INDYMAC’S COLLAPSE WAS SPECTACULAR, A frantic run on the bank—the kind of financial crisis that was not supposed to happen in America anymore. The scene evoked the grainy black-and-white images of the Great Depression, only this time the pictures were in color.
Insiders already knew about the bank’s problems, of course, thanks to the lawsuits and IndyMac’s securities filings, but the public remained largely in the dark until June 26, 2008. That’s when Charles Schumer of New York, the third most powerful Democrat in the US Senate, released a public letter expressing dismay about government regulators’ inability to confront “serious problems” at the thrift. “I am concerned that IndyMac’s financial deterioration poses significant risks to both taxpayers and borrowers,” Schumer wrote. The bank “could face a failure if prescriptive measures are not taken quickly.”1 Critics would later argue that it was Schumer who sparked the run. The senator retorted he was simply pointing out the obvious. “The regulator was asleep at the switch,” he said at a press conference. “The administration is doing what they always do, blaming the fire on the person who called 911.”2
In any case, news of the bank’s troubles swept through Southern California, as local television newscasters stoked the panic with live stand-ups across six lanes of traffic. Throngs of customers pushed, shoved, and screamed in front of the six-story headquarters in Pasadena, trying to pull their deposits. If IndyMac’s coffers had been eroded by piecemeal reimbursements for its sins, now they were suctioned without interruption. Customers withdrew increasing amounts of money as the days went on—$97.5 million on Monday, July 7; $185 million on Tuesday, July 8; $209 million on Wednesday, July 9.3
Faced with these mounting withdrawals, the Federal Deposit Insurance Corporation dispatched a team from Washington to close the bank. It was led by the FDIC’s chief operating officer, John Bovenzi, a heavyset man with a wisp of hair combed over to cover an increasingly bald head. Bovenzi flew out to Burbank, using his personal credit card to buy his airplane ticket, rental car, and hotel room at the local Hilton. Dozens of other FDIC employees had done the same thing, booking their own travel out of Washington and their own accommodations in Southern California. The idea was to keep news of IndyMac’s closure secret, to prevent public panic. It didn’t work—especially after some customers went online and found their accounts frozen. As word leaked out, the panic snowballed. On July 11, 2008, the day the FDIC team came for IndyMac, depositors withdrew $250 million.
That day, Bovenzi and his associates arrived at IndyMac’s headquarters early in the morning, and by the afternoon they rode the elevator up to the top floor and walked into an executive conference room. In a carefully staged but oddly private event, with a serene view of the San Gabriel Mountains out the conference room window providing a sharp contrast to the mania below, John Bovenzi looked Michael Perry in the eye and relieved him of his duties. Now the government owned the bank, which, on paper, at least, had $32 billion in assets.4 Most of those “assets,” however, amounted to bad loans that might never be repaid.
INDYMAC FAILED TWO months before the collapse of Lehman Brothers, before Congress passed the bank bailout, before the true scale of the financial crisis was known. Unemployment was still relatively low at 5.7 percent5 and the Dow Jones Industrial Average hovered above 11,100.
Despite all of IndyMac’s drama, outside of Southern California, the news was treated as an afterthought by politicians and the news media. On the presidential campaign trail that day, neither party’s presumptive candidate, Republican John McCain and Democrat Barack Obama, spoke about the bank’s collapse or even the US economy. The New York Times ran its story about IndyMac’s failure on page five of the business section.6
It wouldn’t be long, though, before the public woke up to the broader implications of IndyMac’s collapse. As with larger banks that would fail later, such as Washington Mutual and Wachovia, the public would learn that IndyMac’s business model was based on selling bundles of loans to investors in the form of mortgage-backed securities. But there was one key difference between IndyMac and its larger rivals: IndyMac collapsed before the government could save it. This meant that the government, in the form of the FDIC, now owned the bank.
The new owners of IndyMac announced they would reopen the bank the following Monday. They called big national media outlets and asked them to project a message of tranquility and composure. Predictability, that request raised eyebrows. “The federal government wants to calm customers’ jittery nerves and convince them that it’s business as usual,” CBS News correspondent Bill Whitaker intoned at dawn, shortly before the bank reopened. “But as they say, that remains to be seen.”7
Seen it was: by then, the crowds had exploded, twisting around the block as they had the previous week. Outside, government bankers in black suits stood in 90-degree heat, trying to keep order, distributing bottled water to combat the oppressive humidity, and telling customers to head home. One woman in the long line fainted and was taken to the hospital by paramedics. Yet despite the admonishment, the customers stayed, leaving only after they secured cashier’s checks for $100,000—the maximum amount insured by the government—which they clutched in their hands as they walked back to their cars. “People were hysterical,” Bovenzi told me years later.
The FDIC’s chief operating officer stood for the cameras, giving one interview after another, and then circulated through the crowd. “We told them this bank is now owned by the federal government; nothing is safer in the world,” he recalled. “This one woman just looked at me and said, ‘Can you assure me the government will be here tomorrow?’ What do you say to that?”
In the days to come, the bedlam would subside. The FDIC set up tents with folding chairs outside of IndyMac’s thirty-three branches, and handed out numbers to customers, which made the withdrawals more orderly. Heart-wrenching stories began to play out in the press—ten thousand depositors had more than $100,000 in IndyMac, and they weren’t necessarily rich. There was the mother of a soldier killed in Afghanistan, who’d put her son’s life insurance check in an account there; the policeman who had just sold his home and deposited the proceeds; and the office manager who had $180,000 from her grandfather earmarked for a down payment on a house. Small businesses lost money set aside for payroll—and there were many, many retirees who had placed their life savings in the bank, thinking it was safe.
Consumers demanded help, and, in the days and weeks that followed, the FDIC hosted community meetings to extend a helping hand. But the law was the law: the government could provide no more than $100,000 to depositors at failed banks. The chairwoman of the FDIC, Sheila Bair, offered no apologies. IndyMac was the largest bank taken over by the government since the Great Depression. It was her job to safeguard not only the consumer but also the health of the banking system and the taxpayer. “It is incumbent on people to know the FDIC deposit limits and stay below them,” she wrote later.8
THE FDIC NEVER wanted to run IndyMac, and the government certainly never hoped to run it for long. The ideal chain of events, which is common during less stressful economic times, is that the agency shutters a bank under one ownership on a Friday evening and reopens it under a new one on Monday morning. Whenever possible, the failed bank is subsumed by another financial institution with experience and staff in the region. The quick sale benefits the government because the assets of the failed bank stay off the government’s books. The consumer barely notices the difference.
This was possible because banks rarely failed, and those that did tended to be of the smaller, community variety. The case of Miami Valley Bank was typical. On October 4, 2007, the government announced simultaneously that it had closed the Ohio bank, which had $87 million in assets, and that its branches would be open the next day. The only difference was that the offices would now be outposts of the Citizens Banking Company of nearby Sandusky. The government estimated its losses at $3 million.9 The public barely noticed. But the IndyMac situation was nothing like this. First, IndyMac was huge, with billions of dollars of bad loans. It could not easily be subsumed into some other regional bank, and, in any case, its assets were so toxic that no other bank wanted to buy them.
“IndyMac had very few true customers in the traditional sense. It was everything a bank shouldn’t be,” Bovenzi told me. Though it had $18 billion in deposits, IndyMac’s only true customers were the investment banks that bought its mortgage-backed securities. When housing prices dropped, the investment banks wouldn’t buy the securities. IndyMac could no longer off-load its risky loans. The bank started hemorrhaging money, failing even faster than the government expected.
The FDIC would eventually sue Perry for negligence, accusing him of “rolling the dice” on risky mortgages.10 It sought $600 million but settled for just 2 percent of that, or $12 million, including a $1 million personal payment from Perry and an agreement that banished the former executive from banking for life. No one went to jail.11
But that settlement wouldn’t come until four years later and, furthermore, suing Perry didn’t help the government out of its immediate problem: with no Home Owners’ Loan Corporation to buy mortgages off IndyMac and negotiate homeowners into less usurious loans, the FDIC faced a replay of bank failures that hearkened back to an earlier era. It was now the owner of a giant failed bank, and it was desperate to find a buyer.
“We had to beat the bushes,” Sheila Bair told me. “Very few people had any money then, and the last thing most of them wanted to do was buy a failed bank.” But if most of American business wanted nothing to do with a financial institution crippled by the housing bust, there was a handful of businessmen who saw opportunity.
ON THE DAY of IndyMac’s collapse, Steve Mnuchin stood in his office in Midtown Manhattan, watching the bedlam on the financial news channel CNBC.12 A thin man with a square face, receding hairline and trademark designer black plastic-rim glasses, the hedge fund manager had never run a commercial bank.
“We need to figure out how to buy it,” he reportedly told a colleague. Mnuchin said that IndyMac’s failure reminded him not of the Great Depression, when the government intervened to help homeowners, but of the savings and loan failures of the late 1980s and early 1990s, when a small group of private equity giants bought a mountain of toxic assets off the government for pennies on the dollar and then flipped them to other investors. Because the government sold so cheap, they were able to walk away with billions.
“I’ve seen this game before,” Mnuchin declared.13
IT WAS AS if Steve Mnuchin had been bred for this moment. Born December 21, 1962, to philanthropist Elaine Terner Cooper and Robert Mnuchin, a Goldman Sachs partner on the firm’s management committee, Steve had practically been raised on Wall Street, destined to live a life of luxury on Park Avenue while spending weekends in the Hamptons. He grew up in the rarified world of ultrawealthy New Yorkers. His grandfather, attorney Leon Mnuchin, cofounded a yacht club.14 His parents sent him to the exclusive Riverdale Country School, its gorgeous campus set upon thirty flowing acres nestled between the Hudson River and Van Cortland Park at the Westchester County line. There young Steve swam in what would later be called the Mnuchin Family Pool. In high school, when most of the kids from Manhattan rode the bus up to the Bronx, Steve drove a red Porsche to class. Even then, classmates said, the future hedge fund manager had a reputation as a hard charger. He was determined to win every game of tennis and argued with his teachers when he didn’t like a grade.
After Riverdale, Steve attended his father’s alma matter, Yale University. He lived off campus in the former Taft Hotel. His roommates included Salem Chalabi, nephew of Iraqi exile leader Ahmed Chalabi, and Edward Lampert, who would later become a billionaire investor, known for buying distressed companies, including Kmart and Sears, and stripping them of their assets.
In college, Mnuchin worked on the Yale Daily News, not as a journalist but as publisher. Back in those days, before the advent of on-campus start-up accelerators that propel undergrads into a career of moneymaking, the paper offered a rare opportunity for Mnuchin to showcase his business acumen. His roommate, Eddie, was the general manager. Journalists who worked on the paper in those years said the business and editorial sides were almost completely separate and usually came from different social classes. Editor Bennett Voyles, who graduated in 1985, the same year as Mnuchin, remembers the publishing team as “a sleek crew in Lacoste shirts who would glide in and out of the News building.”15
The paper’s editor in chief, Anndee Hochman, recalls, “The majority of us were public-school educated and saw ourselves as scrappy defenders of the underdog, truth tellers, and people who were skeptical of enshrined power. The people on the business side were the opposite of that.” Hochman, who went on to become a writer on family and community, said she frequently tangled with her publisher over monetary issues, such as the number of pages per issue. But Mnuchin never interfered with the content—or even expressed an opinion about it. On a campus frequently inflamed by politics, he did not project any particular ideology. “I don’t think we ever went to lunch together,” she reflected. “Our interactions were almost exclusively in the Yale Daily News building.” The only evidence of Mnuchin in the paper’s archives, beyond the publisher credit in the staff box, are ads recruiting staff for the business side of the paper. “Interested in Business? Money? Call Steve Mnuchin,” reads one ad from 1982.16
FOR MNUCHIN, THERE had never been much question about what to do next. His father had gone to Yale and then to Goldman Sachs, where he’d worked his way up the totem pole for twenty-two years. Steve’s older brother, Alan, had also attended Yale, graduating a year earlier, and likewise went to Goldman. So, in September 1985, after a summer internship at rival Salomon Brothers, Steve joined Goldman, too.
It was the height of the Reagan era, with Wall Street constellated with wild parties, leveraged buyouts, hostile takeovers, and insider trading scandals, encapsulated by the Gordon Gekko line in director Oliver Stone’s 1987 film Wall Street: “Greed . . . is good.” Steve found a home in Goldman’s mortgage department, working under the tutelage of cigar-smoking partner Michael Mortara, who, in addition to his business acumen, gained notoriety as an early Wall Street helicopter commuter, making two to three round trips a week from his home in Litchfield, Connecticut. “It’s very convenient,” he said of the forty-five-minute flight. “I could do it every night, except the demands of my business are such that I end up having to go out to dinner in New York a few times a week.”17
Mortara was only thirty-eight when he and Mnuchin started working together, but he was already a legend. As a young man at Salomon Brothers in the 1970s, Mortara and his partner Lewis Ranieri had been instrumental in creating mortgage-backed securities, pioneering a practice far more complicated than the traditional way banks had turned a profit. Before that, lenders made money by accepting deposits from individuals and businesses, keeping the money safe, and lending it out at higher interest than they paid to depositors.
Mortara and Ranieri are credited with making it commonplace to bundle home mortgages as financial instruments. Mortara was an evangelist for the “product,” which he grew as dramatically, and expansively, as he could. In 1985, for example, the investment banker formed a syndicate and partnered with Freddie Mac on a program to sell $100 million worth of American mortgages on the international market. It was the first time that the government-chartered mortgage company, established in 1970, allowed mortgages to be traded overseas.18 For Mortara, this was great news—a way to profit off the emerging market of debt trading. But for consumers, it was just the latest indication that the connection between homeowners and their lenders was being severed.
That same year, Mortara helped American companies finance commercial real estate in the United States with money from the international bond market.19 This meant more money pumped into financing for urban office towers and suburban shopping malls, with the investors on the hook for those deals spread around the world, totally disconnected from the relative merits and feasibility of the projects themselves—which proved to be a cause of the collapse of the savings and loan industry at the end of the decade. Mortara also expanded debt-backed securities beyond home loans to create similar products that covered other types of consumer spending.
The financial press fawned over these developments. When Mortara developed a tradeable financial product to cover car loans, the newspaper American Banker called it “a breakthrough”20 because investors could now buy the underlying debt of an auto loan without taking on the servicing rights—in other words, the process of actually collecting on the debt or seizing the car if the borrower defaulted.
Mortara and other supporters of these mortgage-backed securities said they helped make loans more available because the banks that sold them into the secondary market received new cash to lend out again. What was good for Wall Street, they explained, was good for everyone.
OF COURSE, THE beneficiaries of this system were, first and foremost, investment bankers like Michael Mortara and Steve Mnuchin. The more securities that were created, the more money they made. But despite their fervent enthusiasm, the growth of these balls of debt was slower than they would have liked. They needed a change in the law to really get things going.
That came in 1986. The year after Mnuchin joined Mortara at Goldman, President Reagan signed an overhaul of the American tax system containing a provision allowing bond traders who bought and sold mortgage-backed securities to cut what had been large, single bundles into tranches. Rating agencies graded tranches from the most secure to the most risky. The highest rated—and safest—tranches fetched the highest prices and got paid first if the borrowers defaulted and the security failed. The lower rated ones were the cheapest and got paid last. A trader could buy as little, or as much, of a particular mortgage-backed security as he liked. With tranching, the market exploded—from $150 billion in 1986, to an astonishing $9 trillion in 2010.21
It was thus that investment bankers turned home mortgages—something so simple and essential to American family wealth—into a financial instrument to be bought, sold, and traded. It was the system of buying and selling loans that, exacerbated by the 1986 overhaul, would eventually crash the global economy. Steve Mnuchin was there from the beginning.