Feds: CEO's Push for Risky Mortgages Killed IndyMac Bank

Customer run on IndyMac Bank in 2008

Even when he knew the economy was headed for the abyss, former CEO of IndyMac Bank Michael Perry “negligently” directed his company to sell $10 billion worth of risky mortgages that drove his company into bankruptcy, according to a lawsuit filed last week by the FDIC.

IndyMac was one of the largest mortgage lenders during the housing boom. Its bankruptcy in 2008 was the third-biggest banking failure in U.S. history at the time.

“Perversely, instead of enforcing credit standards, Perry chose to roll the dice in an aggressive gamble to increase market share,” according to the FDIC’s complaint, even though a responsible banker “would have suspended, limited, or stopped the production of these risky loans during this time of known, unprecedented, and escalating risks.”

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This is the second federal lawsuit against Perry. In February the Securities and Exchange Commission charged him with securities fraud for allegedly misleading investors about IndyBank’s finances.

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Perry’s lawyer, D. Jean Veta, said the FDIC’s lawsuit is “baseless.”

“Mr. Perry led IndyMac with integrity and intelligence. The FDIC’s belated claim that Mr. Perry was somehow ‘negligent’ is dead wrong,” Veta said in an emailed statement.

The case involves Perry’s decisions between April and October 2007, right when investors began to show reluctance about buying mortgage-backed securities because of growing concern that many homeowners might default on the underlying loans. That posed a serious problem for IndyMac’s business model, which was based on generated fees by selling mortgages to homeowners, and then packaging those loans and re-selling them to investors, according to the federal suit.

But instead of responding to investors’ concerns by tightening credit requirements and writing fewer mortgages, Perry doubled down, the FDIC says. During six months in 2007, IndyMac wrote $10 billion worth of new mortgages. Most of those loans were called “Alt-A,” which means they required less documentation from borrowers than traditional mortgages.

But that wasn’t even the riskiest part of the strategy. Ten percent of the mortgages, worth over $1 billion, were no-documentation loans, often called “liar loans,” since they didn’t require borrowers to provide any documentation at all about their income or their ability to repay. Others were “interest only,” in which borrowers pay only the interest on the loan for the first few years, with principal (and significantly higher payments) getting tacked on in later years.

To put this in perspective, this would be like Ford continuing to crank out millions of new SUVs during a gas price spike, when dealers’ lots were already filled to capacity with unsold vehicles. Oh, and some of those SUVs had a nasty tendency to explode as they were driving down the highway.

The result: IndyMac got stuck with $600 million in mortgages it couldn’t sell. When those loans began to fail, IndyMac did, too.

Perry told internal critics of his plan to get out of the way. When IndyMac’s risk management team raised concerns in 2005 that the company was taking on too much risk, Perry wrote in an email to senior managers that the risk management department “will be far more effective, if they [sic] focus on the details and facts, not on excessive worry over what the future holds,” according to the FDIC complaint.

Three years later, Perry’s lack of concern about the future caused IndyBank to go bankrupt, the FDIC alleges. In October 2007, Perry gave a written statement to IndyMac’s board admitting his mistakes.

“This time the losses are 100% operating management’s fault (from me on down),” Perry wrote.

“Simply put, Perry negligently elevated his desire to increase the Bank’s market share over prudent risk management,” according to the FDIC’s suit.

Not true, Perry’s lawyers say. In an emailed statement, Veta and her co-counsel Benjamin Razi say the government is retroactively expecting Perry to foresee a financial crisis that “nobody else did,” including FDIC and other bank regulators.

“This lawsuit is another transparent ploy designed to deflect blame away from the FDIC for its own failures,” Razi said in the press release.

The lawsuit was filed July 6 in U.S. District Court in Central California, where IndyMac was based. The suit asks that Perry be forced to pay a fine of $600 million.

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Image: Zoli Erdos, via Flickr.com