You can’t make this stuff up.
And it’s almost impossible to believe even when it is simply reported. Except that it all happened in the case of the 1999 closure of First National Bank of Keystone, W.Va. (We’ll come to the matter of the backhoe.) Some well-documented examples from Robert Pasley’s Anatomy Of A Banking Scandal:
• Bank examiners at First National Bank of Keystone were told that the only road out of town could be dangerous, that “there are some crazy drivers out there.”
They took this comment—from special security guards allegedly hired to protect them but who were spying—as a serious threat that someone might run them off the road if they kept digging. Before long, U.S. Marshals are brought in to protect the exam team.
• Blatantly hateful emails are found concerning officers of the embattled bank—implying that the bankers ought to be dead, among other things.
They are said to have been written by a former OCC employee who had been examiner-in-charge for Keystone. They are conveniently printed out and duly given to his former superiors a year after he left the agency. These damning emails “found” by the bank turn out to have been made up from whole cloth in an attempt to discredit him, and, apparently, knock the agency off-kilter at a point when it was closing in.
(And, mind you, at points the bank bugged the examiners’ workroom, secretly recorded phone calls with OCC representatives, and engaged in many more such antics.)
• A senior bank officer made threats on the lives of employees on multiple occasions, and was known to have a handgun in her desk drawer and access to other, more powerful weapons. On the day the bank was closed, law enforcement personnel found and removed various weapons.
• A $31 million loan file discrepancy that a bank official explained with , “Golly, I made a mistake.”
Not long afterward, the national accounting firm conducting an audit declared the bank sound. And before much time passed, the exam team then in the bank told the board that $515 million in loans was missing.
And then a senior bank official confessed: “There isn’t any cash, and there has never been any cash. I guess my goose is cooked.”
And, mind you, this about a bank that enjoyed a stellar reputation for a time—all built on fraud and lies—at a national level.
Not your average case study.
The story told in Robert Pasley’s Anatomy Of A Banking Scandal reminds me of ugliness that goes so far beyond merely unattractive that it becomes fascinating in its repulsion. I have known many honest bankers over the years, and I’ve known a handful of characters, and I’ve met one or two who I had suspicions about. I’ve spent time with three exam teams.
But Anatomy is a fascinating walk through a very strange land.
Lessons in unbridled avarice
Pasley’s painstakingly researched and written book ought to be required reading for every present and would-be bank examiner, internal or external auditor, forensic accountant, and anyone else who hopes to help keep banks clean, strong, and legitimately profitable.
In fact, it should be read by executives attending graduate schools of banking in the hope that its lessons will keep future leaders on the straight path.
What we really have here is something of a detective story, told in uncompromising detail by Pasley. Think not so much Sherlock Holmes as some variation of “CSI,” but in a financial vein.
Banking journalists would do well to read it, too. For West Virginia’s First National Bank of Keystone, centerpiece of the book, was rated by one national banking publication as a top-performing bank, on the basis of numbers submitted to, and published by FDIC. This happened not once, but several times. (Nothing to gloat about for any publication, because it could have been any of us. By the time bank figures are public, most assume they are golden.)
Problem was, it was all smoke, mostly a pack of lies. Towards the end, it became quite unclear what was really there, what had gone away, and what had never really been there at all.
Except profit. There had been precious little of that. Towards the end, the bank’s leaders and some minions doctored up fake CD records in an attempt to show funding that didn’t exist.
Behind it all: A complicated program of securitizing subprime mortgages never really worked right—the details made me dizzy and I’ve written about securitizations—but was used as the basis of the supposed mega-earnings. The bank lacked the staff expertise to manage such a high-risk product.
“Yet no one was screaming from the rooftops that this was crazy—not to be believed—a tiny bank in the middle of nowhere with no qualified staff and no established infrastructure getting involved in the securitization of subprime mortgages and earning more than any other similarly sized bank in the entire country,” writes Pasley. The bank grew quickly from a tiny bank of around $100 million in a small West Virginia town where next to nothing was happening to over $1 billion.
That is only the center ring of a multi-ring circus of crime and incompetence. Crooked players steal from the bank. They steal from the estate of a deceased crooked banker and former Keystone president and chairman. They steal from each other. Outside parties play their own fraudulent games. Board members allow themselves to be duped on multiple occasions. Attorneys, accountants, and advisors fail to do their jobs right. Even the regulators, from the top down to the newest exam team member, don’t walk out of this book completely unscathed, though the problem there was not lack of morals.
The depth and breadth of the deception, lies, embezzlement, fraud, incompetence, double-dealing, mutual theft, and more emanating from a single, small rural community bank and the players that touched it before its closure in 1999 builds through this book like an orchestra working up to a massive crash of cymbals.
Pasley worked at the Office of the Comptroller of the Currency for 30 years, as an attorney, a senior attorney, and an assistant director of the agency’s Enforcement and Compliance Division. He is now in private practice.
This is a story with few heroes. One bank staffer—Meredith Hale—realizing a part of what is going on, refused to be a part of it. She was fired immediately. Owen Carney, a former senior regulator, very briefly aboard as a replacement CEO, smelled a rat and got the heck out of Dodge, or, rather, Keystone. His successor, ill-informed at every turn, it would seem, wound up heading the bank at the point of the failure and couldn’t get work as a banker afterward.
Many other small fish looked the other way, taken in by the real crooks, or simply so desperate for work in an impoverished county that they thought they couldn’t afford to speak up. What a horrible place to be. Others simply knew not to ask questions.
So large is the cast of characters that Pasley includes a roster of roughly 150 names up front to help the reader track who’s who. He also lists the agencies and other entities that play a part in the story.
One realization emerges from reading this book: Honesty is a window that, once cracked, tends to continue to crack. That first small step may take one places one would not go if one could do it again, somewhat like telling a “little lie.”
A key chapter describing the subprime securitization arrangement and its difficulties is entitled “A Train Wreck A Comin’.” That was an understatement, in financial, regulatory, and legal terms. The 1999 Keystone Bank failure spawned a huge number of regulatory actions and civil and criminal lawsuits. To research the story, Pasley read thousands of pages of court transcript and related records and interviewed many of the people in the story. The case wound up as the subject of congressional hearings.
Seeking gold in subprime loans
Bankers of a certain age may vaguely recall the Keystone Bank failure. It went down as “the bank with the backhoe.” The bank kept many records in an auxiliary building and, when things began to get hot, in more ways than one in the summer of 1999, management decided to bury potentially incriminating evidence—literally. A large hole was made at an area farm with the backhoe, and truckload after truckload of records dumped and covered there. Finding the suspected cache of records required the FBI’s use of ground penetrating radar.
That episode—excerpted on this website with the publisher’s permission—opens the book, though it occurs somewhat in the middle of the whole story.
The financial drama begins early, with a politically connected president who builds up a tiny bank to around $100 million with many out-of-area loans to doctors. Over about five years, a program for subprime loan purchasing and securitization—to the tune of about $2.7 billion in mortgages—inflates the bank to over $1 billion. An accounting gimmick allowed the bank to book anticipated profits from the securitizations right away. In actuality, only one of the 19 securitization packages turned out to be profitable.
“The bank knew that the securitization process was a failure early on,” writes Pasley. “However, the bank’s reaction to this reality was not to pull out … but, instead, it was to double-down.” As Pasley describes it, management had to keep the process going to make it possible to keep cooking the books.
The story of the fraud, the crime, and the exam process that all-too-gradually put the brakes on things, and shut down the bank has the makings of a novel. The book goes on to cover in much detail the many trials that resulted from the failure. On the criminal front alone, five players went to prison and three were put on probation. Reputations were destroyed, personal fortunes diminished.
In a sense, Anatomy of a Banking Scandal is attorney Pasley’s own “case.” His definitive presentation of the way First National Bank of Keystone rose and fell culminates in two relatively short themes.
• Subprime troubles. The first ties in with the book’s subtitle, regarding the bank being a harbinger of the subprime crisis. The bank was closed in early September 1999, about nine years before the crisis erupted. However, Pasley cites congressional hearings about the bizarre case where Keystone was termed “a wake up call.”
Writes Pasley: “… apparently, the marketplace and the federal banking agencies slept through it.”
• Reform the system. The book’s final sections tie together a running thread throughout much of the book: Pasley’s judgment that many aspects of the bank regulatory system don’t work as well as they should.
This section of the book is essentially a policy paper, better written than most churned out by policy wonks. Possibly that’s because Pasley has spent so much time documenting the weaknesses of the system in the majority of the book that the reader can rapidly appreciate his points regarding reform.
Pasley’s chapter on consolidation of the federal banking agencies won’t be popular in many regulatory nor banking offices. He makes a good case that failures like Keystone can happen when too many regulators are involved.
On the other hand, Pasley observes, quite accurately, that banking is unusual in that institutions can choose their regulator, to a degree.
“There is no other system like this in the world and it supports and encourages a concerted effort on the part of many banks to find what they perceive to be the weakest—or most lenient—regulator,” Pasley writes.
Early in the sad story of Keystone, many threats are made to change charters, to escape OCC regulation.
“It is an absurd situation,” writes Pasley.
Finally, one of Pasley’s conclusions, backed up with the following quote from the last chief examiner to work the Keystone case, will not be popular among many bankers:
“There needs to be more faith shown in field examiners and OCC senior management should support the examiners first rather than respond as if the bank is always in the right. Senior management support is critical, particularly when the real problems [start] to surface.”
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