Don't Forget the IndyMac Debacle

While Countrywide Financial is back in the financial news, it's worth readers remembering IndyMac Bank and New Century Financial.  The linked post above still makes good reading, but I want to expand on IndyMac from the role of the CEO and his enabling board.  None of these folks are in jail either, as far as I know. 

IndyMac CEO Michael Perry began his career as a KPMG auditor, and was an inactive CPA during his tenure at IndyMac. After working in the mortgage business at Commerce Security Bank, he joined IndyMac when it had four employees. By 2006, the bank had about 8.000 full time equivalent employees.  Despite the complexity of subprime financial services Perry clearly understood subprime mortgage origination, and how the product affected the income statement and balance sheet.

The board of directors included Lyle Gramley, a retired member of the Board of Governors of the Federal Reserve System. Gramley's pronouncements about monetary policy, interest rates and banks had been very visible in the financial press for years.  Hugh Grant was a director who served as the Managing Partner for the Western Region of KPMG, where he worked for 38 years.  Retired California Senator John Seymour was a board member whose legislative career had centered on housing and finance issues. 

According to the 2006 proxy, the CEO's incentive compensation rested on EPS and ROE targets, both of which were subject to the highest degree of accounting manipulation in this subprime mortgage business.  IndyMac's reported earnings were of low quality, and its balance sheet reported inconsistently with its risk profile.  We've noted a few of thise points in the previous posts, and won't repeat anything here.

In 2004, the CEO expressed to his risk managers via emails his concern that credit quality was deteriorating.  Yet in the corporate culture of the firm, risk managers were routinely overridden by a network of roguish, non-employee mortgage originators whose only objective was to maximize their own commissions.  By 2006, the Office of Thrift Supervision's Inspector General noted that 75% of IndyMac's option ARM holders were making only the minimum monthly payments on their mortgages.  Yet, provisioning levels continued to be minimal, and reported earnings were high.

At the end of fiscal 2006, three sophisticated institutional investors held stakes that were reported in the proxy: Barclay's at 13%, NWQ (Nuveen) Investment Management at 10%, and Capital Guardian Trust at 7%.  Investors got what they wanted with outsized earnings growth, the share price outpaced the Russell 1000 Financial Services Index by a wide margin, and management paid itself handsomely, despite the fact that they had to have known that the reported numbers were of dubious quality and the business unsustainable.  These sophisticated investors apparently couldn't see through the numbers to the fundamentals either.   The problem is not about process. It almost never is, yet our regualtion only addresses layering on more process. It is all  about individuals being bad actors and not doing their jobs, for which there is no accountability.