Third Quarter, FY2012 (All Appendices)
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SIGTARP: Quarterly Report to Congress | July 25, 2012 Congress to Quarterly Report SIGTARP: PECTO INS R G AL EN CI ER E A P L S T R M O A U R B G L E RO D A F P SSET RELIE Office of the Special Inspector General Q3 for the Troubled Asset Relief Program SIGTARPSIGTARP 2012 SIGTARPSIGTARP Advancing Economic Stability Through Transparency, Coordinated Oversight, and Robust Enforcement SIG-QR-12-03 202.622.1419 Hotline: 877.SIG.2009 Quarterly Report to Congress [email protected] July 25, 2012 www.SIGTARP.gov MISSION SIGTARP’s Mission is to advance economic stability by promoting the efficiency and effectiveness of TARP management, through transparency, through coordinated oversight, and through robust enforcement against those, whether inside or outside of Government, who waste, steal, or abuse TARP funds. STATUTORY AUTHORITY SIGTARP was established by Section 121 of the Emergency Economic Stabilization Act of 2008 (“EESA”) and amended by the Special Inspector General for the Troubled Asset Relief Program Act of 2009 (“SIGTARP Act”). Under EESA and the SIGTARP Act, the Special Inspector General has the duty, among other things, to conduct, supervise, and coordinate audits and investigations of any actions taken under the Troubled Asset Relief Program (“TARP”) or as deemed appropriate by the Special Inspector General. In carrying out those duties, SIGTARP has the authority set forth in Section 6 of the Inspector General Act of 1978, including the power to issue subpoenas. Office of the Special Inspector General for the Troubled Asset Relief Program General Telephone: 202.622.1419 Hotline: 877.SIG.2009 [email protected] www.SIGTARP.gov CONTENTS Executive Summary 3 Oversight Activities of SIGTARP 10 SIGTARP Recommendations on the Operation of TARP 11 Report Organization 11 Section 1 THE OFFICE OF THE SPECIAL INSPECTOR GENERAL FOR THE TROUBLED ASSET RELIEF PROGRAM 13 SIGTARP Creation and Statutory Authority 15 SIGTARP Oversight Activities Since the April 2012 Quarterly Report 15 The SIGTARP Organization 33 Section 2 TARP OVERVIEW 35 TARP Funds Update 37 Financial Overview of TARP 42 Housing Support Programs 63 Financial Institution Support Programs 87 Asset Support Programs 128 Automotive Industry Support Programs 144 Section 3 AIG REMAINS IN TARP AS THE LARGEST TARP INVESTMENT 151 Introduction 153 Rise and Fall of AIG Prior to TARP 154 Changes at AIG After the Government Bailout 156 AIG’s Current Businesses 160 AIG’s Changing Regulatory Environment 164 Section 4 TARP OPERATIONS AND ADMINISTRATION 169 TARP Administrative and Program Expenditures 171 Current Contractors and Financial Agents 172 Section 5 SIGTARP RECOMMENDATIONS 181 Recommendations from SIGTARP’s Audit of the Hardest Hit Fund 183 Recommendations from SIGTARP’s Audit of the Net Present Value Test’s Impact on the Home Affordable Modification Program 186 Update on Recommendation Regarding Hardest Hit Fund Information Security 187 Endnotes 206 APPENDICES A. Glossary 228 B. Acronyms and Abbreviations 232 C. Reporting Requirements 235 D. Transaction Detail 239 E. Cross-Reference of Report to the Inspector General Act of 1978 320 F. Public Announcements of Audits 321 G. Key Oversight Reports and Testimony 322 H. Correspondence 324 I. Organizational Chart 333 EXECUTIVE SUMMARY 4 SPECIAL INSPECTOR GENERAL I TROUBLED ASSET RELIEF PROGRAM QUARTERLY REPORT TO CONGRESS I JULY 25, 2012 5 Last quarter, SIGTARP reported that TARP’s legacies include white-collar crime that SIGTARP is uncovering and stopping. This quarter, SIGTARP agents, along with our law enforcement partners, arrested the CEO of TARP applicant the Bank of the Commonwealth (“BOC”) of Norfolk, Virginia, and four other bank executives for their alleged role in a massive fraud that contributed to the bank’s 2011 collapse and the financial crisis.i The Federal Reserve Board Office of Inspector General (“FRB OIG”) found that the bank’s regulator identified fundamental weaknesses with the bank as early as 2000. However, the regulator did not take advantage of multiple opportunities to “take stronger supervisory action by implementing more aggressive enforcement actions.” Bank failures have profound effects, including taxpayer losses for failed TARP banks;ii losses to the FDIC’s fund that insures customer deposits; and losses to communities that suffer from decreased access to lending for homes, small businesses, and education. Bank failures fueled by fraud erode public confidence in the financial system — confidence already down because of public perception of risky banking practices, soaring executive compensation, and recent scandals. BOC’s failure and the criminal charges provide lessons to be learned for the future. Banks should not wait for the Government to catch fraud. Banks must better regulate risky practices, strengthen internal controls, and eliminate opportunities to conceal losses. Banking regulators must be vigilant in their examinations and enforcement to discover risky practices and potential fraud that could threaten the safety and soundness of banks. This is particularly true at the more than 300 banks left in TARP in which taxpayers are investors. Only then will confidence in our nation’s banking system and a sense of accountability be restored. Bank Failures Bank failures skyrocketed following the onset of the financial crisis, from zero to five failures a year between 1995 and 2007, to an average of 107 per year from 2008 through 2011. According to FDIC, 2010 was the high-water mark for bank failures post-crisis, with 157 bank failures. The pace of bank failures has slowed since the 2010 peak, but continues at an elevated rate, with 38 bank failures so far this year. While the crisis in real estate markets undoubtedly factored into the spike in bank failures, internal problems such as poor corporate governance, weak risk man- agement, and weak internal controls were contributing factors as well. The Federal Reserve Bank of Philadelphia stated in a 2009 article, “People often presume that the challenging economy and sluggish housing market were the key drivers behind these failures, particularly since many tended to be geographically clustered in distressed regions. While the external economic environment certainly was influen- tial, it was rarely a standalone factor in a bank’s demise. The root causes of problems are often traced to inherent risk exposures or management weaknesses that become i In November 2008, Bank of the Commonwealth applied for $28 million in TARP funds, but was asked by its banking regulator to withdraw its application. ii As of June 30, 2012, 17 TARP banks have failed. 6 SPECIAL INSPECTOR GENERAL I TROUBLED ASSET RELIEF PROGRAM more pronounced under stressful conditions and ultimately impair an institution’s ability to weather adverse conditions.” This is borne out in SIGTARP’s criminal investigations of failed TARP applicant and recipient banks. SIGTARP’s Criminal Investigations SIGTARP has found in some of its criminal investigations that the financial crisis was a crossroads for many bank executives, particularly those at regional or community banks, whose business models focused predominantly on real estate loans. Thousands of bank executives faced bank losses during the financial crisis without turning to fraud. Those bank executives told the truth about losses and non-performing loans and adequately reserved for future losses or wrote off losses. Others turned to crime. For some bankers committing fraud, the sudden availability of TARP funds was seen as a way to play the float in concealing past due loans as bankers waited for a market upturn. These bankers viewed the financial crisis as an opportunity to extend their fraud by exploiting our nation’s vulnerability. The financial crisis also unveiled fraud that had been ongoing for years, as shrinking capital and increasing delinquent loans left bankers with nowhere to hide. For example, the criminal charges against five BOC executives and seven co- conspirators highlight a massive bank fraud at the highest levels of management, fueled by greed that included an unsuccessful attempt to use TARP funds.iii BOC was the eighth largest bank failure in 2011, with an FDIC-estimated loss of $268 million. The indictment alleges that for years the bankers fraudulently masked the bank’s condition out of fear that the bank’s declining health would negatively impact investor and customer confidence. According to the charges, many of the bank’s loans were funded and administered without regard to industry standards or the bank’s own internal controls. FRB OIG reported on the causes of the bank’s failure, including corporate governance weaknesses, insufficient risk management practices, and pervasive internal control weaknesses that when combined with deteriorating real estate markets led to rapid asset quality deterioration. The bank failed to acknowledge the extent of its problem loans and adequately reserve for losses. FRB OIG reported that the bank’s supervisor, FRB Richmond, identified the bank’s fundamental weaknesses in 2000, but did not take early and decisive action to resolve those weaknesses. The regulator identified broad authority in the hands of CEO Edward Woodard, an ineffective board that had not monitored risks, and a weak internal audit function. FRB OIG reported that the failure to implement appropriate risk management and internal controls created the opportunity for the bank to engage in unsafe and unsound practices designed to mask the bank’s true financial condition. In FRB OIG’s opinion, more forceful supervisory action through enforcement actions or downgrades could have mitigated losses. iii Federal indictments are only charges and not evidence of guilt. A defendant is presumed to be innocent until and unless proven guilty. QUARTERLY REPORT TO CONGRESS I JULY 25, 2012 7 These findings, along with allegations in the criminal charges resulting from SIGTARP’s investigation, provide an opportunity for banks and their regulators to take advantage of lessons learned. This is particularly true for banks in which taxpayers still hold a TARP investment. Banks should not wait for the Government to catch these schemes.