It’s not every day that a multi-billion dollar bank fails and is taken over by the FDIC. However last friday (July 11th, 2008) IndyMac Bank was seized by federal regulators after it was deemed illiquid and unable to continue on with business as usual. As you may have read elsewhere The Office of Thrift Supervision has said that it transferred IndyMac’s assets to the FDIC because it did not think the lender could meet its depositors’ demands. Here are some interesting facts about the bank and its failure:
- IndyMac had $32.01 billion in assets as of March 31
- The bank is the second-largest financial institution to close in U.S. history
- IndyMac specialized in Alt-A loans – loans which required very little proof of income or assets
Why Did It Fail?
I could argue until I’m blue in the face about what caused IndyMac Bank to fail, but I’d like to stick to the facts here. First of all we’ll focus on the fact that they specialized in Alt-A loans. These loans, although not subprime, are essentially “liar loans” considering that income and assets did not really need to be proven. It would be safe to say that those who were applying for this type of loan did not have the means to legitimitely purchase the real estate that they were interested in, but caught up in the hype of the housing boom decided they could handle it for six months until they were able to sell said property for a nice hefty gain. Of course we all know what happened then – and is still happening. The “boom” turned into a bust. Property values have been dropping drastically and as people were unable to unload these properties many of them have been forced to either foreclose or walk away from their purchases. This in turn has taken a nasty toll on IndyMac Bank and their income statement & balance sheet. To put things into perspective this bank lost $614 million last year, mostly coming from losses related to these Alt-A loans.
Of course huge losses are going to take a toll on any financial institution, no matter their size. When banks are faced with liquidity crises they have to turn to several places in order to build up their cash deposits. They need new depositors, they need investors and they often turn to the Federal Reserve to take advantage of their term loans, such as the discount window. It would be safe to assume that IndyMac Bank had been following all of these channels in order to remain liquid enough for daily operations. Somewhere along the line, however, something went wrong and they lost over $1 billion of their customers’ deposits. Usually always the cause of bank failures IndyMac Bank experienced a run. Within a matter of weeks customers had pulled out $1.3 billion in deposits. This unfortunately was the root cause of their inability to function and hugely related to their failure.
The Irony Of Self-Fulfilling Prophecies
The part of this story that I was most interested in was not the fact that such a large bank failed but that it ironically was faced with this run after a politician issued a public letter (released on June 26) essentially stating that regulators should have been more focused on IndyMac and that they were facing collapse. In the 11 days following this letter IndyMac Bank was stampeded with customers demanding to withdraw their deposits. Hence the run on the bank. It’s debatable whether IndyMac would have been faced with this run if this politician would have said nothing publicly. He of course later followed up saying that the run on IndyMac was not his fault and that it was due to long-standing practices by the bank. Obviously the root cause of their failure was their business practices, but it seems to me that if it weren’t for these remarks that IndyMac would as of today still be standing as a business. They probably could have made it through these rough times with a little help from outside investors and The Fed. They didn’t however. I’m calling irony and self-fulfilling prophecy. What do you think?