5:107–108; emphasis added)
“Middle ground” and “referee” make clear how Dochow saw his role and the Bank Board system. A referee is a neutral between two contesting parties. To Dochow, we were not part of the Bank Board, so he could be neutral in a dispute between the FHLBSF and Keating. To us, the FHLBSF was an integral part of the Bank Board. We were the Bank Board’s field unit for California, Arizona, and Nevada. We were intensely loyal to the Bank Board’s mission and to the Bank Board as an institution. The FHLBSF supervisors knew they were in a knife fight with Keating. They wanted a leader who would support his troops (or clean house if there was deadwood or abuses). Moreover, no one at the FHLBSF saw Dochow as a neutral referee. The FHLBSF thought that Dochow was in Keating’s corner.
Wall, who spoke of his open-door policy, never permitted a briefing by the FHLBSF (or ORPOS) on the FHLBSF recommendation to appoint a conservator for Lincoln Savings. Wall, Martin, and headquarters senior staff, however, met dozens of times with Lincoln Savings to get its views. This, too, was unprecedented. Bank Board officials met with Lincoln Savings representatives on three more occasions in September and October 1987 (U.S. House Banking Committee 1989, 5:506–596). Wall met with Keating in September. The FHLBSF was not represented at any of these meetings and often was not even informed they were to occur.
Although stopping the field examination was an enormous victory, Keating (and Wall) suffered a serious setback in fall 1987. Dochow had promised to review a 750-page document with many boxes of exhibits, the FHLBSF examination report and supervisory correspondence, the results of Anne Sobol’s enforcement investigation, and the FHLBSF’s response to Lincoln Savings’ rebuttal. Many of the materials were complex, involving arcane accounting and finance issues. Others involved legal interpretations. Dochow could not possibly review this mass of materials by himself. But now the limitations of Wall’s efforts to replace Gray’s supervisory culture surfaced. Dochow called on his staffers who were liaisons with the FHLBSF, and who were already familiar with the examination report and the supervisory correspondence, to do the review. The official in charge was Al Smuzynski; his principal aide was Kevin O’Connell. Kevin had worked for an S&L and then the FHLB-Chicago before joining the Bank Board. He was a prodigious worker with good analytical skills and a phenomenal memory. He was also a son of the S&L League’s executive director, William O’Connell. Al was an “old timer” with broad experience. He was steady and calm. Kevin was impassioned and had a wicked sense of humor. They made a good team. Dochow’s problem was that he had no one at ORPOS who was loyal primarily to him (as opposed to the Bank Board’s mission).
O’Connell was also a problem for Dochow and Wall because he was too candid. He told a Bank Board attorney handling a fairly minor application by Lincoln Savings that Wall had ordered Dochow to have the S&L rescind the application because Wall did not want to have to make any decisions concerning Lincoln Savings. O’Connell warned her that any matter involving Lincoln Savings was “politically dangerous” (U.S. House Banking Committee 1989, 5:674). She was so startled and upset that she wrote down what he said as soon as he left her office and then memorialized it in a memorandum to the file.
The more fundamental problem for Wall and his senior staff was that Lincoln Savings was always an easy call. Anyone with any experience knew it would be a catastrophic failure. It fit the pattern of control frauds, and they all ended the same way. This was why it had been a straightforward task for me to draft a memorandum in 1985 for Norm Raiden’s and Bill Schilling’s signature recommending that Lincoln Savings’ application to exceed the direct-investment threshold be denied (U.S. House Banking Committee 1989, 2:370–386). Because Dochow did not yet have staff who would serve as unthinking yes-men and yes-women but did have a record establishing that Lincoln Savings was the last S&L that should be given regulatory concessions, he was digging his own professional grave (one big enough to hold Danny Wall also) when he assigned Smuzynski and O’Connell to independently review the examination and Lincoln Savings’ response. Smuzynski was already well known for his (correct) position that the FHLBSF had erred in supervising Keating by taking too long to stop his abuses.
Keating had two primary arguments. First, bias. Gray had hated him because he opposed Gray’s direct-investment rule. Gray’s bias had infected the FHLBSF when he sent Patriarca as its chief supervisor and when I became its general counsel. The problem was that there was zero evidence of any personal bias against Keating on any of our parts (for the very good reason that there was no such bias). Smuzynski had dealt with Patriarca, Gray, and myself on hundreds of occasions and knew these claims were spurious. More to the point, Smuzynski and O’Connell knew that other control frauds routinely made similar claims of bias against whoever was supervising them.
Keating’s second argument was on the substance of the examination. Yes, the examiners had found many technical violations and paperwork problems, but they had missed the bottom line: Lincoln Savings was highly profitable. That second argument was also certain to fail with O’Connell and Smuzynski. The underlying problem again was the already clear pattern of the control frauds: Lincoln Savings fit it to a T. Vernon Savings had earlier claimed that it was the most profitable S&L, then failed. All the high-flier Ponzis reported exceptionally strong profits, and all of them were catastrophic failures. Moreover, the FHLBSF had already found that the losses were growing and that Lincoln Savings was covering them up. The FHLBSF write-ups were extremely tightly reasoned, documented, and professional.
In addition to these weaknesses in his case, Keating had created an additional insuperable problem for himself. Lincoln Savings had deceived the agency. That was what the forging of documents and signatures and the file stuffing were all about, and Sobol had documented both offenses. That was decisive in Robertson’s recommendation to the Bank Board that nothing short of a takeover would be adequate (U.S. House Banking Committee 1989, 5:602). It was certain that Smuzynski had been heavily involved in drafting Robertson’s memorandum. The FHLBSF had reacted the same as Robertson and Smuzynski: when you lie to the regulator, you cannot be trusted and you are trying to hide something very bad. Until Dochow, this was universally the reaction of regulators to Lincoln Savings’ deception.
The result of O’Connell and Smuzynski’s review was devastating for Keating’s case. They found that the examination report was overwhelmingly correct, the claims of bias spurious; they emphasized the criminal attempt to deceive the agency; they pointed out that Lincoln Savings was following the classic high-flier pattern; and they predicted that, like all the others, it would crash and burn. They thought it would probably cost the FSLIC roughly $500 million to resolve the failure, and noted that the cost would increase the longer Lincoln Savings remained open (U.S. House Banking Committee 1989, 2:603–618).
O’Connell and Smuzynski reported their results to us and Dochow at an October 7, 1987, meeting at the Bank Board. Rosemary Stewart, Dorothy Nichols, and Carol Larson, a Bank Board accountant, also attended the meeting. Dochow was plainly the odd man out. He spoke up to say that he was very concerned about the risks posed to the FSLIC by the way Lincoln Savings was operating, but he was not sure Keating was all that bad. The entire group (other than Stewart) hammered him about the file stuffing and the backdating and forging of documents and signatures. He admitted that he was wrong. He told us that a conservatorship was out of the question because it was politically unacceptable to the Bank Board. Indeed, he told us that some members of the Bank Board felt that our recommending a conservatorship showed that we were overly aggressive.
We began, collectively, to rough out a stringent cease-and-desist (C&D) order to stop Lincoln Savings’ unsafe practices. I spoke of the need to have a “united front” when dealing with the S&L, and Smuzynski responded that he thought we had one. Rosemary Stewart expressed no opposition to seeking a C&D. Mike Patriarca, trying to mend fences, sent a memorandum to Dochow on October 8 applauding the united front and asking for permission to conduct the field visit.
Dochow then met with Lincoln Savings representatives on October 21 to give them the results of Smuzynski and O’Connell’s findings. Again, the FHLBSF was excluded from the meeting, even though the review had vindicated us. Dochow sent a memorandum to Patriarca two days later with his summary of the meeting. Dochow said that Lincoln Savings understood that its examination and supervision should return to normal and that the examiners would return by the beginning of 1988. Keating’s threats had bought at least a four-month halt to any examination. Dochow reported that the S&L’s lawyers acknowledged that they needed to improve their operations:
I don’t think they want to continue the fight and appear willing to take the proper corrective actions if we (the FHLB of San Francisco and ORPOS) also remained reasonable. (U.S. House Banking Committee 1989, 5:667)
Dochow badly misread Keating and his lieutenants. First, the implication was that Lincoln Savings would be fine if only its managers took “the proper corrective actions.” But what the FHLBSF and Anne Sobol had found, and ORPOS had confirmed, was that Lincoln Savings was run by dishonest people in the classic high-flier manner, which inevitably meant disaster. Dochow thought that if they just put some systems in place (that was Dochow’s area of expertise and his mantra), all would be well.
Second, the belief that Keating did not “want to continue the fight” sent the Bank Board down the road to Munich, with Wall reprising the role of Neville Chamberlain. Keating loved to fight, and by threatening to bring an utterly baseless suit, he had killed the field visit. Keating was sure to reprise tactics that had proven so successful. Moreover, Keating could not allow the examiners to discover his massive frauds involving the tax-sharing agreement.
Third, Dochow implicitly stated that Keating’s team was acting “reasonably” and would continue to do so if only the FHLBSF would also do so. What did “reasonable” mean in this context? Dochow made that clearer in the remainder of his memorandum. He asked Patriarca to consider taking no enforcement action and to put the corrective action in an unenforceable, voluntary agreement with Keating. The united-front meeting had unanimously and explicitly opposed any action below the level of a C&D. Now, Dochow suggested that it would be reasonable not to take any enforcement action and rely on Keating’s promises. The united-front meeting, of course, had concluded that the Bank Board’s most acute concern was that Keating had repeatedly lied to the agency and that Lincoln Savings’ efforts to deceive the agency were criminal. It was clear at that meeting that Dochow was the weakest link, and this confirmed it.
Worse, Dochow ended the memorandum with a new, ominous threat to the integrity of the agency. He informed Patriarca that Lincoln Savings was “very anxious” to change its supervisors; he had told it that if it acquired an S&L in another FHLB district and headquartered there, it could be supervised by the other FHLB. This too was unprecedented. No S&L had ever been permitted to acquire another S&L for the purpose of escaping supervisors it found to be too vigilant.
In addition to the obvious impropriety of rewarding someone like Keating who behaved abusively and deceptively and was leading an S&L into a catastrophic failure, this “supervisor shopping” was inappropriate for several less-obvious reasons. The law required S&Ls to have a satisfactory Community Reinvestment Act (CRA) record. Lincoln Savings made zero investments in its community. It made virtually no home loans (eleven in roughly eighteen months, and those were special favors reciprocating favors done by others), and virtually all of its investments were in Arizona real estate projects. It was a California S&L with its branches in Southern California. Its CRA record was probably the worst in the nation.
S&Ls that are serious supervisory problems, and Dochow had just agreed at the meeting with us that Lincoln Savings was a severe supervisory problem, are not permitted to buy other S&Ls. Dochow had strongly agreed with the unanimous view at the united-front meeting that Lincoln Savings was critically undercapitalized relative to its extremely risky investments and that its growth must be stopped. Yet Dochow, only two weeks later, was now contemplating approving massive growth through acquisition.
At this point, Keating drew a new card and played it brilliantly. He announced that Bill Hinz would be the new CEO of Lincoln Savings. Hinz was a well-respected S&L executive of unquestioned integrity and someone Jim Cirona knew well. Hinz met with Cirona and assured him that Keating had given him carte blanche to transform Lincoln Savings into a well-run institution. It was, of course, too good to be true, but Cirona trusted Hinz and felt pressure from Dochow to act “reasonably,” as he explained:
I have known Hinz for years. He came to see me and told me that he had never seen “such a goddamn mess” as he encountered at Lincoln. He started saying all these wonderful things about how he was going to make Lincoln into a traditional savings and loan association. (U.S. House Banking Committee 1989, 2:826)
An FHLB-Seattle official added:
Lincoln told us that Hinz is on his way out. He was hired to work things out with Cirona but is on his way out because he failed. (ibid.)
Hinz reported to Cirona weeks later that Keating had reneged on the initial agreement and was personally directing the investment areas the Bank Board was most concerned about. Hinz, to his discredit, stayed on as an extremely well-paid figurehead for many months. Keating had bought himself another several weeks and had gotten to the end of 1987 with no examination, no supervision (Lincoln Savings refused, in writing, to comply with FHLBSF directives after Wall became chairman), and no enforcement.
We felt bitterly disappointed as 1987 came to an end, but hopeful that the stringent C&D would soon be issued and the examination resumed. Patriarca kept pressing for the return of normal examination-and-supervision authority to the FHLBSF, for the issuance of the C&D, and for sending examiners into Lincoln Savings. Dochow avoided saying either yes or no to these requests. The FHLBSF was left twisting slowly in the wind.
Wall and Dochow were confident that another FHLB would agree to allow Lincoln Savings to purchase an S&L in its district and take on the task of supervising Keating. Dochow had been director of Agency Functions at the FHLB-Seattle. Jim Faulstich, the president of the Seattle Bank, had recommended Dochow to Wall. Dochow asked Faulstich to allow Lincoln Savings to buy a district S&L and transfer its supervision to Seattle. No FHLB president in his right mind would have wanted to supervise Keating, and Faulstich made clear that he had no interest in the proposal. Dochow and Wall continued to pressure Faulstich. He agreed to have his supervisory staff meet with Keating and hear his proposal.
The meeting was a failure for Keating, Wall, and Dochow. This was another instance of Keating’s behavior producing immediate distrust in people who had just met him. The Seattle staff asked Keating why he was not an officer or director of Lincoln Savings: “He responded to the effect that he did not trust the regulators and did not want to go to jail” (U.S. House Banking Committee 1989, 3:7). The staff was also upset by his willingness to purchase any S&L in Seattle, sight unseen. He obviously had only one interest: escaping the FHLBSF’s jurisdiction. If Seattle said yes, it would, implicitly, send the message that it believed in weaker supervision. Seattle also studied the FHLBSF examination, the recommendation to appoint a conservator, and the ORPOS work confirming San Francisco’s findings. FHLB-Seattle representatives notified Dochow that they agreed with the FHLBSF findings and opposed Keating’s proposal to purchase a Seattle S&L (ibid., 2:961). Dochow and Wall did not take “no” for an answer. They asked Seattle to reconsider—and were rejected.
The FHLBs engaged in periodic peer reviews. The FHLBSF underwent such a review of its operations in late 1987. The peer review team criticized the Bank Board’s interference with the FHLBSF’s examination-and-supervision powers over Lincoln Savings (U.S. House Banking Committee 1989, 5:514).
By early 1988, Wall was having significant trouble neutralizing the FHLBSF’s effort to close Lincoln Savings. Dochow’s key staff had confirmed that the FHLBSF’s findings were correct, found that there was no evidence of improper actions by the FHLBSF, and predicted that if Lincoln Savings were not closed promptly, it would cause very large losses (U.S. House Banking Committee 1989, 2:603–618). The FHLB-Seattle had killed the elegant solution of transferring jurisdiction over Lincoln Savings, and had put its agreement with the FHLBSF and ORPOS staff in writing. The peer review had supported the FHLBSF. The California Department of Savings and Loans (CDSL) supported the takeover (ibid., 2:960). Dochow and Stewart had agreed that the minimum acceptable response to Lincoln Savings’ violations was an extremely stringent C&D order (ibid., 2:452–463). Hiring Hinz had been exposed as another of Keating’s endless line of stall tactics. Dochow had proved ineffectual in derailing the FHLBSF’s efforts to close Lincoln Savings.
The staff knew that the C&D would lead to the recognition that Lincoln Savings was already insolvent. The C&D would require Lincoln Savings to sell $600 million in direct investments that it had made in violation of the rule. Stewart, Dochow, O’Connell, Smuzynski, and Robertson agreed with the FHLBSF that the S&L had severe losses that would be exposed by the sale. It had taken far too long, and Wall’s order killing the field visit had led to horrific additional losses, but the professional staff had finally reached an agreement that would lead inevitably to closing Lincoln Savings. Unfortunately, Keating understood that too, and he had another political card to play.
Keating used two of the Keating Five to checkmate Wall. First, Keating convinced Senator Glenn to invite Speaker Wright to meet Keating and Glenn on January 28, 1988, to discuss Lincoln Savings’ complaints against the FHLBSF. Keating’s chief political fixer, and former Glenn aide, Jim Grogan attended. The Senate Ethics Committee later gave Grogan immunity in order to induce him to testify. He remained a fervent supporter of Keating’s, so his admissions against Keating’s interests are particularly credible.8 Grogan testified that Keating habitually dominated all conversations. Wright, however, was so demonstrative at the luncheon meeting that Keating could hardly get a word in. Wright spent the lunch denouncing Gray and me. After lunch, Wright invited Keating and Grogan to his offices to continue the discussion and to plan actions against Gray and me. Wright kept demanding plans to have me fired and to have Gray and me sued (U.S. Senate Committee 1990–1991a, Part 1 closed, 85–89; Part 2 open, 237).
Keating then left for a meeting with Wall. Senator Cranston, another member of the Keating Five, arranged this meeting. Keating began the meeting by emphasizing that he still had the Keating Five’s support and had added the Speaker’s support. Keating told Wall he had just come from personal meetings with Senator Glenn and the Speaker. Referring to the Speaker, he told Wall “that is one man in Congress you would get along with much, much better if you took care of the problem in San Francisco. There is a red-bearded lawyer that’s a real problem. If you took care of that problem, you would get along much better with Speaker Wright” (U.S. Senate Committee 1990–1991a, December 13, 1990, transcript 31). Keating was referring to me. Plainly, he did not think that Wall would react badly to a naked invocation of political power designed to remove one of Wall’s senior officials in the field. Keating renewed his threat to sue the Bank Board if he did not escape the FHLBSF’s jurisdiction.
The incident also shows that Speaker Wright ended up helping the two most notorious S&L control frauds and that he was willing to intervene despite being threatened with ethics charges stemming from his analogous acts on behalf of the Texas control frauds. His willingness, indeed zest, to take such a politically imprudent act demonstrates the ferocity of the Speaker’s animus and the complete frustration he felt at being unable to stop press criticism.
This series of January 28, 1988, meetings proved decisive. Wall told Keating at that meeting that he would direct Dochow to reach an “amicable solution” to the dispute (U.S. Senate Committee 1990–1991b, Special Counsel Exhibit 150, 2–3, 5). Dochow told his aides and Patriarca of Wall’s direction. Kevin O’Connell told his FHLBSF counterparts working on the Lincoln case about Wall’s orders. They memorialized the directive in a February 8, 1988, e-mail message (U.S. House Banking Committee 1989, 5:559). The meaning was obvious: “amicable” meant that there would be no litigation (ibid., 5:96). Anyone who had ever dealt with Keating knew that he would not agree to anything other than the Bank Board’s surrender. Moreover, Wall had just demonstrated that political pressure and litigation threats could cause him to capitulate. It was certain that Keating would use the same tactics to override any resistance by Dochow’s professional staff to the order to appease Keating.
Wall needed political cover for the order to appease Keating. The newly created Enforcement Review Committee (ERC) was used to try to provide that cover. This was a logical tactic, but it backfired, and caused further humiliation for Wall and his lieutenants. First, Dochow tried a last, desperate measure to convince the FHLBSF to cave in to Keating’s demands. This was hopeless, and it further embarrassed the agency in unexpected ways. The FHLBSF team met with Dochow on February 3, 1988. Dochow informed us that Keating was demanding that our jurisdiction over Lincoln Savings be removed, that Dochow believed he would recommend that the agency accede to that demand, and that the agency was already negotiating a memorandum of understanding with Keating’s lawyers that would remove our jurisdiction.
In short, the ERC was a fig leaf giving the vaguest cover to an act of naked political power. In addition to Dochow, Barclay and Luke were the voting members of the ERC. The choice of Barclay for the committee revealed a great deal about the ERC. Wall chose him, the only principal supervisory agent (PSA) with no supervisory or enforcement experience. Barclay was the only PSA who owed his appointment to Wall and the only PSA that Wall had leverage over. Barclay’s vote, therefore, was a foregone conclusion. Luke, who had no supervisory experience and had followed without protest Wall’s mandate to accede to Keating’s demand that the field visit be halted, would make the vote unanimous. The two nonvoting members of the ERC were Rosemary Stewart and Karl Hoyle (Wall’s congressional relations man). They voted, however, on one enforcement case, Lincoln Savings, providing greater cover to Wall and Martin. (Allowing nonvoting members to vote in favor of non-enforcement had a certain baroque symmetry.) Stewart detested the FHLBSF and was Keating’s greatest defender on the staff, so her vote was never at issue, and Karl Hoyle’s job was to keep Wall from suffering Gray’s fate, so a unanimous vote in favor of appeasing Keating was inevitable. In (mild) defense of the ERC members, they rarely tried to hide the fact that removal of the FHLBSF’s jurisdiction was certain because Keating demanded it as a precondition.
Dochow inadvertently informed us at the February 3 meeting that Keating had provided Martin with a file that was supposed to have adverse information about Cirona and me. Naturally, we asked to see it so we could respond. Dochow said he could not show it to us without Martin’s permission. We told him that was outrageous, and we insisted on seeing the file that day (U.S. House Banking Committee 1989, 2:877–896).
We then discussed the proposed meeting with Keating. (This was the meeting that Dochow was referring to in the testimony I quoted previously about how he saw his role as a “referee” between Keating and the FHLBSF.) Dochow told us that Keating insisted that I be excluded from the meeting and that he, Dochow, believed that if that was what Keating wanted, I should be excluded. Again, for obvious reasons, all of this was unprecedented. Cirona told Dochow that was unacceptable. I was his general counsel; he had confidence in my integrity. Keating wanted me excluded because of my abilities and knowledge. No regulator could function if the regulatees could exclude the regulators they found most effective. Further, Keating was threatening to sue the FHLBSF and the Bank Board, and Cirona said that I was the first person he would pick to accompany him to a meeting with Keating. Dochow said he would still recommend that I be excluded. Cirona said that if the Bank Board gave Keating a veto over FHLBSF participants, no one from the FHLBSF would meet with him. Dochow responded that he had hoped Cirona would not say that because his recommendation would be to meet with Keating without any FHLBSF representatives. Cirona requested the right to meet with the Bank Board Members about the file that Keating had given Martin and about Keating’s demands to exclude me from the meeting.
We called over to headquarters and found that White was the only Board Member who would make himself available for a meeting. Martin’s special assistant also attended the meeting. White told Dochow that he should provide us with what had become dubbed “the secret file” and said that permitting Keating to veto the agency’s representatives at the meeting could set a bad precedent. The Bank Board members would have to meet to decide whether to acquiesce in Keating’s demand. Given White’s views, we told him we would return to San Francisco to await the Bank Board’s decision on the meeting.
Martin’s special assistant contacted him. Martin ordered her to retrieve Dochow’s copy of the secret file to prevent us from seeing and responding to it. Martin alerted Wall to Cirona’s position about the meeting and to our having flown home to await the agency’s decision. Wall and Martin decided to go forward with the meeting without FHLBSF representatives.
That meeting, and a subsequent ERC meeting, produced a further humiliation for Wall and his team. (I was also excluded from the ERC meeting at which Keating and his representatives made a five-hour presentation. The FHLBSF was permitted to have a representative present only as an observer. The ERC forbade our representative to ask any questions or respond to Keating’s claims.) Keating renewed his claim that Gray and I had a vendetta against him. His evidence of this vendetta was the following story (which we learned the details about over a year later, when Keating’s lawyers deposed Stewart and my lawyer deposed Keating). Keating said that he attended a league convention in Hawaii and had noticed at one point that Gray was looking at him. A man came up to Keating and said that he had overheard Gray speaking to other Bank Board officials at his table. The man reported that Gray pointed at Keating and said, “That’s Charles Keating. I’m going to get that cock-sucker.” Stewart testified at her deposition that “I believed him” (she believed Keating when he told this anecdote). The anecdote is powerful. It offers direct support of Keating’s claim that Gray had a vendetta against him. Indeed, Stewart found it so powerful and believed it so completely that it led her—after Lincoln Savings was finally taken over and proved beyond any doubt to be the nation’s worst control fraud—to testify under oath that Gray had “a vendetta attitude” against Keating (U.S. House Banking Committee 1989, 5:19).
Stewart and Dochow led the Bank Board delegation that met with Keating. Neither of them asked Keating any questions about this anecdote. This is why Keating had to exclude me from the meeting. In 1989, Keating brought a Bivens lawsuit against me for $400 million. The key to such a lawsuit is that it allows you to sue the federal employee in his individual capacity. The only silver lining to this is that we were finally able to take Keating’s testimony under oath. My attorney and I crafted a series of questions about the anecdote.9 Here is my recollection of the substance of Keating’s responses.
Q. Who told you that Gray made these statements?
A. I don’t know.
Q. When did he tell you that Gray made these statements?
A. I don’t know.
Q. Which year did he tell you?
A. I don’t know.
Q. Where were you when he told you?
A. I don’t know.
Q. Were you in Hawaii when he told you?
A. I don’t know.
Q. Did you take any steps to check on the accuracy of what he told you?
A. Yes.
Q. What did you do?
A. I talked to former members of Gray’s staff who sat with him at the table in Hawaii.
Q. What did they say?
A. They said that Gray did not make any such remark.
Q. Why didn’t you include this alleged statement by Gray in the motion you filed to recuse Gray on the grounds of bias against you?
A. (Keating, looking very sheepish) Given what we’ve just gone through, I didn’t think anyone would believe me.
I was not in Hawaii, but I can attest that Gray never made any statement like this about anyone in my presence or to my knowledge. He also did not use that kind of vulgar language.
Stewart was the director of enforcement. By training, experience, and personality one would think that she would be certain to ask exactly the questions that immediately popped into my head when I finally heard Keating’s claims about Gray. But Stewart had logical reasons to detest Gray, Patriarca, and me. We believed that the Bank Board needed a new, more vigorous head of enforcement. Patriarca and I led the effort to get her pushed laterally into some newly created office with a fine title and no real responsibility so that Gray could appoint a new director. Stewart believed that Gray, Cirona, Patriarca, Selby, and I were too aggressive. Keating was criticizing people she was predisposed to believe the worst of, and she chose to believe him uncritically. Luke, of course, lacked this excuse. One would have expected the agency’s general counsel to probe Keating’s claim, but Luke did not.
Again, Dochow is harder to explain. Part of the problem, well known to criminologists who study fraud, is that we are not inclined to believe that respectable people will blatantly lie to us. Dochow is a fastidious man whose expertise was systems, not frauds. The FHLB-Seattle did not have a substantial problem with control frauds. Keating wore expensive clothes, and he looked like a former champion swimmer (which he was) and a highly respectable businessman (which he was not). Dochow explained to the ERC that he was comfortable with Keating because “he looked me straight in the eye” (U.S. House Banking Committee 1989, 2:974). Control frauds, of course, can lie fluently while looking one directly in the eye and swearing simultaneously on a holy text and their mother’s honor. The more important reason for Dochow’s behavior was that Wall had given Dochow his orders and Dochow followed orders. Wall did not tolerate dissent, and he could remove Dochow at will. Keating conned Dochow, but Dochow made the task simple by shutting down his critical reasoning abilities.
We followed up with formal demands for copies of the secret file and an opportunity to respond. Martin’s initial response to that demand was that he could not give the file to us without Keating’s permission (U.S. House Banking Committee 1989, 2:979–981). It turned out that Martin had obtained the secret file at his own request. Keating, in one of his many meetings with the Bank Board members (all of which we were excluded from), launched one of his many personal attacks on senior FHLBSF officials and Gray. He referred to a file while making the attacks. Martin asked him for a copy. Martin then circulated it to senior Bank Board officials without informing us of the file. When we persisted in demanding the file, Martin gathered up all copies of the files at the Bank Board and returned them to Keating. He did so for the express purpose of preventing us from responding to the charges.
Dochow, supported by other staff, and Martin told two inconsistent stories about the contents of the secret file. Dochow said it simply had old newspaper clippings of stories criticizing Keating and Lincoln Savings but no information about Cirona or me. Luke and Stewart said it had two documents: Lincoln Savings’ motion to recuse Gray (which contained no evidence of bias of Gray and did not deal with me or Cirona) and Keating’s general counsel’s memorandum of “talking points” that the Bank Board officials said had “nothing new” (U.S. House Banking Committee 1989, 2:912–913).
Martin, however, approached Cirona at a party and told him that he thought that the Bank Board would have to give Keating what he wanted. Cirona asked why. Martin said that Keating was threatening to sue the agency. Cirona responded that threats of lawsuits, and actual lawsuits, were common in America. It did not mean that you stopped doing what was right. Martin said that this was different: he had seen a Lincoln Savings file, and it had enough embarrassing dirt to make settlement prudent.
I believe Dochow’s version. Once the Bank Board finally took over Lincoln Savings, there were many lawsuits, hundreds of depositions, and tens of thousands of documents produced. If Keating had had any dirt, he would not have hesitated to use it, and no dirt ever emerged. It did not exist. Keating’s claims of a vendetta were pure fiction. The secret file remains important for four reasons. First, pretending it contained embarrassing information about us was a reprehensible way for Wall, Martin, and Dochow to treat their staff. Second, it enraged us and made the dispute personal. Third, it was critical that we not be given the file because our response would have been devastating and on the written record. Fourth, and most important, Martin’s seizing on a group of articles that had no negative information about Cirona and me and concluding that it proved that we were engaged in personal misconduct demonstrates the degree of personal animosity he felt.
We later received confirmation of the intensity and persistence of his hate. Years later, the Bank Board was able to see the work done by Lincoln Savings’ outside counsel. One memorandum sets forth the basis for bringing a Bivens lawsuit against me.10 It has a long passage discussing Martin. The context is that Michael Binstein, a reporter who worked for the syndicated columnist Jack Anderson, had written articles describing the February 10, 1987, Bank Board meeting with Speaker Wright and the April 9, 1987, meeting with the Keating Five. Both articles were critical of the politicians. The legal memorandum argues that I must have been the source for both articles because I was the only person present at both meetings. The conclusion was logically and factually fallacious; I was not Binstein’s source for either article. But the memorandum continued:
Perhaps the most significant evidence that Black is Binstein’s source is an investigation conducted by Roger Martin. Martin has stated to Jim Grogan that he has no doubt that Black is the individual who has provided Lincoln’s confidential information to Binstein and to other reporters. Martin’s conclusion is based on an investigation he conducted of an anonymous letter received shortly after the initiation of settlement discussions between Lincoln and the FHLBB. The anonymous letter, in Martin’s words, called him “on the carpet” for helping Keating. The letter stated that Keating was actually Martin’s enemy. Martin has told Grogan he is certain that the anonymous letter came from Black. Martin said that after he received the letter he authorized an investigation to determine if the postmark on the letter could be matched with the travel schedules of various Eleventh District personnel. Martin discovered that the letter was postmarked from the city in which Black and an assistant to Black had traveled to on government business on the day the letter was mailed. (Kaye 1988, 4–5)
Kaye, Scholer’s description of Martin’s role is priceless. Remember the context. Lincoln Savings was constantly threatening to sue the Bank Board for a vindictive campaign of leaks of confidential information. Martin, even more than Wall, believed that the threat of suit (plus the political pressure) required the Bank Board to capitulate to Keating. In these circumstances, Martin told Grogan (Keating’s in-house lawyer and chief political fixer) that he was sure that a Bank Board official had violated the law and harmed Lincoln Savings. That would have made Martin the star witness for Keating in the lawsuit. Martin would have confessed that the agency was guilty.
If Martin really believed that he had proof that I was leaking documents to damage Keating, he had a clear duty. That would constitute cause to fire me, and I should have been fired immediately. Martin, of course, never tried to fire me, because there was no basis for the claim. It is also revealing that Martin spent his time investigating the Bank Board’s field personnel and reporting the results to Keating instead of investigating Keating and sharing the findings with the field. Of course, his idea of an “investigation” or of “proof” was idiosyncratic. When the president defines the government as “the problem,” and appoints leaders who treat their staff as “the problem” and the thieves as their confidants, the thieves have a field day.
Martin was so supportive of Keating that he served as a confidant even regarding information about Wall’s private views. On May 6, 1988, Keating called Senator Cranston’s top aide and complained that “Black … precipitated this whole thing” and that “Danny Wall is too weak to stand up against him.” Keating said that “Rodger [sic] Martin … said as much to him”(U.S. Senate Committee 1990–1991b, Special Counsel Exhibit 150, 2–3).
Martin’s belief in the FHLBSF’s perfidy was so complete that, like Stewart, he retained his belief that the FHLBSF was worse than Keating, even after Keating had been shown to be the worst S&L control fraud. When Patriarca left government service and joined Wells Fargo Bank, a San Francisco newspaper wrote the traditional blurb announcing the new hire and noting how he had warned the Bank Board that Lincoln Savings should be closed. Martin wrote the reporter a letter on February 24, 1992, attacking Patriarca. The first paragraph showed that Martin’s inferential skills and standards of proof remained unchanged:
I read with interest your flattering article of [sic] Michael Patriarca. Perhaps you wrote this because he leaked information to you.11
The ERC process continued to produce new problems for the Bank Board. Barclay had Selby accompany him to all ERC meetings until Selby agreed with the FHLBSF when it argued against removing Lincoln Savings from its jurisdiction. After that, Selby later testified, Barclay “disinvited” him to all future ERC meetings (U.S. House Banking Committee 1989, 2:1048). The SEC then informed the Bank Board that its investigation corroborated the FHLBSF’s criticisms of Lincoln Savings, and the Justice Department began a criminal investigation of Lincoln Savings’ massive file stuffing and document and signature forgeries (ibid., 5:676–677).
The ERC seized on a new leak about Lincoln Savings as a justification for removing Lincoln Savings from the FHLBSF’s jurisdiction. Unfortunately for their purposes, the source of the leak proved to be a relatively recently created document that the FHLBSF (and Gray) had never had access to. The Bank Board could have been the source of the leak, but the far more likely explanation is that it came from Congress (which the Bank Board had supplied with the document). Despite the logical difficulties of using this as a basis for removing the FHLBSF’s jurisdiction, the ERC implied that it was a valid basis.
Meanwhile, the Munich negotiations continued, and produced further problems for the Bank Board. The documents that were emerging would, purportedly, “freeze” the S&L’s risk. The actual documents, however, did not freeze any aspect of the S&L’s risks. Lincoln Savings was permitted to grow rapidly using high-risk assets, including direct investments (despite its massive violation of the rule) and junk bonds (because the Bank Board did not understand the authority of California-chartered S&Ls). The Bank Board’s ignorance was understandable because it deliberately excluded the FHLBSF and the CDSL from the negotiations. The only persons knowledgeable about the S&L’s investment powers were Lincoln Savings’ counsel. They did not find it prudent to point out that the Bank Board had left a gaping loophole through which the S&L would soon drive an enormous increase in junk bonds, just as the junk bond market tanked.
It misses the primary point, however, to focus on the Bank Board negotiators’ failures. Dochow and Stewart were in an impossible position. The central problem was that Wall’s order (fully supported by Martin) to negotiate an agreement that Keating would approve required the Bank Board to surrender unconditionally. Keating was not aiming for a toothless enforcement agreement; he insisted on a nonenforcement agreement with serrated teeth that would slice through the Bank Board’s enforcement powers. Any enforcement agreement that Keating agreed to sign would, from the Bank Board’s standpoint, literally be worse than no agreement at all. Here Dochow was at a critical disadvantage, for he did not understand the Bank Board’s enforcement powers and was not gifted at interpreting complex legalese. He had to rely on Stewart, and she was the staffer most supportive of Keating. This would eventually lead to a breakdown of their relationship as Dochow came to believe that Stewart had misled him about how seriously the agreements restricted the Bank Board’s normal supervisory and enforcement powers.
Stewart compounded her eventual problems by personally signing a “side letter” to Lincoln Savings saying that the Bank Board had “no present intention” of filing criminal- or securities-law referrals against Lincoln Savings (U.S. House Banking Committee 1989, 2:1004). The Bank Board did have substantial new evidence of additional criminal acts by Lincoln Savings officials at the time she signed the letter, so the agency should have updated the criminal referrals. Stewart negotiated the side letter at Keating’s request, but the Bank Board authorized her to sign it. Nevertheless, the personal signature was sure to make her the focus of investigators’ wrath if Keating proved to be a fraud. Both the Justice Department and the SEC were likely to be furious with her (not just with Wall and Martin). The existence of the side letter was kept secret from the field.12
Keating’s primary outside law firms for dealing with the Bank Board, Kaye, Scholer and Sidley & Austin, competed to see which could pummel the helpless Bank Board negotiators harder. They knew that Keating graded law firms on results and aggressiveness (U.S. Senate Committee 1990–1991a, 6:323–324). Margery Waxman, Sidley’s lead partner on the matter (and Henkel’s ethically challenged ethics counsel) wrote a January 22, 1988, memorandum to Keating discussing the February 5 meeting.
If we bring a lawsuit against San Francisco before the meeting, Bill Black … will advise them not to meet with us. This will give Black and everyone else in San Francisco who is out to get us the leverage to pull the case out of Washington. “They” have been saying we are incapable of sitting down and rationally discussing the exam. Dochow knows that isn’t true but he won’t have a choice after we sue. Even Jordan Luke will advise him against talking to us after the lawsuit is filed….13
If you can’t reach a settlement with Dochow … then launch your nuclear offensive … they will deserve everything they get. (Waxman 1988a, emphasis added)
Keating forced Dochow to agree to exclude me from meetings. Keating then convinced Dochow to exclude the agency’s outside accounting firm, Kenneth Leventhal—which the FHLBSF had hired at the recommendation of ORPOS because of the firm’s real-estate expertise and reputation for honesty—from visiting Keating’s hotel, the Phoenecian (which ultimately suffered a $100 million loss). In another of those small things that show so much, Dochow kept referring to the FHLBSF as having an “aggressive” edge in examining Lincoln Savings. When we pressed, the example he came up with to support this claim was that the FHLBSF had hired Kenneth Leventhal—which, we pointed out, we had done at ORPOS’s recommendation. Dochow had no response at this meeting, but we later learned that he continued to criticize us as “aggressive” when we were not present. Dochow believed that an aggressive supervisor was so self-evidently a bad thing that he never explained why the label should not be considered a compliment.
When the FHLBSF commissioned an independent appraisal that showed a large loss on the hotel, Keating swung into high gear. Lincoln Savings paid a bank over $20 million in “fees” to arrange for the Kuwaiti Investment Office (KIO) to purchase a major interest in the hotel at a price suggesting that the hotel’s market value was well in excess of the value found by the appraiser. Simultaneously, Lincoln Savings had an outside law firm research the Foreign Corrupt Practices Act, which prohibits U.S. companies from bribing foreign officials. I joked that we now had good evidence of the market price of bribing a Kuwaiti prince (the royal family runs the KIO), not the market value of the hotel.
In response to the FHLBSF’s warning that excluding me from meetings would set a terrible precedent, Dochow said that he saw no precedent. Keating reached the opposite conclusion. Encouraged by its success in excluding first me and then the agency’s accountants, Kaye, Scholer induced Dochow to exclude O’Connell from any subsequent examination of Lincoln Savings and further stipulated that the Bank Board
will give us names of everyone on the examination team for FHLB before hand and Dochow said he would listen to any objections that we might have as to suggested people. (U.S. Senate Committee 1990–1991a, 4:258)
Dochow went even further on January 3, 1989. He formally removed O’Connell from all matters involving Lincoln Savings (U.S. House Banking Committee 1989, 5:856). With the FHLBSF removed, O’Connell had emerged as the most vigorous and effective critic of Lincoln Savings. Keating, logically, targeted the officials who he most feared would stop his crimes. By 1989, however, Dochow knew that Keating was a control fraud and that he had looted Lincoln Savings so severely that it was certain to fail. Dochow also knew that the FHLBSF and the CDSL would be harshly critical of his supervision of the S&L. Dochow could not afford to have O’Connell turn on him. O’Connell understood his leverage and had a firm moral compass. He told Dochow he would resign if he were removed from the case. Dochow quickly rescinded his earlier order but tried to keep O’Connell away from taking any visible role on the case.
The FHLBSF compounded Wall’s problems in the run-up to Munich. Patriarca told Dochow that the precedents the Bank Board was setting would irreparably damage the agency. He also noted a central logical flaw. If the FHLBSF was engaged in a vendetta against Keating, its leadership had to be removed. It could not be left in charge of the largest district (with over 30 percent of the industry’s total assets). Patriarca and Cirona asked Dochow to fire us if he believed Lincoln’s claims. (We were not offering to resign, and we would have used the effort to fire us to expose Wall’s capitulation to Keating and the damage it would inflict.) Patriarca appeared, accurately, as the essence of professionalism, whereas the reputations of Wall’s lieutenants’ fell.
The FHLBSF also kept its cool. We were dragged back to headquarters on minimal notice, taking “red eye” flights in and flights back that same night. We were then attacked personally by our colleagues and treated as the enemy while we were exhausted. But we never lost our cool or responded with personal attacks against the ERC members, Wall, or Martin while there was still a chance we could convince them that they erred. Instead, we documented why the path they were advising would produce a disaster. The FHLBSF knew far more about Lincoln Savings, about control frauds, and about Keating than any of the ERC members. Our advantage was in logical analysis, and we maximized that advantage by concentrating all our efforts there. This meant that the record before the ERC would be acutely embarrassing to the Bank Board when Lincoln Savings failed.