The ERC gave Wall all the cover it could, unanimously recommending the removal of the FHLBSF’s jurisdiction over Lincoln Savings. The ERC members knew that they had Wall and Martin’s votes. The issue was not whether their recommendation for removing the FHLBSF’s jurisdiction would be adopted, but whether they could avoid embarrassment.
White was the only Bank Board member willing to be briefed by the FHLBSF. At the end of our briefing he explained that he would vote against removing the FHLBSF’s jurisdiction, but would not make the matter a cause célèbre, because he “had bigger fish to fry.” He explained that Wall and Martin’s inept sales of failed S&Ls could cost the taxpayers many billions of dollars. If he went to the mat with Wall on Lincoln Savings, Wall would thereafter freeze him out, and he would be unable to stop worse scandals in the sales. White never understood the human dimension of regulation and leadership. Removing the FHLBSF’s jurisdiction at Keating’s behest was of transcendent importance to the Bank Board, and it was important to every regulatory agency (Seidman 1993, 188). There were billions of dollars directly at stake in Lincoln Savings (more than White could have saved on any other FSLIC deal), but the indirect cost of capitulating to Keating was far greater.
Dochow and Stewart realized that their greatest risk of embarrassment came from the FHLBSF. Their solution was straightforward: they recommended that the FHLBSF not be permitted to address the Bank Board on the most critical matter the Bank Board and the FHLBSF had ever dealt with. Bank Board meetings to consider enforcement actions always included the FHLB with jurisdiction over the S&L in question. Nevertheless, the FHLBSF was not invited to participate in the May 5, 1988, meeting. Indeed, the Bank Board kept the date of the meeting secret from the FHLBSF. Similarly, Dorothy Nichols, the litigation director, and Anne Sobol, who led the OE investigation of Lincoln Savings and recommended that the agency make a criminal referral, were not invited to attend the meeting. The CDSL and the SEC were not invited to or informed of the meeting.
But fate was unkind to the ERC members. Luke, the ERC chairman, had sent Cirona a copy of the ERC’s recommendation to remove the FHLBSF’s jurisdiction over Lincoln, and Cirona called Luke on May 4. Luke did not see the message slip until the morning of May 5. Luke told the Bank Board meeting that Cirona had called, but he had not responded. Luke was concerned that Cirona would attack them for secretly rushing through the ERC’s recommendation at a hastily called Bank Board meeting kept secret from Cirona (U.S. House Banking Committee 1989, 6:407–408). Wall responded to Luke’s concerns an hour later (9:20 a.m. in Washington, D.C.). The meeting transcript captures his characteristically convoluted style of speech.
Let me just make the announcement that we are trying to locate Jim (Cirona) as long as was reasonable, given the difference in time, to see if he can get on the bridge [conference call]. I think it’s appropriate to give them an opportunity; on the other hand, the observation has been made that the other side, the Lincoln side, is—would not be a participant. I think we have certainly heard, I think, a fair, and what appears to be even-handed presentation and it’s appropriate, I think, for us to give consideration, specifically, to part of the System, in this particular case, the—our regulatory arm. So we’ll see if we can get him involved (U.S. House Banking Committee 1989, 6:437–438; subsequent citations for this meeting come from this source).
It may be obvious, but here is what was going on. The Bank Board began its meeting at what was 5:20 a.m. in California. An hour later, after the ERC presentation, it woke up Cirona at his home in San Francisco (at 6:20 a.m.). (Cirona’s home phone number was on a card carried by Wall’s senior staff, and since it took under ten seconds to add someone to the conference line, the delay was intentional.) Cirona did not hear any of the presentation; he had no materials at home; he was half-asleep; and he was not the FHLBSF expert on Lincoln Savings—we, his senior staff, were. Despite the palpable cynicism underlying the call, Cirona, ever the gentleman, simply declined to take part in those circumstances.
Dochow first noted that he doubted the Bank Board members had read the FHLBSF memorandum to the ERC. He said that although he knew it was “unfair” to do it this way, he would read the captions from the memorandum to explain the FHLBSF’s position (435).
Freed of any knowledgeable opposition, Dochow, Stewart, Hershkowitz, Hoyle, Barclay, and Wall produced such revealing quotations that they ultimately sealed their own fates. It worked out better that we were excluded from the meeting.
The transcript is replete with tragicomic vignettes, but it can be boiled down to three areas. First, there are odes to Keating. Dochow’s recommendation was premised on the belief that Keating had not been sufficiently involved in running Lincoln Savings and that the solution was to have Keating take full control of the S&L. The theme of “Keating as paragon” spread. Dochow said that any deficiencies at Lincoln Savings, e.g., its misrepresentations to the agency, had occurred when Keating was not “focused” on the matter (414). Anything Keating focused on was apparently a success. Dochow told the Bank Board:
It’s my personal belief that Mr. Keating is probably a very fine real estate developer, and so many things come to mind that, in my opinion, would indicate that (416).
Indeed, the key was to let Keating do more, to cut back supervisory restrictions, and, in Dochow’s phrase, to let him “have a little bit of room” (418). Dochow paraphrased Keating’s plea as “Trust me.”
Hoyle predicted that Keating would prove “a good regulatory citizen” because he owned substantial stock in ACC (434–435). Hoyle did not have any expertise in regulation, so he may not have known that the worst S&L control frauds invariably owned substantial stock in the S&Ls they looted.
Wall spoke of his personal regard for Keating’s business acumen.
It seems to me that Mr. Keating, in my own knowledge, has been a very active, and a very entrepreneurial businessman for at least the last 13 years, that I’ve known him only known him basically and very much at a distance, but he is clearly not a flash in the pan and he’s not a Don Dixon [who looted Vernon Savings] (450).
The second major embarrassment involved apologies for Keating’s misconduct. I discussed one major example, the claim that the agency had been repeatedly lied to only because Keating had not focused on the matter. But the OE, through Stewart and her deputy Hershkowitz, mounted grander defenses of Keating. Stewart began by claiming that there was no evidence of “abnormal risk” at Lincoln Savings (422). In fact, there had never been a more sophisticated and ample documentation of “abnormal risk” by any Bank Board entity in the history of the agency than that presented by the FHLBSF and its outside experts. Dochow had just finished explaining how Lincoln Savings was replete with abnormal risk. No one pointed out the contradiction or asked how enforcement attorneys had become experts on risk.
Stewart hit her stride with her description of Sobol’s findings.
A lot of depositions were taken, and people do disagree about the conclusions. I find them not particularly startling, not particularly indicative of criminal activity except by some fairly low level folks at Lincoln. (423)
The depositions proved that Lincoln Savings had engaged in massive file stuffing to deceive the examiners about its lack of meaningful underwriting of loans and investments. They also proved that hundreds of forged documents and signatures were intended to deceive the agency into believing that hundreds of millions of dollars of direct investments had been made much earlier and then “grandfathered.” Everyone at the agency other than Stewart and Hershkowitz found this both startling and indicative of criminal activity. Stewart even claimed that Keating’s lawyers had a “plausible” explanation for why it was permissible to forge documents and signatures.
The files were stuffed and the documents and signatures forged by “fairly low level folks at Lincoln” (and Arthur Andersen). But no one believed that these secretaries and paralegals decided on their own to engage in these enormous fraudulent exercises. Top lawyers ran both forms of criminality out of the Lincoln Savings and ACC legal departments. Stewart, Dochow, Wall, and Martin continued to meet with those lawyers in order to negotiate the Bank Board’s surrender to Keating even though the Bank Board had filed a criminal referral against them. Indeed, Stewart had concurred in the appropriateness of that referral. Nobody at the agency thought that the lawyers were engaged in some frolic of their own not ordered by Keating. Powerful lawyers who force “low level folks” to commit forgeries are culpable and contemptible.1
Stewart’s most novel support for Lincoln Savings, however, came when she brought up the subject of leaks.
Finally, I believe very strongly that Lincoln has been victimized by deliberate leaks of information. My own recommendation is, in large part, based upon that belief. How the Bank Board deals with that kind of situation, when we do not have a person that we can prove is responsible for those leaks, becomes difficult….
So, in an indirect way, [the ERC’s recommendations] address those illegal leaks of information and the harm to Lincoln. Much like Affirmative Action addresses discrimination, it’s not directly in response, and yet it seems to be a fair way to deal with what we have on the table. (423–424)
This may be the single most muddleheaded analogy in regulatory history. It was not spontaneous: Stewart had been trying it out on others for months. The irony of Stewart calling for “Affirmative Action” for Keating, one of the most privileged human beings on the planet, was rich. She was probably not aware that he was a racist and sexist bigot of truly epic proportions and that he despised affirmative action (Binstein and Bowden 1993, 236, 248, 380).
Regardless of Stewart’s analogy, there was no evidence that anyone at the FHLBSF had leaked anything or that the most recent leaks could possibly have come from the FHLBSF. How could removing the FHLBSF’s jurisdiction over Lincoln Savings be the appropriate remedy? But no one told the Bank Board that the leak could not have come from the FHLBSF, even when Wall intimated that the FHLBSF was the most likely source of the leaks (U.S. House Banking Committee 1989, 6:808). In any event, Keating, not the press, victimized Lincoln Savings.
Hershkowitz’s defense of Keating was even more robust. Stewart had said, in essence, maybe he’s not crooked; maybe it’s just his secretaries. Hershkowitz went much further: he seemed to be saying that the Bank Board should take no action regarding Keating, except perhaps to praise him.
The documents that we’ve been talking about are all traditional enforcement documents. But this is not a traditional regulatory case. The institution is not doing anything illegal; in fact it is engaging in those types of transactions that have been contemplated by Congress and contemplated by this Board as the general direction that the industry might go in order to increase its profits outside traditional business…. [M]anagement [has] a personal stake in the transactions and have been successful in turning real profits, not paper profits, in these kinds of transactions. (432)
This was an extraordinary defense of Keating. Even Stewart conceded that Lincoln Savings had committed illegal acts. How did an enforcement attorney know that Keating was producing real profits when Dochow’s staff found it was producing real losses? Congress prohibited federally chartered S&Ls from engaging in almost all direct investments. But Hershkowitz was presumably reflecting accurately what was “contemplated by this [Bank] Board.” Wall and Martin thought that direct investment was sure to “increase … profits.” The argument that Keating posed no risk to the FSLIC because he had “a personal stake in the transactions” ignored the fact that officers and directors are not supposed to have “personal stakes” in S&L transactions. Such a personal stake creates a conflict of interest that violated Bank Board rules. Keating did, in fact, have such conflicts in several transactions, and they produced large real (not paper) losses. The FHLBSF examination had documented, and ORPOS had confirmed, that virtually all of Lincoln Savings’ claimed “profits” were paper, not real.
The third area of embarrassment was the adoption of a bizarre, mirror-image sort of logic. Lincoln Savings was certain to fail, and fail catastrophically, if it was supervised conventionally. But using the Bank Board’s logic, what appeared to be Keating’s greatest weaknesses flipped, and became strengths. Keating’s abusive, confrontational style and his disdain for regulation meant that Lincoln Savings’ survival depended on a hands-off style of regulation. Hershkowitz explained it this way:
Based on what I’ve seen, and I think I’ve talked to Kevin [O’Connell] about this, we agree that if the institution remains in its current supervisory situation, it will, inevitably, fail. An institution that engages in high-risk transactions requires extra supervisory surveillance, and it needs a regulator that will permit management to make management decisions. San Francisco has demonstrated in the past with this institution that it believes that its current assets and risk profile is such that it will not permit them to do that. (433)
Keating’s use of political power against the Bank Board should have been a major problem for him, but it became his greatest strength. The great hope became that Keating would use his political power to get favors from local and state governments, and that this would cause the value of Lincoln Savings’ real estate investments to surge. Under this logic, the worse off Lincoln Savings became, the more essential it was to keep Keating in charge and free of regulatory restrictions. (Of course, they ignored the fact that Lincoln Savings was steadily getting worse precisely because Keating controlled it.) Each of these points is exemplified by Barclay’s comments to the Bank Board.
I believe also that Keating probably is the only one who can preserve a significant amount of value for Lincoln. I believe that he is a—and he proved to us, he is a very strong sales oriented individual and I believe, although he says he has no political connections, that only he can get some of the zoning changes that are necessary to enhance the value of the properties [that] otherwise would be substantial losses for the institution. (419)
Barclay went even further about fifteen minutes later, expressing concern should the Bank Board win an enforcement action against Lincoln Savings.
And the chances of … if we are successful in court, would be to have the people who are most qualified to enhance and preserve value gone and the cost [to the] FSLIC would be excessively greater. (429)
Barclay voiced the reductio ad absurdum: when the S&L fails, the Bank Board will have to rely on Keating’s political power to reduce losses. No one asked why Lincoln Savings was failing if Keating was such a superb real estate developer and was supported by politicians who provided him with optimal zoning and easy permit approval.
Wall and Martin voted to remove the FHLBSF’s jurisdiction over Lincoln Savings. White dissented. Ever nonvigilant, the Wall Bank Board was later shocked when Keating wanted an even more abject surrender, and threatened the Bank Board politically and with litigation until it surrendered unconditionally.
The Bank Board’s May 5 vote gave Keating everything he demanded. Characteristically, he responded to appeasement by increasing his demands. He and his lobbyists contacted members of the Keating Five to have them pressure the Bank Board into giving in to Keating’s newest demands.
Once the FHLBSF had been excluded, Waxman was confident of complete success. As she gloated in her May 10, 1988, memorandum:
You have the Board right where you want them and you should be able to reach an agreement tomorrow which will completely satisfy you.
As you know, I have put pressure on Wall to work toward meeting your demands and he has so instructed his staff. They all know the Wednesday meeting is crucial to their future. If they mess up this time, it is all over. The points that you should come out with tomorrow are: San Francisco is finished. [N]othing can be done to follow up their exam. (U.S. Senate Committee 1990–1991a, Vol. 2, pp. 180–181)
The remainder of the memorandum (accurately) predicted the details of the Bank Board’s surrender, which was formalized ten days later.
Grogan was so excited by the victory that he told a CDSL supervisor that Keating and Lincoln Savings “got everything they wanted from the Bank Board” (MDL #OTS-D11-0553847). The CDSL learned of the Bank Board’s May 5 meeting and decisions through Grogan, not the Bank Board. This, predictably, added to Commissioner Crawford’s rage against Wall.
The Bank Board’s capitulation to Lincoln Savings was delayed both by Keating’s desire to place even more restrictions on the agency and by O’Connell’s tenacious rearguard action. By the time the Bank Board signed the instruments of surrender on May 20, 1988, the facts had developed so as to ensure that Wall’s peers would view his action as indefensible. Wall’s central problem was that Lincoln Savings was following the classic control-fraud pattern, which would inevitably lead to failure. As 1987 and 1988 rolled on, dozens more of the high-fliers were proven to be, despite forbearance, failed control frauds. The growth rule was killing the Ponzis, though forbearance and the slowdown in enforcement had extended their lives and deepened their damage.
The track record was even more dismal for S&Ls that had invested primarily in direct investments. Every S&L that had invested more than 10 percent of its total assets in direct investments in 1983 (the ones Benston had praised) had failed by 1988. Wall was betting that Lincoln Savings would be the only survivor.
Before the Bank Board could reach an agreement with Keating, it was embarrassed by an incoming tide of developments involving Lincoln Savings. The agency dealt with those embarrassments instructively. Shortly after Robertson recommended that Lincoln Savings be taken over, Wall removed his authority over it. After Selby supported the FHLBSF, Barclay barred him from attending any future ERC meetings. After the Seattle bank supported the FHLBSF, it was excluded from the May 5 meeting even though the deal contemplated eventually moving Lincoln Savings to their district.
The SEC found that the FHLBSF was correct about numerous acts of securities fraud by ACC that arose from Lincoln Savings overstating the value of its assets. The SEC also found that ACC/Lincoln Savings and their new outside auditor, Arthur Young, were so uncooperative that it was forced to institute a formal investigation. (Contemporaneously, Dochow assured the Bank Board that Keating had turned over a new leaf and was now a good regulatory citizen.) So, naturally, the SEC was not informed of the Bank Board’s meeting or the planned agreements with Keating, even though they obviously undercut the SEC’s case against ACC for securities fraud. The CDSL supported the FHLBSF’s actions. It was, contrary to uniform Bank Board practice, excluded from the May 5 meeting. The ERC at least told the Bank Board that the CDSL opposed the proposed agreements, but it said that the CDSL’s views were not entitled to any weight because it had been influenced by the FHLBSF. (Yes, the CDSL listened to our arguments, and to Dochow and Stewart’s arguments, and it agreed with us. That was not a reason to disparage its views unless Dochow viewed the FHLBSF as an infectious agent.)
The ERC did not inform the Bank Board that the peer review of the FHLBSF had opposed the Bank Board’s removal of its jurisdiction. Then, between May 5 and May 20, the Justice Department, which had (because of resource constraints) originally indicated that it would not investigate the FHLBSF’s criminal referrals, informed the Bank Board that it had begun the investigation. O’Connell made a last ditch, impassioned effort to convince Dochow not to sign the agreements, but the only effect of his plea was to convince Dochow that he should greatly limit O’Connell’s role in the examination.
Wall and Martin’s gamble became desperate. If Keating turned out to be a crook, everyone would have the evidence and the incentive to say that they had warned the Bank Board not to capitulate. Dochow had a similar problem. After rejecting O’Connell’s pleas, he made his own plea to Keating (through Keating’s lawyers). Their notes show that he recognized there were enormous loopholes in the agreements that would allow Keating to greatly increase Lincoln Savings’ size and risk. Dochow told Keating’s lawyers that he was staking his reputation on the belief that Keating would not exploit the loopholes. To throw oneself on Keating’s mercy was a remarkable act. Unfortunately, Dochow was entrusting the public purse along with his personal reputation to Keating’s mercy. Again, it has to be stressed that the people who directed him to appease Keating (and the administration that appointed them) are most responsible for this scandal.
The agreements signed were, of course, unprecedented. They represent the only time in history that a financial regulatory agency consented to what was, in substance, a cease-and-desist order against the agency and permitted an institution that it had found to be in massive violation of its rules to increase those violations. The Bank Board got no meaningful restrictions on Lincoln Savings; instead it surrendered unconditionally and provided reparations (“affirmative action,” in Stewart’s parlance).
There were three documents signed on May 20, 1988. The Bank Board eventually gave copies of two of them to the CDSL, which gave us copies. The third document was not disclosed outside a small group at headquarters (and Lincoln Savings). The Bank Board got two things in the agreement: ACC agreed to contribute $10 million to Lincoln Savings to increase its capital, and Lincoln Savings agreed to recognize a relatively small number of accounting adjustments that would have the effect of reducing its capital. The bad news, which was not in the agreement, was that ACC and the Keating family had taken roughly $120 million out of Lincoln Savings and ACC during the time the Bank Board had forbidden the FHLBSF to examine or supervise Lincoln Savings. Returning $10 million left Keating over $100 million to the good. The agreement allowed Lincoln Savings to “un”-adjust its accounts to “un” recognize the loss of capital if its accountants agreed, and the Bank Board knew that Arthur Young agreed with Keating that the adjustments should not be made. The provision, therefore, proved illusory.
Sadly, the Bank Board claimed a third advantage to the agreement, the right to examine Lincoln Savings. The Bank Board had an absolute right to examine any S&L, and as I explained, Lincoln Savings could not get a court to block its examination. The agreement had a number of other illusory provisions in which Lincoln Savings agreed not to do things it could not lawfully do.
The memorandum of understanding (MOU) was the first agreement a regulator ever made in which it effectively consented to a cease-and-desist order against its own supervisory powers. Recall that ORPOS and the SEC had confirmed the accuracy of the FHLBSF examination. The Bank Board nevertheless agreed that it could not use that examination to support any action against Lincoln Savings or ACC or any of their officers. Worse, in a very broadly drafted section, the Bank Board agreed that it could not bring an enforcement action against these entities even if it independently verified violations that arose from matters criticized by the FHLBSF examiners. The Bank Board agreed to remove the FHLBSF’s jurisdiction over Lincoln Savings and bar its personnel from any examination. The Bank Board also agreed to limit its power to bring even enforcement actions that were unrelated to the FHLBSF findings. The MOU even allowed Lincoln Savings to expand its direct investments in ways that otherwise would have been unlawful.
Keating achieved more with the MOU than he had attempted to obtain through Henkel’s subterfuge or the Keating Five’s political pressure. Henkel and the Keating Five would have obtained immunity only for Lincoln Savings’ existing violations of the rule. The MOU not only provided the long-sought immunity, but also allowed Lincoln Savings to make even greater direct investments with impunity. The Bank Board never brought an enforcement action against Lincoln Savings for violating the direct-investment rule, despite ORPOS’s confirmation that the FHLBSF examiners were correct and Sobol’s findings of widespread fraud designed to make such investments appear lawful. The political pressure finally paid off on May 20, 1988. Substantively, the MOU was the disastrous document.
The third agreement incurred the most intense wrath because it best captured the nature of the agency’s surrender. It was the document kept secret from the CDSL. Stewart, at the direction of the Bank Board and the demand of Keating’s lawyers, signed a side letter saying that the Bank Board had “no present intention” of making any referrals to the Department of Justice and the SEC. Again, although Stewart recommended providing the letter and drafted it, the blame has to be placed on Wall and Martin. Even if the Bank Board had not signed the side letter, it would have been extremely loath to make additional referrals against Keating, so the letter probably had little substantive effect. The letter became a flash point in the 1989 House Banking Committee investigation of Lincoln Savings’ failure.
I have quoted the memoranda showing that Keating got everything he desired from the Bank Board, but the best evidence of how happy Keating was with the deal was the party he threw when the Bank Board signed the deal on May 20, 1988. Keating, the antiporn activist, celebrated Wall’s surrender with a wild party at which he taped together men and women facing each other and poured Dom Perignon down women’s blouses. The revelers threw a computer out the window for good measure (Binstein and Bowden 1993, 71–72). The Bank Board’s humiliation seemed complete, but it would yet deepen.
Keating’s celebration was so intense because his victory over the Bank Board was so complete. The agreements made the task of the examiners more difficult because they impaired the Bank Board’s normal powers of examination, supervision, and enforcement. They also made the promptness and the effectiveness of the examination more critical because they authorized Lincoln Savings to make additional high-risk investments that would have been unlawful but for the deal. Lincoln Savings continued to grow rapidly and to place virtually all of its investments in ultra-high-risk assets. Worse, the investments were made in fraudulent transactions.
The Bank Board faced the problem of doing something it had never done: run an examination. It had to draw on the FHLBs to do that, and that posed many problems for Dochow. No FHLBSF examiners were permitted. None came from the FHLB-Dallas because its staff remained overwhelmed by local control frauds. That left ten districts, and Dochow created a team drawn from nine of them. It was, of course, difficult to assemble such a team, and the time passed. By the time the examination finally began in mid-1988, no full examination team from the Bank Board had been on-site for over a year and a half. Lincoln Savings, of course, had used that time to defraud.
Control frauds that relied on direct investments and ADC loans were clustered in the states that had deregulated the most. That meant that FHLBSF and FHLB-Dallas examiners and supervisors had by far the most experience evaluating such frauds. The FHLBSF had far more experience with control frauds that relied on direct investments because only California permitted its S&Ls to invest 100 percent of their assets in direct investments. The result was that new entrants intending to use direct investments as their primary fraud mechanism overwhelmingly sought California charters. By excluding staff from Dallas and San Francisco, Dochow had eliminated most of his expertise. Lincoln Savings was known to be the most complex S&L in the nation, so expertise was vital.
Dochow’s selections of senior examination staff exacerbated the expertise problem. Dochow could not solve the expertise deficit by drawing on former colleagues at the Office of the Comptroller of the Currency because national banks are forbidden to make direct investments. Dochow selected Steven Scott from the Seattle bank to run the examination team even though he had never conducted an Office of Thrift Supervision (OTS) examination and lacked experience with the types of assets Lincoln Savings invested in. Also selected were an examiner from the Pittsburgh bank to review Lincoln Savings’ real estate (which made up about 80 percent of its total assets), and an examiner from the Indianapolis bank to review the $1 billion junk-bond portfolio. The Pittsburgh and Indianapolis examiners were junior enough that I will not use their names. They had no experience with complex ADC loans, direct investments, junk bonds, or frauds. The blame for their mistakes belongs with Dochow (or Wall and Martin).
Scott was an unfortunate choice. He, like Dochow and Keating, was a fastidious dresser who believed himself to be financially sophisticated. This is the easiest personality type for a financial fraud to con. One incident captured this point for me. After Keating’s massive frauds were fully exposed (no thanks to Scott), Scott met with Patriarca and me to brief us on the current condition of Lincoln Savings: the Bank Board was about to restore the FHLBSF’s jurisdiction over Lincoln Savings. Scott gave us a dispassionate description of one fraud after another. At lunch, he switched subjects and went on, at great length and with real passion, about how superb Keating’s private jet was. It had one of the best sound systems he had ever heard, the wood paneling was rich and tasteful, and the seats were luxurious and comfortable. Keating had superb taste. Scott was so intent on this narrative that he did not notice that Mike and I were staring at him in horror. Scott had still not lost his intense admiration for Keating.
Scott was so open in his admiration for Keating during the 1988 exam that he caused a revolt among the other examiners, state and federal. David Riley, an FHLB-Atlanta examiner, testified about how Scott instructed new examiners when they arrived in Phoenix (Lincoln Savings was a California S&L, but all its senior management and its records were in Phoenix, where Keating ran ACC):
Scott … informed the examiners that the examination of Lincoln would start from a clean slate. He said that we would not be provided a copy of the previous examination report. He explained that we would not be allowed general access to ACC/Lincoln offices or employees, nor would we generally be allowed access to original documents. Instead, all questions or requests were to be directed to Tim Kruckeberg of ACC/Lincoln…. Scott expressly prohibited our access to ACC’s main headquarters building where the offices of Mr. Charles Keating, ACC Chairman of the Board, and the other top officers were located. Steve further said that any examiner who harbored any prejudicial attitudes toward Lincoln should go home. (U.S. House Banking Committee 1989, 3:513–514)
Riley went on to testify that each of these restrictions was unprecedented and each imperiled the exam’s accuracy (ibid., 514). The staff revolt, and CDSL protests, eventually caused Dochow to reduce—but not remove—these limits. In addition to these overall restrictions, Scott imposed additional unprecedented, harmful restrictions on Riley in the course of his particular assignment. Riley concluded that those restrictions were designed to blunt criticism of Lincoln Savings’ asset quality and its management abuses. He and several examiners from other FHLBs complained to Scott without avail. They then complained to senior officials at their home FHLBs and were told to start documenting the problems (ibid., 514–517). The revolt became so widespread that Dochow had to visit Phoenix and assure the exam teams that he did not desire a whitewash.
The FHLBSF heard from several FHLBs and the CDSL that the 1988 examination was a whitewash. We were told that Scott had explained to new examiners that the Lincoln Savings/ACC managers were so brilliant that they were out of the Bank Board’s league. Scott’s most disturbing statements, however, were that everything would be fine because Keating and his lieutenants were so smart that they could prevent losses even when they made bad investments (U.S. House Banking Committee 1989, 3:64). This was obviously a troubling statement for those fearing a whitewash, but it was also a strange statement. Lincoln Savings and ACC managers were obviously inferior. For the most part they were inexperienced graduates of second- and third-tier schools (with large chips on their shoulders about status). Keating deliberately hired callow yes-men (Black 2001; Binstein and Bowden 1993, 163).
Hiring people for their weak moral fiber exposed Keating to the risk that they would steal from Lincoln Savings. Keating’s audacity came to the fore when Mark Sauter, Lincoln Savings’ director of regulatory compliance, was the lieutenant placed in charge of the file stuffing and forgeries. Sauter had also embezzled from Lincoln Savings. Keating eventually discovered this. Keating had a serious problem: he had to remove Sauter, but if he fired him, Sauter would make a deal with the prosecutors investigating the file stuffing and forgeries. He would plead guilty to the crimes and reveal that they his superiors had ordered the fraud. That disclosure would endanger Keating directly, but it would also embarrass the Bank Board and vindicate the FHLBSF. The press and Congress would place enormous pressure on the Bank Board to remove Keating and clean the stables.
Keating’s answer to the problem of phony documents was to craft two more false documents. He reprised the strategy he had used with his Arthur Andersen resignation letter by writing a letter to Dochow and enclosing a letter from Sauter to Keating. The Sauter letter announced that he was resigning. Sauter’s letter recounted how he had been eager to work with the regulators to show that an entrepreneurial S&L could be both innovative and a superb regulatory citizen. The letter then praised Keating’s brilliance, ethics, etc. Sauter then explained that he was resigning because he had become convinced that the FHLBSF and Gray had a vendetta against Keating and were out to destroy him. Keating’s letter to Dochow opined that it was a travesty when abusive government officials drove such a fine young man to despair and to lose faith in his own government. Dochow and Stewart did not investigate to find out why Sauter really resigned. Instead, they accepted Keating’s letter as further proof of the FHLBSF’s abuses. Keating’s audacity conquered the credulous once more. Sauter would eventually plead guilty to the felonies outlined in the FHLBSF’s criminal referrals for file stuffing and forgery, but Lincoln Savings was long dead by then.
Combining inexperienced examiners and a supervisor who supported Keating produced an examination that found only minor losses at Lincoln Savings. The S&L was insolvent by roughly $3 billion by late summer 1988, but the federal examiners had identified less than $10 million (and perhaps as little as $5 million) in real-estate losses by what they intended to be their last week on-site (U.S. House Banking Committee 1989, 3:16).
Please consider what would have happened if the examination had truly found only small losses at Lincoln Savings. The Bank Board would, implicitly, have confirmed that Lincoln Savings was profitable and exceeded its capital requirements. Keating would have been permitted to grow and to change FHLB districts by acquiring another S&L. Lincoln Savings’ growth rate would have increased, and all of its new investments would have been in high-risk assets. (Virtually all of the new investments would also have been fraudulent.) It would have grown by roughly $1.25 billion in the first year, and by more than that each year it remained open. It would have lost more than this amount each year because the new real estate it financed would have deepened the glut, causing larger losses to its existing real estate. All other Arizona real estate owners would also have suffered increased losses. Lincoln Savings, and the politicians who intervened on its behalf, would have been vindicated and emboldened. Keating would have found it far easier to garner support if future examinations found problems. The FHLBSF would have been completely discredited, and other control frauds would have successfully emulated Keating’s tactics to escape its jurisdiction. Control frauds in other FHLB districts would have followed the same strategy. Keating would have corrupted the entire FHLB system. The results would have been catastrophic.
As with the fortuitous defeat of the administration’s effort to give Keating control of the Bank Board by appointing Henkel and Benston, the nation got lucky. Once more, effective public servants were essential to our good fortune. Keating was within days of his greatest triumph—a Bank Board examination that “proved” he ran a superior S&L—when he was brought down by the CDSL (Crawford, his deputy and successor Bill Davis, Gene Stelzer, and Dick Newsom), O’Connell, Smuzynski, and two examiners from the FHLB-Chicago, John Meek and Alex Barabolak. Others deserve substantial credit for fighting bravely against Scott’s efforts, but they were not in a position to deliver a decisive blow.
Crawford was the essential man. The FHLBSF had recommended that the Bank Board examine Lincoln Savings, its holding company, the tax-sharing agreement, and suspicious transactions that transmuted losses found by the FHLBSF into purported highly profitable “sales” of real estate. The Bank Board did not follow up on any of these recommendations. (If we had been cleverer, we would have begged the Bank Board not to investigate these subjects.) Crawford later told Dochow that the tax agreement smelled, and needed to be examined. The revolt (which Crawford supported) against the whitewash led Dochow to see the advantage of appearing responsive to such a recommendation.
In August 1988, ORPOS accountants looked at the impact of the tax-sharing agreement on Lincoln Savings (which is what the September 1987 field examination would have done). They found that Lincoln Savings had sent $94 million in cash to ACC (the parent holding company) under the purported authority of a tax-sharing agreement between ACC and Lincoln Savings.2
The tax-sharing fraud relied on a “cash for trash” scheme to transmute real losses into phony profits. The “profits” were so large that the tax-sharing agreement required Lincoln Savings to pay the $94 million to ACC. ACC, however, did not owe any taxes, so it was illegal for Lincoln Savings to make what was, in essence, an unsecured $94 million loan to its parent. That would have been true regardless of the financial condition of the parent, but it was a disaster given ACC’s financial condition.
It was a personal disaster for Dochow. Keating had personally assured him that he did not take a dime out of Lincoln Savings. Because of that assurance, Dochow had always dismissed criticisms of Keating’s (and his kin’s) outrageously large salaries and his rampant nepotism. ACC had long been deeply insolvent on a stand-alone basis (i.e., without Lincoln Savings) and sharply unprofitable. That meant that ACC could not repay Lincoln Savings. It was also clear that Keating would not voluntarily repay Lincoln Savings even if he could. ACC, of course, had failed to recognize the $94 million debt to Lincoln Savings as a liability, so the Bank Board had yet another reason to know that ACC was committing securities fraud by selling worthless junk bonds to widows and stock to the general public.
Indeed, now that Dochow knew that ACC was looting Lincoln Savings through tax-sharing payments, he had to order an immediate halt to any further payments to ACC. He did so on September 6, 1988 (the best birthday present I received that year). ACC had only two positive sources of cash flow—tax-sharing payments and the junk bond sales to widows. ACC lost money on operations at a prodigious rate, mainly because of the grossly excessive salaries paid to Keating and kin. The Bank Board knew that by stopping the tax-sharing payments it was ensuring that ACC would have to increase greatly the rate at which it defrauded the widows.
The Bank Board also knew that ACC would inevitably default and cause many thousands of widows to lose hundreds of millions of dollars. This would transform the arcane S&L crisis into a political scandal. For the first time, identifiable human victims would exist. We empathize with individuals, not statistics. These victims would have faces—grandmothers’ faces. There were tens of thousands of elderly victims, and there were “deep pockets” like the multitude of law firms, and three of the Big 8 audit firms, that helped Keating loot Lincoln Savings. That meant there would be private plaintiffs’ counsel and congressional hearings. The lawyers and congressional aides would search for victims who were personable and articulate and had heart-wrenching stories. As a longtime congressional aide, Wall knew what was coming. He could not know specifics such as the elderly man who committed suicide when he learned that he had lost his life’s savings. Or the mother who told Keating’s bond seller that she was investing her savings to earn enough interest to make a down payment on a wheelchair-accessible van—for her daughter who had suffered “catastrophic brain stem damage” (U.S. House Banking Committee 1989, 4:142).
The young man (so polite, so clean cut) explained to her why she should put all her savings in ACC’s junk bonds. The young bond seller earned a very nice bonus, and a “bond for glory” T-shirt. Maybe he had enough decency to refrain from mocking his victims at the ACC Christmas skits that made fun of the elderly who bought what one expert had publicly implied was “the worst” investment in America (U.S. House Banking Committee 1989, 2:471). In fairness to them, the bond sellers were so young and unqualified that some of them bought ACC bonds. The central point, however, is that it was Keating who devised the scheme and pressured his aides to maximize the take from the widows. He bears the moral culpability. The efforts of his defenders to excuse him on the grounds that he did not sell the securities himself, but caused callow youths to carry out the actual fraudulent sales, miss the point (Fischel 1995; Black 2001). He is more culpable, not less, and certainly more craven, because he twisted these young people (in ways that must have damaged them) into weapons against the widows.
The tax-sharing deal also meant that Lincoln Savings had made an unlawful $94 million loan that clearly could not and would not be repaid, so it needed to recognize a $94 million loss, which would cause it to fail its net-worth requirement. Killing the field visit had allowed Keating to evade the FHLBSF’s order barring Lincoln Savings from paying dividends to ACC. ACC had looted Lincoln Savings of $94 million, most of it after Wall’s ability to close Lincoln Savings was restored by passage of the Competitive Equality Banking Act (CEBA) in August 1987.
Dochow knew that this was only the beginning of the bad news. It was more than suspicious that Lincoln Savings claimed to have sold real estate for massive gains in a glutted real estate market. Since the FHLBSF had shown that the real estate came with large losses, the odds were good that the purported profits were phony and that the deals were “cash for trash” scams. If they were scams, then $94 million did not begin to suggest the depth of the losses. To produce $94 million in tax payments, Lincoln Savings had to have produced roughly $300 million in profits. If the profits were fictitious, then Lincoln Savings would have to reverse the recognition of over $200 million in income, and that would mean that Lincoln Savings was hopelessly insolvent. Even the $200 million loss figure did not capture Lincoln Savings’ full loss exposure. In a cash-for-trash deal, the amount of cash the S&L loaned was several times larger than the fictitious profits. Lincoln Savings, therefore, could well have losses approaching $500 million from about ten loans likely to be cash-for-trash scams. Each of the borrowers defaulted.
Dochow also had to keep in mind our constant warning: CEOs that lie to the agency about one area are likely to lie about many areas. Kenneth Leventhal, the real estate specialists, eventually issued a report saying that every Lincoln Savings deal that they had reviewed was fraudulent, explaining that “Lincoln was manufacturing profits by giving its money away” (U.S. House Banking Committee 1989, 2:298).
Dochow faced a crisis in his examination. His examiners had not found a loss in any of the likely cash-for-trash deals. Indeed, the 1988 examination did not recognize that the deals, on their face, had every indicia of being cash-for-trash scams. They had missed the link between the deals and the tax-sharing agreement. The examination was criticized as a whitewash, and Dochow had personally chosen all the key individuals conducting the examination.
Dochow decided that he needed to heed the FHLBSF’s and the CDSL’s advice to examine ACC. Indeed, the CDSL, despite its very limited resources, informed Dochow that it would examine ACC. O’Connell was put in charge of recruiting the exam team. He came from the Chicago-FHLB and knew a holding company exam specialist, Alex Barabolak. Barabolak brought (the inaptly named) John Meek as his deputy. Together, they led an examination team that uncovered and documented new abuses, many of them criminal, everywhere they looked. Barabolak reported directly to O’Connell, not Scott. Barabolak and Meek knew that they were dealing with a control fraud. They were calm, professional, and insistent. Keating and his troops, who had been praising Scott and Dochow, soon raged at Barabolak and Meek.
The arrival of the Chicago examiners freed the CDSL to examine Lincoln Savings. Crawford’s instructions to his team were to “go for the throat” (U.S. House Banking Committee 1989, 3:56). Gene Stelzer and Richard Newsom were unleashed on Keating. They, within ten days, had found three times as many losses as Scott’s examination (ibid., 3:16, 269). Moreover, their conclusions were well documented, and the S&L’s initial responses often dug Keating’s grave deeper. Newsom was a real-life Detective Columbo. It was a special horror for the ever-elegant Keating to be taken down by such a slovenly character who also turned out to be whip smart, tenacious, fearless, and extremely competent. Within a month, Newsom had identified over $50 million in losses—over five times more than Scott’s team (ibid., 3:271).
In a speech in Berlin in 1963, President Kennedy noted that “Dante once said that the hottest places in hell are reserved for those who in a period of moral crisis maintain their neutrality.”3 The Bank Board should have considered that, just as it should have known that Lincoln Savings was a control fraud before it surrendered so abjectly to Keating in May 1988. But by early September 1988 there was no doubt that the Bank Board knew that Lincoln Savings and ACC were deeply insolvent, that Keating was running an enormous control fraud, and that ACC was targeting widows and using fraud to sell them worthless junk bonds. The Bank Board had clear authority to stop the sales. The CDSL, Barabolak and Meek, and many others in the field recommended that the Bank Board stop the sales immediately and beseeched senior Bank Board officials to act (U.S. House Banking Committee 1989, 3:57).
The Bank Board, however, took no action to halt or even slow the sales or to warn the widows. The CDSL did what it could, ordering Lincoln Savings not to sell ACC’s junk bonds and desperately seeking a change in state law that would authorize it to place in conservatorship a state-chartered S&L engaged in serious violations of law or safety, even if it had not yet been proven insolvent. The CDSL informed Wall that it would close Lincoln immediately if the law passed.
Wall and Martin faced disgrace if they stopped ACC’s junk bond sales. The junk bond sales to the widows were a Ponzi scheme. ACC was insolvent and losing money. If the Bank Board stopped the sales, ACC would fail within weeks because it could not pay its debts. It would default on the junk bonds and over ten thousand widows would lose much of their life savings. ACC would file for bankruptcy protection. The widows would line up outside Lincoln Savings branches holding signs protesting the fraud. By bowing to pressure from the Keating Five and Speaker Wright, preventing the FHLBSF examination, and removing its jurisdiction over Lincoln, Wall and Martin had ensured weeks of national news coverage of the scandal. At a minimum, they would lose their jobs. It was more likely, however, that they would also be pilloried in public. The administration would be furious. Awkward questions would be asked about who had led the push to deregulate S&Ls (answer: Vice President Bush). Lincoln Savings was the biggest proponent of deregulation and the worst exemplar of it. The administration’s effort to give Keating control of the Bank Board would also be acutely embarrassing in an election year. Wall and Martin, loyal Republicans, would not close Lincoln Savings before the election.4
No one leaked the findings to the press to warn the widows. The examiners knew that if they blew the whistle, the Bank Board would fire them on the spot, make a criminal referral against them, and try to suppress publication of the story. Keating’s law firms, he had roughly 100 of them on retainer, would sue the examiner in his individual capacity for hundreds of millions of dollars. The release of the information would (appear to) damage ACC; in fact, it would precipitate its failure. Keating would blame the failure on the Bank Board, and faced with a lawsuit that finally had some (apparent) validity, Wall and Martin would cave in to the threat of litigation. By blowing the whistle, the examiner would have been committing professional and financial suicide and aiding Keating instead of the widows.5
Only White was in a position to effectively demand action, but he still declined to make Keating’s, Wall’s, and Martin’s actions a cause célèbre, ACC was able to defraud thousands of new victims, mostly widows, of tens of millions of dollars. Although Edmund Burke did not write the words so often attributed to him, the words remain apt: “All that is necessary for evil to triumph is for good men to do nothing.”
Wall’s bigger problem was that St Germain was the rare committee chairman defeated for reelection in 1988. Gonzalez became chairman of the House Banking Committee. Gonzalez believed that it was his duty to remove Wall from office. As one of his first acts as chairman, he held field hearings in San Francisco in January 1989 and invited FHLBSF witnesses as well as Dochow and O’Connell. The FHLBSF had briefed the committee’s investigators on the Bank Board’s appeasement of Keating while St Germain chaired the committee. Gary Bowser, Jim Deveney, and their staff leader, Jake Lewis, were up to speed on the facts, convinced that the Bank Board had acted badly, and eager to remove the blot that St Germain had placed on the committee’s reputation when he rejected their recommendation to hold hearings and told them to end their investigation.
The Bank Board was in an impossible situation. Its examination had shown that the FHLBSF was correct about the true state of Lincoln Savings and of Keating’s character. Dochow was already negotiating with Cirona about how to return Lincoln Savings to the FHLBSF’s jurisdiction. Dochow could not attack the FHLBSF, and Wall would not permit him to acknowledge that the Bank Board had made a mistake. The FHLBSF witnesses would criticize the Bank Board’s actions if they were permitted to testify about Lincoln Savings. O’Connell might join in that criticism. Dochow deliberately made O’Connell unavailable for the hearing, but he could not keep the FHLBSF witnesses away. Wall used his only real option: he ordered us not to testify about Lincoln Savings and refused to allow the committee to see any of the examination findings about Lincoln Savings and ACC (U.S. House Banking Committee 1989, 5:927). Gonzalez ordered us to testify, and Wall backed down. Our testimony made it clear that we were intensely critical of the Bank Board’s surrender and its failure to stop Keating’s ongoing abuses. The Bank Board finally ended the bond sales shortly after Gonzalez indicated that he would conduct a series of full committee hearings on the Bank Board’s handling of Lincoln Savings. ACC stopped selling bonds on Valentine’s Day 1989, over five months after ORPOS figured out the tax-sharing fraud (ibid., 4:268). Gonzalez had shown that exposing the Bank Board’s actions to public scrutiny worked.
The Bank Board had to act, but it could not act. ACC had unlawfully taken $94 million from Lincoln Savings. The Bank Board could not permit that. Dochow directed Lincoln Savings to demand the money back from ACC; Lincoln Savings refused. Dochow went to Stewart to get her to bring a temporary cease-and-desist order against ACC ordering it to repay Lincoln Savings. A temporary C&D is effective immediately; ACC would have been required to repay Lincoln Savings at once. Stewart knew that ACC could not repay Lincoln Savings, so a temporary C&D would force ACC to file for bankruptcy, which would expose the scandal. She refused to bring the C&D order, arguing that the MOU she and Keating’s lawyers had drafted forbade bringing such an order without prior negotiation with the S&L. This incident created a serious rift between Dochow and Stewart. She had personally assured him that nothing in the MOU restricted the Bank Board’s normal enforcement powers. That assurance was now shown to be false. The larger point, however, is that Stewart refused to bring any enforcement action against ACC and Lincoln Savings; indeed, she declined even to investigate, Stewart knew that any enforcement action would have the same effect as ordering a halt to the junk bond sales to the widows: it would expose the failure of ACC and Lincoln Savings as well as her leadership role in the Bank Board’s acquiescence in Keating’s demands.
Stewart had championed affirmative action for Keating on the grounds that newspaper articles had (accurately) exposed his misdeeds. She now decided that the Bank Board should take no meaningful affirmative action on behalf of the widows or the taxpayers. Dochow, shorn of any enforcement support, issued an unenforceable “directive” to Lincoln Savings to stop a significant number of acts, but he had issued no directive to ACC to stop the bond sales in 1988. Keating, of course, violated the directive with impunity. The Bank Board took no enforcement action in response to the violations. Stewart did not even investigate the violations.
The Bank Board indisputably needed to close Lincoln Savings immediately. Keating began to tell Scott that if the Bank Board took over the S&L it would cost the FSLIC $2 billion. That was tantamount to admitting that it was insolvent by $2 billion. Keating also began to line up the traditional scam acquirer groups that would purportedly solve the problem by buying the S&L without any FSLIC assistance.6 The Bank Board had a great deal of experience with such scams, and normally did not let them stall enforcement action.
The details are too complex for a book of this length, but it is easy to summarize the three problems all such deals shared. First, they were based on accounting scams. The novel aspect in this case was that the accounting fraud was disclosed.7 The CDSL forcefully made it clear that it would not approve any scam deal and that any deal to buy an S&L that was insolvent by over $2 billion without FSLIC assistance was a scam. That was the second thing wrong with every one of the proposed deals. The third problem was that each deal was designed to keep Keating in total control of Lincoln Savings, ruling through straw parties. The saddest variant brought former Bank Board member Hovde in (he offered his services to Keating, he was not recruited) as a straw for Keating.
Despite these facts, Wall and Martin pushed Dochow to try to negotiate a deal with each new shill. Keating bombarded Cranston and DeConcini with pleas to pressure the Bank Board. His messages—often in writing—were crude. He warned that Lincoln Savings would soon fail and that the failure would harm the senators’ careers. He asked for a “politically powerful person” to call Wall and Martin and pressure them (U.S. Senate Committee 1990–1991b, April 8, 1988, Special Counsel Exhibit 178).
Even when the Bank Board finally decided on April 5, 1989, to reject the latest scam deal and ready itself to appoint a conservator for what it now knew was likely to be the most expensive S&L or bank failure in U.S. history, Wall said the following about Keating:
[W]e are dealing with someone who has … been very successful in financial transactions of one kind or another, it seems to me that we could see the ultimate proffer of an offer to buy this institution on a totally arms length basis. And frankly, I will not be surprised if that happens. I have no knowledge of anything other than my understanding and perspective as to this man’s success over the years. And it is clear to me he may well pull a rabbit out of the hat…. So I submit we may not necessarily [sic] going only to a conservativeship [sic]. We may be looking at another kind of an acquisition put forward very quickly. (U.S. House Banking Committee 1989, 5:904–905)
Wall’s “understanding and perspective as to this man’s success over the years” was so erroneous and so unshakeable that even when he had been shown that the “success” was really failure hiding behind a fraudulent façade, he retained his faith in Keating’s myth. Alternatively, perhaps Wall believed that Keating was so accomplished a fraud that he could con an independent party into purchasing the most insolvent S&L in history without any FSLIC assistance. No rabbit popped out of the hat, and the Bank Board took over Lincoln Savings two years after the FHLBSF recommended it do so.8
Keating responded with a barrage of lawsuits challenging the appointment of the conservator and suing many officials in their individual capacities through Bivens actions. (He sued me for $400 million.) Keating then uttered the words that so injured the Keating Five. He called a press conference. Keating gave a presentation to the press: written questions to him and written answers to those questions, which he read aloud. He did not permit the press to ask any questions. (That enraged the press.) The important point is that Keating’s remarks were not a spontaneous miscue.
One question … had to do with whether my financial support in any way influenced several political figures to take up my cause. I want to say in the most forceful way I can: I certainly hope so. (U.S. Senate Committee 1990–1991a, 1:1116)
Vice President Bush won the 1988 presidential election. Wright ruined the S&L debacle as a Democratic Party campaign issue. One of the new president’s first acts was to order Wall to stop all “Southwest Plan” deals and to appoint the FDIC, not the FSLIC, conservator or receiver. Bush also made it clear that the FSLIC and the Bank Board would be eliminated: the insurance function would be transferred to the FDIC and to a new regulatory bureau, which became known as the Office of Thrift Supervision (OTS).9 This was an obvious slap in the face to the Wall. William Seidman, the FDIC chairman, writes that Wall launched into a fierce personal attack on him when the new Bush administration briefed them both on the plan (Seidman 1993, 196).
President Bush, however, was personally loyal to Wall. He introduced legislation in early 1989 to deal with the S&L crisis. It provided that Wall be made director of OTS, without the “advice and consent” of the Senate and the normal confirmation hearings. Scholars warned the administration that this might well be unconstitutional, which it was later found to be.10
Riegle, Cranston, and Garn were on the Senate conference committee that would negotiate a compromise bill with its House counterpart, chaired by Gonzalez. Gonzalez maximized his negotiating leverage by making his top priority blocking Wall’s appointment. He was able to win concessions in many other areas by finally agreeing not to insist on confirmation hearings. He did not give up on his belief that the government must remove Wall from office.
Gonzalez attacked Wall publicly by holding a series of hearings on the failure of Lincoln Savings. This took considerable courage on his part, because it was certain that the hearings would embarrass the Keating Five, and four of the senators were fellow Democrats. The party pressured Gonzalez to stop the hearings, but Gonzalez was relentless.
The FHLBSF was determined to tell the full truth about Wall. We believed that he had degraded the reputation of the agency and that he would cause new scandals if he were subjected to similar pressure. But the event that had enraged us was the Bank Board’s decision to let Keating defraud the widows in the hopes that this would delay ACC’s failure and allow him “to pull a rabbit out of the hat.”11 Wall compounded his mistake by ordering Patriarca and me to headquarters to coordinate our testimony with his staff’s testimony (U.S. House Banking Committee 1989, 2:89–90). We were told that if we agreed to place the blame on our staff (for purportedly failing to document Keating’s abuses adequately), Wall’s staff would praise our efforts to bring Keating to justice. We were offended that they thought there was any chance we would agree to such a proposal. We resolved to go full bore. The meeting had one advantage: it led inadvertently to my discovery of Stewart’s side letter.12
Wall, Dochow, and Stewart were hurt badly by the Gonzalez hearings. The first witness was FDIC chairman Seidman. He damaged the Bank Board’s strategy of blaming everything on the FHLBSF. He testified that FDIC officials had reviewed the FHLBSF findings and concluded that they would have responded to such evidence by promptly imposing a stringent cease-and-desist order or placing the S&L in conservatorship (U.S. House Banking Committee 1989, 1:21). He presented the Resolution Trust Corporation’s (RTC) lawsuit against Keating, which described his claims of FHLBSF bias as “baseless” and noted that Keating had been able to remove our jurisdiction through “political pressure” (ibid., 1:168). Seidman did not say a single supportive thing about Wall and his lieutenants.13
Patriarca and I testified at the next hearing. Wall launched a preemptive attack, providing the committee and the media with a chronology that was written to support his position. We were able to make that strategy backfire because the chronology was too selective in its omissions. We highlighted two: it did not contain ORPOS’s written recommendation to Wall on July 23, 1987, endorsing the FHLBSF’s recommendation that the Bank Board appoint a conservator for Lincoln Savings; it also failed to note that Bill Robertson, the ORPOS director who made the recommendation, was demoted days after he wrote the memorandum and that the Bank Board never allowed either the FHLBSF or ORPOS to brief it on the recommendation. We explained that this was unprecedented (U.S. House Banking Committee 1989, 2:17–18, 23).
Wall’s chronology also described the MOU and the agreement but did not reveal Rosemary Stewart’s side letter. I read the side letter to the committee, explained why it was such a harmful (and revealing) symbolic act, and noted that we referred to it as “Rosemary’s Baby” after the movie in which the husband makes a deal with the devil (U.S. House Banking Committee 1989, 2:25–26). The committee took up the phrase with relish. We also filed highly detailed and documented analytical testimony that explained the substance of what Wall and Martin had done wrong and rebutted the attack on our staff. The testimony generated very adverse publicity for Wall, provided a roadmap for critics, and made public many documents revealing the extent, nature, and consequences of the appeasement. We put the responsibility squarely on Wall.
Selby and the CDSL’s leaders (Crawford and Davis) testified with us on the same panel. Selby testified about the ERC members’ being driven by fear of litigation and “political retaliation,” explained that he was “disinvited” from ERC meetings immediately after he wrote a memorandum supporting the FHLBSF’s position, and emphasized that the OE’s poor performance at Lincoln Savings reflected their general failings, which he attributed to the “overriding fear by OE of losing a case” (U.S. House Banking Committee 1989, 2:32, 1048–1049; 5:1005–1006).
Davis revealed that Lincoln Savings had bugged the examiners’ phones (ibid., 2:35, 1149–1155). Crawford explained Keating’s efforts to get his bosses to fire him (ibid., 2:38). Davis bemoaned Wall and Martin’s lack of “courage” (ibid., 2:100).
Federal and state examiners who participated in the 1988 examinations of Lincoln Savings and ACC, along with the FHLB-Seattle supervisors who met with Keating, testified next as a panel. Their testimony emphasized three themes. First, Scott was a strong supporter of Keating’s operations, and this resulted in minimal “loss” findings until Newsom, Barabolak, and Meek exposed the attempted whitewash. Second, Lincoln Savings and ACC were pervasively corrupt. Third, Keating’s approach to the FHLB-Seattle was so outrageous that it alerted them, and should have alerted any competent regulator, that Keating was a crook (U.S. House Banking Committee 1989, 3:54–55, 75–79).
The FHLB-Seattle witnesses emphasized headquarters’ pervasive fear of litigation (ibid., 3:13). They noted their amazement that Keating had boasted about getting Henkel appointed to the Bank Board, and had said that it proved that he could accomplish anything with his political power (ibid., 3:54, 71). The FHLB-Seattle knew that Henkel had resigned in disgrace after being caught trying to immunize Lincoln Savings’ $600 million violation of the direct-investment rule, so it was appalled by Keating’s boasts. Representative Leach asked a question that showed that he understood the FHLB-Seattle’s professional staff better than Dochow, their former leader:
Mr. Leach: You knew that you were being asked to be dupes for the San Francisco office, to replace them as weaker regulators, which I think you should have found very offensive.
Mr. Clarke: We did. That thought did occur to us. (ibid., 3:55)
Clarke then gave the best four word summation of the Bank Board’s removal of the FHLBSF’s jurisdiction: “very strange, unprecedented, wrong” (U.S. House Banking Committee 1989, 3:56).
The single most damaging moment came when Representative Schumer asked the entire panel: “[W]ould any of you disagree … that Washington knew … the subordinated debt was virtually worthless, and still allowed the sale to proceed?” (U.S. House Banking Committee 1989, 3:74). No one disagreed.
Both FHLB-Seattle witnesses then responded to Schumer’s question whether there was any “plausible explanation” for Dochow’s conduct.
Mr. Clarke: There is no plausible explanation that was ever given to us, and I cannot think of one, frankly….
Ms. McJoynt: No. (U.S. House Banking Committee 1989, 3:77)
SEC chairman Richard Breedon’s testimony delivered the next heavy blow to Wall. He said that the MOU had destroyed the SEC’s ability to bring a timely enforcement action against ACC for securities fraud; that the Bank Board had entered into the MOU without consulting or notifying the SEC; that the Bank Board had caved in on taking action against the accounting fraud at Lincoln Savings; and that both Arthur Young and ACC/Lincoln had obstructed the SEC’s investigation while Dochow was telling the Bank Board that Keating was committed to being a good corporate citizen (U.S. House Banking Committee 1989, 4:47, 52, 54, 76, 154–156).
Wall, Dochow, and Stewart testified on November 21, 1989. Their first strategic mistake was not to admit that they had made a mistake. Their second was to direct the vast bulk of their testimony, and all of their fervor, at attacking their critics instead of Keating. Their third was using Stewart to lead the attack.
Stewart concentrated her attack on Gray, Patriarca, me, and the FHLBSF as a whole. She had suffered the most personal attack (“Rosemary’s baby”), and the committee members believed that her side letter was indefensible. She also had the greatest antipathy for Gray, Patriarca, and me. This put her in an inherently poor position as Wall’s primary defender.14 The central problem, however, was that Stewart’s rage at us caused her still to believe that Keating was the victim and we were the villains. She testified, under oath, that Keating’s theory of the case (he was innocent victim of vendetta because he opposed reregulation) was correct. I, for example, was a “perjur[er]” because I had read the text of her side letter and criticized it (U.S. House Banking Committee 1989, 5:22). One does not have to be a lawyer to know that this could not constitute perjury.
Stewart’s testimony, of course, was so over the top and so unsupported that it was disastrous for Wall and Dochow as well. She told Representative Kanjorski that he was engaged in “an absolute falsehood” (U.S. House Banking Committee 1989, 5:181). Wall (“child of the Senate” and veteran of hundreds of hearings) cringed and began whispering furiously in her ear, but the damage was irretrievable. The hearing closed on a bipartisan note that sealed Wall’s fate:
Chairman Gonzalez: The Chair is compelled at this point, in view of that outburst … [to note,] Ms. Stewart, your attack on your current and former agency colleagues—and now added Mr. Kanjorski, not to mention former Chairman Gray—is scathing and unrelentless.
On behalf of the taxpayers of America who will pick up the bill for the savings and loan nightmare, I offer the following thought: How much money could have been saved if you had pursued these high-flying S&L operators … with the same intensity? Your performance in that regard is well documented … and no amount of attacking others will absolve you of that regard.
Mr. Leach: … Ms. Stewart did not have authority to make these decisions on her own. [T]he Bank board is to be accountable. (ibid., 5:181)
Stewart’s testimony was a godsend to Keating. He had pending litigation challenging the appointment of the receiver and his Bivens actions against Gray, others, and me. Stewart, a senior agency official, had just testified that Keating’s lawsuits were correct. Gray, Patriarca, and I had a “hidden agenda” to “punish” Lincoln Savings because it opposed the direct-investment rule; we exhibited a “vendetta attitude” against Keating; and a campaign of leaks had damaged Lincoln Savings (U.S. House Banking Committee 1989, 5:19). She intimated that we were probably the source of the leaks. She also told the press that Lincoln’s losses were caused by a bad economy, not by any fraud on Keating’s part. Further, her testimony was under oath, so it would be admissible in court.
Keating’s lawyers understandably rushed to take her deposition in order to find additional support for her charges. The great irony is that her deposition, combined with my attorney’s deposition of Keating, destroyed the value of her committee testimony for Keating. The further irony is that the competence of Keating’s lawyer rendered her testimony useless. One can only imagine his dawning horror as his persistent questioning drew out that Stewart’s sole basis for her charge of abuses was what Keating had told her. She had no personal knowledge of any misconduct by any Bank Board official—none, the only personal animus she witnessed was by Keating (U.S. Senate Committee 1990–1991a, 4:337).
I quoted earlier her deposition testimony that “she believed” Keating when he told her (in early 1988) that Gray had called him a vulgar name and vowed to destroy him. I also explained how asking the most obvious questions would have exposed the lie. The remarkable fact is that Stewart continued to believe Keating’s fables in 1990, after the 1988 federal and CDSL examinations, Kenneth Leventhal, the RTC, the SEC, and the Justice Department had all established that the FHLBSF was correct in warning that Keating routinely misrepresented the facts. Moreover, she testified that she had never taken any steps to check whether Keating’s claims of bias were correct (U.S. Senate Committee 1990–1991a, 4:338).
Stewart’s House Banking Committee testimony and her deposition ended any chance that Wall had of remaining in office. President Bush soon indicated his lack of confidence and Wall resigned, with a personal attack on Gonzalez. The testimony also doomed Keating’s suit against Gray and me. My attorney sent a Rule 11 letter notifying Keating’s counsel that continuing the suit, which Stewart and Keating’s deposition testimony had proven to be baseless, would lead us to seek sanctions against the attorney. Keating dismissed the suit.
Bush appointed Tim Ryan to replace Wall as OTS director. Ryan brought in Harris Weinstein as chief counsel. Ryan and Weinstein made their mandate explicit: they had been appointed to make it clear that the administration favored aggressive enforcement, supervision, and regulation. That meant pursuing the most infamous control frauds, their law firms, and their accounting firms. Weinstein delegated enforcement powers to the field and placed senior field attorneys with litigation experience (like me) in charge of regional enforcement groups. Stewart left the agency to work with the Jones, Day law firm. Dochow returned to the FHLB-Seattle as its lead supervisor. Weinstein ended Luke’s prohibition on suing audit firms. The agency began to litigate cases and set favorable precedents. The number of cases more than doubled, and the significance of the cases and the remedies sought increased dramatically. The OTS and the RTC combined to recover well over $1 billion from law and audit firms. Other than an unsuccessful White House effort to remove the OTS’s jurisdiction to bring an enforcement action against the president’s son, Neil Bush, for his contribution to the expensive failure of Silverado Savings (Seidman 1993), political intervention with the OTS halted.
Milken’s guilty plea removed him as the de facto head of Drexel. Without his ability to manipulate the “captives,” the true default risk of junk bonds was revealed, and their value fell sharply. All of the S&L captives failed; their other frauds would have sunk them even without the junk bond collapse.
Keating’s forces went out with a last blast at San Francisco. Lawyers for one of his principal lieutenants were deposing one of our midlevel supervisors. They began asking her which of our employees were homosexual. The OTS lawyer representing her objected, so there was a telephonic hearing with the judge. Keating’s lawyer represented to the court that he had concrete facts that established a good-faith basis for believing that there was a conspiracy among homosexual regulators in San Francisco to destroy Keating. Based on these representations, Chief Judge Bilby directed her to answer the questions. The lawyer’s next question was whether she had heard any “rumors” that employees were homosexuals. The young OTS lawyer from headquarters, unfortunately, did not object immediately. Fortunately, the lunch break occurred shortly after this series of questions. Our supervisor returned to the office in tears, humiliated and outraged at having to testify about rumors regarding who might be a homosexual. I told the OTS attorney to inform opposing counsel that the deposition was over and that we would file an emergency motion with the judge asking him to overturn his order.
According to the opposing lawyer’s conspiracy theory, (1) Keating was intensely homophobic; (2) Keating was a strong opponent of pornography; (3) the FHLBSF employed homosexuals; and (4) therefore (?), homosexual regulators conspired to destroy Keating.15 The lawyer’s explanation for having no evidence to support the last point was that homosexuals are hidden and can conspire secretly. Judge Bilby realized that he had been misled into authorizing an outrageous witch hunt. Furious, he started the hearing. The opposing lawyer immediately dug his grave deeper by demanding that I be excluded from the courtroom. That had worked with Wall, but federal judges do not take kindly to such tactics. The judge proceeded to tear into the opposing lawyer for his misrepresentations and tactics. He ordered a halt to any such questions and the destruction of all records of the questions and responses.
This incident revealed to Judge Bilby the nature of our opponents. He later discovered that Arthur Young had put the disgraced Jack Atchison back on its payroll as a consultant. Judge Bilby was hearing the RTC and ACC bondholders’ case against Young when he learned of this deeply inappropriate arrangement. He announced that his dad, a judge, had told him that a judge always has the power to order a “skunk” out of his courtroom. Young decided to settle the case for a very large sum.
The important control frauds all failed before Ryan became chairman. The failures occurred despite Wall’s vulnerability to political and legal pressure and his support for forbearance. They failed because of Gray’s reregulation (principally the growth restrictions), because of the vigorous field regulators who Gray recruited, and because the 1986 Tax Reform Act and the failure of other control frauds led to the collapse of regional real estate bubbles.
The OTS’s vigor under Ryan and Weinstein was, of course, far too little, far too late. But it showed what could have been done if the administration and the Bank Board had engaged in vigorous enforcement in the 1980s.