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Tracking IndyMac's Downfall

Vikas Bajaj|The New York Times
Tuesday, 29 Jul 2008 | 5:16 AM ET

After his mortgage company nearly crashed a decade ago, Michael W. Perry set a new course. He bought a bank so the company, soon rechristened IndyMac Bank, would never run short of money again.

The financial world now knows how this story ended. Just before 3 p.m. on July 11, federal regulators arrived at Mr. Perry’s headquarters here and seized IndyMac, which was buckling under its burden of bad loans. The debacle, one of the biggest bank failures in American history, could cost the Federal Deposit Insurance Corporation as much as $8 billion. Shareholders have been all but wiped out.

The collapse of IndyMac, one of the nation’s largest mortgage lenders, was the most vivid example to date of the dangers now confronting the nation’s banks and their investors. Two more lenders, both of them relatively small, were taken over by the government last Friday, and many analysts believe more banks will fail as home prices weaken and loan defaults mount.

Fears about the banking industry continue to haunt the stock market. The Standard & Poor’s 500-stock index fell 1.9 percent on Monday, and financial stocks tumbled 4.6 percent.

The F.D.I.C. is still trying to unravel the mess at IndyMac. The tableau of the collapse was shocking, replete with a run on the bank, snaking lines of anxious customers and sober assurances from Washington. Not since the 1980s has an American bank failed so spectacularly.

How could this happen? There has been a lot of finger-pointing. The Office of Thrift Supervision, the federal regulator that oversaw IndyMac, contends that Senator Charles E. Schumer, Democrat of New York, caused a panic among customers by issuing dire warnings about the bank.

Mr. Schumer maintains that the Office of Thrift Supervision was slow to spot the problems at IndyMac, an offshoot of the Countrywide Financial Corporation, the giant mortgage company that has come to symbolize many of the excesses of the subprime era.

But behind the political pyrotechnics is a simple truth: Executives at IndyMac, like many people on both Wall Street and Main Street, apparently never dreamed that home prices might fall. To the contrary, IndyMac made many loans on terms that implicitly assumed prices would keep rising.

Since 2000, IndyMac collected deposits from customers and used the money to make lucrative — and, it turns out, perilous — mortgages a rung above subprime. The bank also let people borrow money without their providing documentation to verify their income and assets.

As long as home prices continued to go up, the company’s strategy was very lucrative for executives, employees and shareholders. Analysts say the boom perpetuated an insatiable hunger for mortgages and a complacency about the risks they posed.

“The sales culture took over, and the sales division really drove the company,” said Paul J. Miller Jr., an analyst at Friedman, Billings, Ramsey.

Mr. Perry, whom friends and co-workers described as a hands-on manager who sometimes personally weighed in on mortgage applications, pushed the boundaries of his trade. But apparently not even Mr. Perry, who spent much of his career at IndyMac and its predecessor companies, saw the trouble until it was too late. He was predicting as recently as February that the bank would not only weather the downturn in the housing market but that it would even turn a profit this year.

Through a spokesman, Mr. Perry declined to comment for this article on the advice of his lawyers.

Formed in 1985 as a small division of Countrywide, IndyMac started making loans in the 1990s and became fully independent in 1997. The company nearly went under when the credit markets seized up in 1998, but Mr. Perry steered the company through that crisis by reducing its reliance on Wall Street financing. In July 2000, he acquired a savings bank to gain access to what was widely presumed to be a more stable source of financing: customers’ deposits.

“He certainly never forgot that experience,” Thomas K. Brown, chief executive of Second Curve Capital, said of IndyMac’s troubles in 1998. Mr. Brown, whose hedge fund had owned 5 percent of IndyMac late last year, described Mr. Perry as an “eternal optimist.”

Mr. Brown said Mr. Perry often referred to IndyMac’s previous hardships by saying, “We have made tough decisions in the past.”

Most of this decade was a golden era for IndyMac, whose profits grew threefold from 2001 to 2006. The company specialized in alternative-A, or alt-A, mortgages, which are made to borrowers with good credit but are not quite as conservative as the prime loans eligible to be bought by Fannie Mae and Freddie Mac, the mortgage giants.

For a long time, Mr. Perry disputed the growing belief that the problems in subprime mortgages would infect alt-A loans.

“That’s like saying that our headquarters in Pasadena is ‘in between’ Los Angeles and Las Vegas,” he said in March 2007. “True enough, but there’s the question of degree: Pasadena is 11 miles northeast of Los Angeles and Las Vegas is 262 miles northeast of Pasadena.”

While alt-A loans have, in fact, defaulted at much lower rates than subprime mortgages, they have nonetheless proved problematic. IndyMac’s biggest problem was a $10 billion portfolio of loans that it had been unable to sell last summer when credit markets froze up.

By the spring of this year, Mr. Perry and his board were working feverishly to raise money, find an acquirer or sell parts of the company, an effort known inside the bank as “Project Iron Man.” Several private equity firms, including Cerberus Capital Management and Oaktree Capital Management, talked to the company, but none of them made a hard offer, according to several people briefed on or involved in the talks.

By late June, IndyMac executives realized no savior would emerge soon, and the Office of Thrift Supervision told the bank it was no longer “well capitalized.” Mr. Perry began laying out plans for closing IndyMac’s mortgage lending business and dismissing half the company’s employees. The bank hoped to reduce its portfolio of loans but continue its profitable reverse-mortgage business to buy time until the housing market stabilized.

What came next stunned IndyMac and its regulators. Mr. Schumer wrote a letter to the Office of Thrift Supervision and F.D.I.C. questioning the bank’s viability. Reports of the letter created a run: In three days, customers withdrew $100 million.

Mr. Schumer later said regulators were “on top of the situation,” but confidence in IndyMac continued to ebb. By Day 11, more than $1.3 billion had been withdrawn from the bank, according to the Office of Thrift Supervision. Many of the customers who withdrew their money had balances of less than $100,000, the maximum amount insured by the F.D.I.C.

“Because there were so few bank failures in recent years, people didn’t fully understand deposit insurance,” said John Bovenzi, the chief operating officer at F.D.I.C. who was appointed chief executive of IndyMac Federal Bank, the government-run successor to IndyMac.

Mr. Bovenzi sat at a conference table in Mr. Perry’s former office, a bare room that had been stripped of the former chief executive’s personal effects save one forlorn plant. In the hallways, business cards of F.D.I.C. officials were taped outside offices, many of which still had names of former IndyMac officials on them. The F.D.I.C. said it has kept all the bank’s former top executives, except Mr. Perry.

In the aftermath of the failure the O.T.S. and Mr. Schumer traded barbs about who was responsible. The O.T.S. director, John Reich, said Mr. Schumer’s remarks “undermined the public confidence essential for a financial institution.” Mr. Schumer retorted that the Office of Thrift Supervision should have moved earlier to check “IndyMac’s poor and loose lending practices.”

Analysts said IndyMac would have gone under or been sold sooner or later, but added that Mr. Schumer’s remarks may have sped up the process by a few months.

IndyMac executives suspected the end was near even before the regulators turned up. Examiners do not warn banks they are coming, but they typically take over failing institutions on Fridays so they can have a weekend to put things in order and reopen under government control on Monday.

As the lines grew outside IndyMac branches during the week of July 7, Mr. Perry talked with an Office of Thrift Supervision official to assess the situation.

“We’ll talk to you on Friday,” the official said, according to one bank official briefed on the call. As word of the call spread through IndyMac, executives began packing their personal belongings.

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