On a miserable December afternoon in 1992, over 100 armed and bulletproof vest-wearing FDIC agents entered unannounced into the headquarters of Meritor/PSFS Savings Bank and the 29 branch offices of its Philadelphia Savings Fund Society ("PSFS"). By the end of that day, the oldest savings bank in America, which over five generations of hard-working Philadelphians had come to respect as a venerated and revered institution, was out of business.
As the bank's shocked and tearful employees were herded into a conference room to hear the bad news from FDIC officials, others stood aghast while much of the bank's records -- historically significant documents which dated to the early 1800s, were being tossed into Dumpsters in the alley.
In response to the government's argument that it had to seize Meritor, Price Waterhouse was commissioned to perform a detailed analysis of Meritor's financial condition as of December 11, 1992. It read in pertinent part:
" ...banks (weaker than) Meritor which, unlike Meritor, were given the chance to do so, survived and profited in the years after 1992. The regulators evidently believed in 1992 that these comparable banks were viable, and hindsight proves that they were right. Meritor was denied continued existence because, unlike these other institutions, a large part of Meritor's capital consisted of grandfathered goodwill. In most other respects, Meritor was as strong as, or stronger than, the comparable banks that were allowed to continue (in existence)."
After being "detained" by FDIC agents until 11 p.m., and with only two weeks until the Christmas holidays, 750 employees, many with over 20 years of loyal and dedicated service, were notified not only that that they had lost their jobs, but that the FDIC was canceling their severance pay as well.
The FDIC would later pay itself $127.4 million in fees as "receiver" of Meritor's estate.
---Philadelphia Savings Fund Society.
"PSFS", as it was affectionately known to generations of Philadelphia school children who opened their first savings accounts there, had managed to survive plagues and famines, the Civil War, numerous financial panics and recessions, the Great Depression and even massive losses during the late 1980's and early 1990's "S&L crisis". But as that gloomy day in December of 1992 loomed ominously in the bank's future, insolvency had become PSFS's biggest problem.
But not its own.
--- "F--k Meritor."
Indeed, while it cannot be denied that PSFS pissed away over $1 billion during the last few years of its existence, it was still far from insolvent, with total assets in excess of $3 billion and nearly $400 million in total equity and reserves on the day it was seized.
Furthermore, PSFS, which had been required by the FDIC to maintain higher capital ratios than virtually any other bank in the country, was in compliance with regulatory capital minimums.
Nope, it was not PSFS's insolvency which would lead to Meritor's demise, but rather that of its insurance company and primary regulator, the Federal Deposit Insurance Corporation.
Except for an initial appropriation of $150 million in seed capital from the government in 1933, for the first 60 years of its history, the FDIC had never operated in the red nor had it ever needed to use a penny of taxpayer money. That's because the FDIC is supposed to be a self-funded agency which receives its money from the banks whose deposits it insures. Every three months, each FDIC-insured bank shaves a tiny bit of interest off each of its depositors' accounts and sends that money to the FDIC as an insurance "premium". Just as is the case with most other insurance companies, those premiums have always exceeded the FDIC's costs and as a result, the FDIC has never had to call upon the "full faith and credit" of the United States government -- which stands behind it -- because the FDIC has never had to worry about operating without sufficient capital. That is, until late in 1991. That's when the U.S. government's auditors, the General Accounting Office ("GAO") changed the rules by which the FDIC had played since 1932.
Prior to 1991, the FDIC's policy was to set up reserves for future bank failures only when the failure of a bank was imminent. However, with the combined impact of the S&L crisis, the Persian Gulf war and the 1990-92 recession, the GAO demanded that the FDIC change its accounting policies and beef up its reserves. Specifically, the GAO insisted that far more banks were going to fail in the ensuing few years than the FDIC was projecting and it demanded that the FDIC book a year-end 1991 reserve of $15 billion, twice as much money as the FDIC had on hand. Indeed, the FDIC, which had prided itself as being one of the government's most spectacular success stories, suddenly found that its formerly pristine balance sheet now showed a $7 billion negative net worth. FDIC officials quickly obtained Congressional approval for an emergency $10 billion line of credit from the U.S. Treasury, but the mere fact that they even had to, for the first time, go to Congress hat-in-hand was unsettling, to say the least, for an agency which had never had to do so in the previous 60 years. For 1992 then, the overriding goal of the FDIC became to wipe out its $7 billion negative net worth -- and to do so as quickly as possible.
During 1992, FDIC leadership and staff -- desperate not to end a second fiscal year in the red -- struggled mightily and had managed, by early December, to whittle the agency's negative net worth down to just under $1 billion. But with just three weeks left to go before the end of its fiscal year, the FDIC was still short of its goal -- and most of the roughly $1 billion in red ink still on its books consisted of an $864 million "reserve" which it had budgeted for the cost of closing down Meritor, paying off its depositors and liquidating its estate. Although there is evidence that at least some FDIC officials suspected all along that the $864 million figure had been vastly overstated, the reserve couldn't simply be eliminated outright as the bank was losing money and was on the FDIC's "problem bank" list. But if Meritor could be "resolved" (FDIC-speak for "seized") by the end of the year; well, that was another story.
FDIC officials would later testify that a bank's tangible equity and reserves serve, in effect, much the same as does the "deductible" on an individual's automobile or homeowner's insurance policy. In the case of Meritor, that meant that that the FDIC's losses would first be cushioned by the roughly $200 million in tangible equity and reserves which Meritor still had on its books. Furthermore, the FDIC knew that the PSFS branch network was worth another $181.3 million which was not listed on the bank's balance sheet; it represented the value of PSFS's 176-year-old franchise. All told, the FDIC calculated that were Meritor to be closed, its real equity and reserves; i.e., the FDIC's "cushion" (or, conversely, Meritor's "deductible"), was really closer to $400 million. Under the circumstances, it is hard to believe that it did not become increasingly apparent at FDIC headquarters that there might not ever be a need for the FDIC to draw upon any of the $864 million it had reserved for "resolving" Meritor. Not only that; closing a bank which had as much residual value as Meritor still enjoyed virtually guaranteed that the FDIC would be able to operate the ensuing "receivership" at a profit -- something virtually unheard of in its 60-year history.
And so late on that December afternoon in 1992, while PSFS's employees were looking forward to their upcoming holiday shopping, the FDIC moved to "resolve" Meritor. Having received, just 48 hours earlier, an eye-popping (and highly secret) bid of $181.3 million for the PSFS branch office network from Mellon Bank (which also agreed to pay off all PSFS depositors in full, thus relieving the FDIC of its major responsibility), and fearful that the deal might unravel unless consummated quickly, FDIC officials tracked down the Secretary of Banking of the Commonwealth of Pennsylvania in her car and asked her to close the bank on a hurry-up basis. As it turns out, however, there was a hitch; under Pennsylvania law, Meritor was entitled to a formal hearing first -- unless there was some sort of an emergency, such as a "run" on the bank, which necessitated "immediate action". On top of that, the up-until-then compliant Secretary, according to FDIC records, had suddenly gotten what one FDIC official candidly described as "cold feet" and was demanding that she be indemnified, apparently fearful that she might likely be sued were she to seize and close down a bank which, in addition to its nearly $400 million in total equity, franchise value, and reserves, also had another $250 million of unamortized "supervisory goodwill" on its books which -- up until then, at least -- the FDIC had always fully counted when determining Meritor's minimum capital ratio.
At a hastily arranged meeting of its board of directors held late in the afternoon of December 9, 1992, the FDIC responded to the Secretary's concerns by immediately notifying her (by fax) of its intent to revoke PSFS's deposit insurance -- an action it surely knew would, as former FDIC chairman William O. Seidman put it in his memoirs published a year later, instantly create a "run" on the bank by terrified depositors. Thus (and as the Court of Claims later held) it turns out that the FDIC itself created the so-called "emergency requiring immediate action" which would give the Secretary of Banking the legal cover she needed in order to seize Meritor without holding the hearing to which it would have otherwise been entitled.
As for the issue of whether the FDIC would continue to count the supervisory goodwill in computing whether Meritor was in compliance with minimum capital ratios, a messenger was quickly dispatched to the bank's headquarters with the answer -- in the form of a letter which had been written at least six weeks earlier, but which had been deliberately withheld for fear that Meritor would sue, thus throwing a monkey wrench into the FDIC's carefully orchestrated plans to seize the bank. In short order, the letter formally notified Meritor's management that the FDIC was washing its hands with respect to the agreement it had made with PSFS back in 1982. From now on, the letter stated, Meritor's supervisory goodwill was effectively worthless (the bank's obligation to pay off the offsetting liabilities to Western's depositors, on the other hand, remained intact). Without it, the bank's capital ratio was well below FDIC minimums. In the meantime, the FDIC board dealt with the Secretary of Banking's fear of being sued by authorizing the FDIC's legal staff to provide her with whatever "technical support" she might require, indicating that if necessary, it might also pay up to $300,000 of any legal fees which she might incur.
With the Secretary's "cold feet" now having apparently been sufficiently warmed, at precisely 3 p.m. she led a SWAT team of FDIC agents into the PSFS building and presented the bank's stunned chairman, Roger S. Hillas -- the dean of Philadelphia's banking community and one of the most highly-respected bankers in the nation -- with an official "Notice of Possession" duly stamped and sealed. While FDIC employees were literally confiscating Mr. Hillas' Rolodex and other personal items from his desk (on the basis that the FDIC, as the newly-appointed "Receiver" of Meritor's estate, was the new owner), over 100 FDIC agents were simultaneously descending on all 29 of the PSFS branch offices, flashing badges and demanding immediate entrance. In the meantime, down the hall from Mr. Hillas' office, Geraldine Banyai, the schoolmarmish Corporate Secretary of Meritor, who had been the custodian of the bank's records for nearly 40 years, walked into her office to find strangers cleaning out her vault. Assuming that the bank was being looted, she collapsed on the spot. By 11 p.m. that night (when the last of the employees were finally allowed to go home), the bank's 176-year-old charter -- signed during the presidency of James Monroe -- was (literally) in the hands of the FDIC and over 750 employees had lost their jobs and previously agreed upon severance pay. However, the FDIC's own net worth instantly went up by $864 million, allowing it to virtually wipe out its own book insolvency and finish its fiscal year at break-even. (In its new capacity as Receiver of the Meritor estate, the FDIC would subsequently use $127.4 million of Meritor's money to pay its own expenses). All in all, December 19, 1992 was a very good day for the FDIC, and its officials would later testify that with perhaps one other exception, it was the only time they could ever recall closing a bank which not only still had a substantial positive net worth, but -- when its unamortized "supervisory goodwill" was included -- had one of the highest capital ratios of any bank in the nation.
As it turns out, there was another reason why the FDIC was in such a hurry to close Meritor, a reason which at first no one would ever suspect. For just a week later, on December 19, 1992, a new piece of legislation called the FDIC Improvement Act of 1991 ("FDICIA") was to take effect. Prior to December 19, the FDIC had no power to close banks; the authority rested primarily with the 50 state banking commissioners, such as the Pennsylvania Secretary of Banking. After December 19, however, the new legislation automatically expanded the FDIC's powers, allowing it to do the job itself. But buried deep in the legislation were provisions creating new due-process rights for the banks. As it turns out, before the FDIC could exercise its new muscle, it had to first allow the targeted bank to go through a formal process of submitting a Capital Plan, having the plan then go through an FDIC staff review process, etc. While the media was concentrating on the FDIC's new authority to close banks on its own after December 19 (indeed, Presidential hopeful Ross Perot was predicting, incorrectly, that over 2000 banks would be seized on that day), the fact of the matter is that the new safeguards granted to the banks absolutely guaranteed that the FDIC's enhanced powers were virtually meaningless until at least 90 days after FDICIA went into effect. And 90 days after December 19 meant that unless the FDIC could somehow persuade the Pennsylvania Banking Secretary to do the job for them before December 19, there was simply no way that Meritor could be closed -- and the FDIC's $864 million reserve be recovered -- until well into the next fiscal year. As a top FDIC official (Paul Fritts) candidly advised the FDIC board, "think of this as a December 19 closing pre-December 19". In other words, one which allowed the FDIC to take advantage of its new powers -- while short-circuiting the bank's due-process rights.
As a result of their stellar performance for 1992, the FDIC employees who had been most closely involved with the seizure of Meritor were awarded substantial year-end bonuses. (The Association is voluntarily withholding names and amounts for the time being). In the meantime, however, PSFS's employees lost their jobs and their severance benefits; Meritor's shareholders saw nearly $400 million in value wiped out literally overnight, and the thousands of working-class families who had done business with PSFS for all of their lives (as did their parents and grandparents before them) woke up the following Monday morning to find that their accounts had been transferred to the Mellon Bank.
Ironically, the recession which had been causing PSFS' (and the rest of the banking industry's) most recent losses had actually ended just a few weeks earlier with the election of a new president, Bill Clinton. And literally within days of PSFS's seizure, virtually every leading indicator of economic activity turned up. It is no secret, of course, that since then, bank and thrift stocks (to say nothing of the economy in general) have gone through the roof during nearly nine of what have been the most prosperous years in our country's history. As just one example, the nearby Wilmington Savings Fund Society ("WSFS"), which was itself on the brink of seizure by the FDIC; whose tangible capital had dipped as low as $6 million, and whose stock could be had at under $1.50 per share in the early 1990's, has traded as high as $60 since that time. In the meantime, however, Meritor shareholders have been waiting for the resolution of a lawsuit filed against the FDIC nearly 14 years ago by Frank P. Slattery, a former member of the bank's board of directors.