Bonfire of the Profanities
An investigator who exposed dishonest savings and loan regulators in the '80s re-encounters an old rival in the latest banking crisis.
By Matt Smith
published: March 04, 2009
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Jake Poehls
Newsom on the beach near his home in Montara.
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Banking regulator Darrel Dochow.
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AP /J. Scott Applewhite
Charles Keating takes the Fifth during a 1989 congressional hearing.
Subject(s):
Matt Smith on investigator Richard NewsomRichard Newsom is campaigning against what he sees as corruption among overseers of America's savings and loan industry. He is perennially, and profanely, annoyed: Regulators today "lack both the stones and the expertise" to rein in rogue bankers, he claims.
But don't let Newsom's rumpled appearance and bricklayer's vocabulary fool you — he's no crackpot. The former state and federal banking investigator is remembered by veterans of America's last banking collapse as the sleuth who helped expose the frauds of legendary bank looter and politician briber Charles Keating during the savings and loan debacle of the 1980s. And he provided Nancy Pelosi with one of the most embarrassing moments of her career during the congressional hearings on the scandal (see sidebar on page 15).
During his days investigating 1980s savings and loan presidents, Newsom made a point of donning wrinkled khakis, an ill-fastened tie, and an unironed shirt, so that they might allow him to examine their books unaware of the "stones and expertise" behind the disheveled facade.
In the end, he says, "they were pretty disappointed to be exposed by a peasant like me."
"Newsom was a real-life Detective Columbo," writes William Black, a former senior savings and loan regulator, in his book The Best Way to Rob a Bank Is to Own One: How Corporate Executives and Politicians Looted the S&L Industry. "It was a special horror for the ever-elegant Keating to be taken down by such a slovenly character who also turned out to be whip-smart, tenacious, fearless, and extremely competent."
Two decades after the savings and loan scandal, America is scrambling to paste trillion-dollar Band-Aids on a global finance crisis without truly understanding the problem we're trying to fix. There have been no equivalents of the fireworks of the October 1989 U.S. congressional hearings into the collapse of Keating's Lincoln Savings and Loan, which ultimately cost the government more than $3 billion. Those hearings, where Newsom was the star witness, left no doubt that the banking collapse was abetted by massive fraud, conducted with the help of government regulators whose duty was to prevent such things. As he has watched the current banking crisis unfold, Newsom has become outraged at how little notice has been paid to the bank-regulation catastrophe that to his eyes is a replay of the meltdown two decades ago.
"Subprime loans were collapsing," he says. Federal regulators "realized this was a big problem, but nobody did anything. It was the old warhorse thing, when you hear the sound of the big guns off in the distance, and you feel that you can contribute."
A report issued by Federal Treasury Department investigators last week confirmed that Newsom, in a homegrown report he sent to government officials in August, accurately identified how regulatory failures helped cause a 2008 California banking collapse with uncanny similarities to the 1980s debacle.
In other words, the high-finance version of Columbo is back on the case — crooked bankers and regulators beware.
A dozen years ago, Newsom retired to tend to his wife, who had suffered a serious illness. Three years ago they moved from San Francisco to Montara; he staked out the local state beach for his daily strolls.
"Retirement was really good," he says, using the past tense. Even though he hasn't officially re-entered the workforce, it seems he's working full-time again, going after officials who whitewash banking scams. It's just like the old days.
Last summer, Newsom began a quest to expose what he came to see as regulatory corruption in the oversight of IndyMac Bank, a $32 billion peddler of "Alt-A" or "alternative documentation" loans (sometimes called liar loans) that allowed people to take out mortgage loans with minimal proof of employment or assets.
On July 24, Newsom happened across a prescient San Francisco Chronicle column by Kathleen Pender, which led by posing the question: "Why wasn't IndyMac Bank, whose problems were well known in the financial community, not on the Federal Deposit Insurance Corp.'s list of troubled institutions until shortly before its failure this month?"
The bank had been under the regulatory authority of the Office of Thrift Supervision's western district office in Daly City. A spokesman told Pender, "We thought IndyMac had the opportunity to work through its problems."
Newsom had heard that kind of explanation before — and it didn't sound right. "Pender was asking the right questions," he says, "but they didn't truthfully answer her questions." So Newsom looked up filings at the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, and the OTS.
IndyMac, as we now know, was a mess. Liar loans are a great business to be in if a banker wants to create the appearance of making extraordinary high-interest-rate profits — before collapsing in a pile of defaults. IndyMac amplified this boom-bust scenario by offering what it called "FlexPay" loans, also known as "option ARMs," which allowed borrowers to choose their monthly payments — even if those payments were so low that the total amount they owed increased each month because they weren't even paying off the interest, let alone the principal.
A $745,800 mortgage taken out in July 2007 on a live-work condo near the San Francisco Hall of Justice illustrates the pitfalls of IndyMac's business. The mortgage holder apparently rented to two tenants, and by the end of the following year owed $816,400 on the loan before losing the property to foreclosure in December.
IndyMac's lax lending standards made it easy for unscrupulous borrowers to defraud the bank. A scenario where a borrower puts no money down, makes no mortgage payments, and collects rent on a property until it is finally foreclosed upon theoretically could allow the borrower to walk away with more than $20,000 in profit merely for signing on the dotted line.
A look at IndyMac's financial filings show unqualified borrowers infected the bank like tuberculosis, which can create in the patient a sort of languid beauty before killing it. At first, these sinking loans made the bank look healthier. When borrowers ended up owing even more money on mortgages than when they started, IndyMac's loan portfolio grew in value. But that growing tissue was diseased.
"These people taking out loans, particularly at IndyMac, a lot of them weren't qualified at all," Newsom says. "They just turned a blind eye, so you'd have waiters who were making more than $100,000 per year. Anybody looking at these things would say it's preposterous what the claimed income was. And initial payments on these things were so low: People were getting teaser rates, but as soon as the rates ratcheted up, they couldn't possibly pay. That seems to have been the crisis in a nutshell."
This made it all the more confusing as to why the OTS and the FDIC hadn't moved earlier to declare IndyMac a troubled institution and prepared to take it over. One clear lesson from the 1980s S&L crisis was that stalling the inevitable only made matters worse, and ended up costing taxpayers a fortune.
While reviewing postcollapse IndyMac data, Newsom also perused the OTS organizational chart and was stunned by a name he saw toward the top: Darrel Dochow, who was named director of the agency's West Region in September 2007.
Newsom knew that name from his days investigating the savings and loan scandal. In the '80s, Dochow was chief of examinations for the Federal Home Loan Banks Board in Washington, D.C. He had gone to great lengths to shield Keating from examiners who might reveal the true state of his fraudulent banking and real estate empire.
Examiners with the San Francisco office of what was then the Federal Home Loan Banks Board — an enforcement arm eventually spun off as the Office of Thrift Supervision — had raised serious questions about Keating's operations and had recommended that Lincoln Savings be shut down. Keating demanded a new examination from a different regional office. He found an unlikely companion in his regulatory window-shopping excursion. According to congressional testimony by Dochow's underlings, the senior regulator became impressed by Keating and his team, and allied with them in attempting to subvert rank-and-file regulators.
"It is fair to describe Dochow as the job foreman of the 1988 federal effort to whitewash the 1988 examination of Lincoln Savings and Loan," Newsom wrote in an 8,000-word letter examining the IndyMac debacle, which he sent in August to Senator Chris Dodd (D-Conn.), chairman of the Senate Committee on Banking and Urban Affairs, to alert Dodd to Dochow's past.
In the late '80s, when regulators with the Federal Home Loan Banks Board of San Francisco determined that Lincoln Savings and Loan was an insolvent zombie — one that was poised to ultimately devour more than $3 billion in bailout funds — Dochow told them to, in essence, chill out, according to their sworn testimony before Congress. As the direct boss of thrift examiners nationwide, Dochow repeatedly pestered them to "keep an open mind" about Keating's quest to find bank examiners more malleable than the ones in San Francisco. The idea was to allow Keating to buy an insolvent bank in Washington state and then claim he was headquartered there, and thus was not subject to examination by California-based officials he considered too tough.
To their credit, Dochow's Seattle staffers rebuffed his entreaties. "Dochow looked Mr. Keating in the eye and became captivated by him," House Committee on Banking and Urban Affairs Committee Chairman Henry Gonzalez said at the time, summarizing testimony from the Seattle officials.
After it became clear that Lincoln was among the worst villains of the savings and loan crisis, Gonzalez, the whip-cracking Texas lion tamer of the '80s banking crisis, called a series of hearings. The most sizzling moments came when he invited a dozen on-the-ground investigators to testify about how their Washington bosses like Dochow had tried to undermine their work.
It emerged that, rather than allow regulators to pursue leads suggesting Lincoln Savings and Loan was a bankrupt shell, Dochow had cut a deal with Keating characterized as a "memorandum of understanding" that limited investigators' ability to examine the bank's financial archives. When low-level regional regulators called Washington with news of problems at Lincoln, they'd hear a version of the Reagan-era refrain about the need for creative entrepreneurs such as Keating needing regulatory leeway to perform their magic.
In 1988, Newsom was an investigator with the California Department of Savings and Loan, a now-defunct state regulatory agency. Unconnected to the federal bureaucracy, Newsom and his state-employed colleagues did not have to weather static from D.C., or Dochow. Newsom was eventually sent to Phoenix to join federal regulators who had already spent weeks examining the books of Keating's company. They described an institution that was basically sound, with billions of dollars' worth of outstanding loans, with less than $10 million considered "troubled," or likely headed for default.
It quickly became clear to Newsom that the federal investigation was a whitewash.
On the evening before he was to testify in front of the House banking committee, Newsom confided to other regional regulators that he intended to be extraordinarily blunt about what he saw as systemic cover-ups by top government officials. The idea of such an approach at once emboldened and terrified his fellow low-level bureaucrats.
"During that period, every day I would go out to start my car, I would turn the key, and if the engine started up instead of exploding, I'd consider myself to have made it through another day," said John Meek II, a former bank regulator based in Chicago. "We were up against some very powerful forces at that time."
Newsom, however, describes no such trepidation. He'd gotten his start in the financial world in 1970 as a bank repo man in Boston's tough Roxbury/Dorchester section. He moved to California in 1974 to work as a state bank examiner, where he had a tough-minded mentor with a talent for tracking down crooks.
In October 1989, Newsom sat before a long wooden table in a congressional hearing room. He was fidgety, exhilarated, and terrified, like a dog being held back from chasing a bull. When called upon by Chairman Gonzalez, he thrust his face into the microphone as if it were something good to eat. In a dark blazer, red tie, mussed hair, and oversize glasses, he paused a split-second before opening his mouth to speak, and allowed himself a half smile.
"By the end of my stay in Phoenix in early November 1988, the phrases 'whitewash' and 'cover-up' were almost standing jokes in Phoenix relating to the Lincoln loan examination, among state and federal examiners," Newsom said. Within hours of cracking Keating's files, Newsom said he found "perhaps the most flagrant self-dealing regulatory violation I have ever seen. The federal Lincoln loan examination was supposedly complete at the time."
Early on, Newsom said he discovered a fishy loan to a project called the Hotel Pontchartrain. The hotel was purchased by a subsidiary of Lincoln Savings and Loan in 1985 for around $20 million, then resold to another company set up by Keating, financed by another round of $38 million in questionable loans through Keating-controlled entities.
"That took me two hours to uncover," Newsom told Gonzalez' committee. "I couldn't believe all those examiners had been there that long, and they didn't see this thing that was just lying there."
In the end, federal investigators determined that Dochow had played a key role in the collapse of Lincoln Savings and Loan by delaying and obstructing proper oversight.
In the aftermath of the Keating scandal, Dochow was demoted to serve in the Office of Thrift Supervision's Seattle branch — the same site he'd apparently offered up as a potential safe regulatory harbor for Lincoln Savings. Over the years, he again rose within the ranks of federal banking regulators.
According to a story in the Washington Post, by the mid-2000s, Dochow again became active in helping banks shop for regulators to their liking. In 2006, he met with executives of Countrywide Financial as they sought to move out from the supervision of the Office of the Comptroller of the Currency, which regulates commercial banks that operate nationwide. According to the Post's sources, the OTS pitched itself as a less antagonistic regulator.
In September 2007, Dochow was promoted to head the agency's West Region, just as the latest banking crisis was escalating.
Newsom, for his part, watched the 2007 wave of defaults from the sidelines, itching to join the hunt.
He talked with old friends at the FDIC, who urged him to get a job training investigators to dig into rotten banks. He didn't get hired — recruiters disqualified him, citing a rule that required new hires to have experience within the previous five years. Newsom says he's conducting freedom of information requests of the FDIC about its bank examination practices, and is considering filing a class-action lawsuit claiming applicants like himself were improperly excluded from consideration for jobs.
Absent a regulatory job, Newsom began digging on his own, provoked by Kathleen Pender's column that suggested IndyMac regulators were late to the game. It turned out IndyMac wasn't the only bank avoiding proper OTS scrutiny. Countrywide's ever-worsening balance sheet now threatens the survival of Bank of America, which purchased it and bailed it out last year. Countrywide, too, should have been on a list of OTS problem banks, yet wasn't, Newsom said.
By early 2008, IndyMac took huge losses on its loan portfolio as defaults surged. Instead of flagging the bank as a problem, Dochow and his department allowed deposits to grow from less than $9 billion in mid-2007 to $16 billion by March 2008.
Newsom looked more closely at the data. The bank's growing mountain of worthless loans meant it was "dead meat," he said. Although it seemed clear the bank wouldn't survive, IndyMac, with the approval of government regulators, continued accepting deposits, including some greater than the FDIC-insured $100,000 limit in effect at the time.
According to bank data compiled by the FDIC, IndyMac accepted $91 million in these uninsured deposits after March 2008, dooming unwitting savers to lose 50 cents on every dollar they deposited over the $100,000 limit. By the time of the bank's July seizure by the FDIC, it held accounts with $2.6 billion in uninsured deposits.
Cheryl Hodgson is a detective with the Orange County Sheriff's Department and the single mother of an 11-year-old son. "My brother has always begged me to move closer, so he and his wife could help out," she said.
She took him up on the offer, sold her house, and took her $360,000 escrow check to IndyMac, where a manager set her up with a regular savings account — just two weeks before the bank failed. Most of Hodgson's savings went up in smoke. Because of the $100,000 FDIC limit, $260,000 of her money was uninsured, and IndyMac, its deposits tied up in worthless liar loans, agreed to pay only 50 cents on the dollar to uninsured depositors.
"Two weeks and $130,000 later, I was devastated," Hodgson recalled. "When I went to the bank in tears, the bank manager smirked and told me I should have had a financial adviser, which is not her job." She is among thousands of IndyMac customers who've lost much of their savings, having been given incorrect advice by bank employees on how to protect their money.
Fran Quittel, an Emeryville headhunter, lost more than $10,000 on an IndyMac account she used to pay employees. "There's no reason for a depositor to be at risk," she said. "Why does a depositor go to a bank? It's not a hedge fund."
Lisa Marshall, a Manhattan Beach pilot whose mother lost $62,000 when the bank failed, created a Web site that has become a clearinghouse for IndyMac sob stories, including one customer who lost much of the money he'd accumulated for his daughter's college fund.
The most appalling bit of news to Marshall's ears, however, came when she learned an official named Darrel Dochow had overseen a regulatory operation that disguised IndyMac's financial condition so the bank could continue recruiting doomed depositors. "It was like all the cylinders collapsing at one time," she said. "You say, 'Oh, my God. This man was back in there in 1989, doing the same thing.'"
In the summer of 2008, Newsom began digging deeper into IndyMac's financial filings, which showed that it should have been declared "troubled" long before regulators actually raised red flags.
On June 26, Senator Charles Schumer (D-NY) wrote to the OTS, saying he was concerned that IndyMac's financial deterioration posed significant risks to taxpayers and borrowers. Dochow's immediate boss, OTS chief John Reich, accused Schumer of spreading "rumors and innuendo" that caused damage that "might not occur otherwise."
The episode played like the rerun of an old movie. At the 1989 Lincoln Savings and Loan hearings, Schumer was the House banking committee member most outspoken in his disgust at Dochow. "Now that we know that Washington knew that the debt was worthless, and still allowed the sale to proceed, I'd like to see those higher-ups start reimbursing those senior citizens who lost their money," he said in 1989. "It's almost as if the regulatory system was in a totalitarian state, where one man, Keating, could pull all the strings."
Newsom could barely believe the headlines he was seeing. Just as in 1989, malfeasant regulators demonized the very whistleblowers seeking to avert a crisis.
Newsom assembled a 100-page dossier for members of Congress, explaining how lax oversight by the Office of Thrift Supervision may have worsened the mortgage debacle and increased losses during bank failures.
"The inexplicable delay in regulatory action at IndyMac appears reminiscent in some respects to the delay orchestrated from 1987 to 1989 in the seizure of Lincoln S&L," Newsom wrote. "Most alarming of all, to we Lincoln S&L veterans, was OTS Director Reich's August 2007 appointment of Darrel Dochow to be the Regional Director of the OTS Western Region; essentially, Dochow became the primary federal regular of IndyMac, Countrywide, and Washington Mutual the month after the current crisis started."
Newsom became among the first to identify the man who has become a sort of Rosetta Stone for understanding the failure of regulators to properly deal with the three failed banks. He made contact with reporters at the Los Angeles Times and the Washington Post. The Times cited him in stories detailing the Dochow link between regulatory malfeasance behind Lincoln Savings and Loan and IndyMac Bank.
In December, the Post reported that Dochow had been reassigned after U.S. Treasury investigators discovered he had "approved a plan by IndyMac Bank to exaggerate its financial health in a May federal filing, allowing the California company to avoid regulatory restrictions only two months before it collapsed."
According to the Post, Dochow allegedly allowed IndyMac to claim it had received an $18 million transfer from its holding company in March that it had actually received in May. The backdating of records allowed the bank to report that it was "well capitalized" and thus solvent enough to stay in business. Despite the ruse, the bank collapsed soon after, and is expected to cost the FDIC $9.4 billion. (It later surfaced that the OTS had authorized similar backdating at four other institutions.)
Last week, the inspector general of the U.S. Department of the Treasury issued an 80-page report examining regulatory failures surrounding the IndyMac failure. Newsom said he hadn't spoken with federal investigators, although the report echoed many of his concerns. "I wrote that this is what you'd have expected to find, given the data that was available last July," he said. "It had to be that way, and it was. In any case, it was really nice to have them follow my road map."
The Treasury report chastised the OTS, just as Newsom had, for failing to identify and regulate IndyMac's strategy of growth via massive, irresponsible lending. It exonerated Schumer from OTS officials' charge that he caused IndyMac's demise. "The thrift was already on course to a probable failure by the time Senator Schumer's letter was made public," the report said.
As Newsom had, the report described the OTS West Region office under Dochow as a regulator asleep at the wheel. "IndyMac engaged in very high-risk activities over many years, yet OTS managers did not downgrade the thrift," it read. "IndyMac did not even appear on OTS's problem thrift list provided to our office, including the June 2008 list provided to us less than a month before the thrift was closed."
According to the report, Dochow believed that IndyMac's CEO, Michael Perry, had recruited investors to inject $1 billion into the bank. When investigators contacted the supposed investor, however, it turned out there was never any serious interest.
The combined disgrace was apparently too much for Dochow. In mid-February — a week before the release of the inspector general's report — he e-mailed staff announcing he would retire this month. "I must admit that being singled out for a series of highly personal attacks after the failure of a prominent thrift has been painful, but I have been humbled by the tremendous support and words of encouragement by many people who truly know me and the job that I have done over the years," Dochow wrote. (He did not respond to requests for comment from SF Weekly to discuss his involvement in IndyMac.)
Dochow also noted he'd be receiving 35 percent of his government pay as a pension, and that he intended to seek out "other opportunities" after he'd got some things done around the house.
Reich, the OTS director who'd attempted to pin the IndyMac debacle on Schumer, also announced his resignation. In a February 25 letter to the inspector general, he wrote that the OTS had "taken aggressive action to address the identified issues. The agency is committed to improve and strengthen its processes based on lessons learned from the failure of IndyMac."
Effectively reregulating the banking industry will require figuring out what went wrong. Newsom says it won't be easy, but it needs to be done. "Examining the Lincoln S&L was like looking up the asshole of government," he says. "Frankly, my investigation into the government's role in the collapse of IndyMac gives me the same queasy, greasy, up-to-the-eyeballs-in-doodoo feel. U.S. treasury officials helped in a de facto swindle of uninsured depositors." It was "an encore to Lincoln Savings and Loan."