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Too Good To Be True: The Fall Of IndyMac
By John Devcic
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The IndyMac bank failure on July 11, 2008, left many shocked and wondering how such a large and formidable bank could collapse. The banking giant rose rapidly and failed just as fast, but this story's intrigue goes beyond its dramatic rise and fall. Read on to learn more about one of the largest U.S. bank failures in history.
The Beginning
IndyMac was born in 1985 but it was originally called Countrywide Mortgage Investment by David Loeb and Angelo Mozilo. It was built to collateralize Countrywide Financial loans that were too large to be sold to Fannie Mae or Freddie Mac. In 1997, Countrywide Mortgage Investment was spun off and became IndyMac. The Mac in IndyMac is short for Mortgage Corporation. So, while the "Mac" may sound like Freddie Mac or some of the other government loan mortgage corporations, IndyMac was always a private company with no ties to the government. (These government agencies suffered problems of their own. See Fannie Mae, Freddi Mac And The Credit Crisis Of 2008 for more insight.)
In 1999, IndyMac loaned out record amounts - $1.6 billion in the first quarter alone. In July of 2000, IndyMac became IndyMac Bank when it acquired SGV Bancorp. The total acquisition cost was $62.5 million and it made IndyMac Bank into the ninth largest bank at the time. IndyMac was also the 28th biggest lender in the country. In 2004, IndyMac expanded by buying a company called Financial Freedom, a company in the business of creating and servicing reverse mortgage loans. Two more acquisitions for IndyMac came in 2007; first up was New York Mortgage Company, which was an East Coast mortgage bank. Later that year the company bought Barrington Capital Corporation, which was a mortgage bank located on the West Coast.
While it is usually difficult to pinpoint why certain companies failed when it came to IndyMac, there are two suspects: Alt-A loans and reverse mortgages. So, while IndyMac's meteoric rise is impressive, the questionable loans that help it get there are one of the biggest reasons it came crashing down.
Suspect No.1
IndyMac specialized in what are known as Alt-A loans. Alt-A is short for Alternative A-paper. Alt-A loans fall in between prime, which is A paper, and subprime. This means the loans are riskier than prime loans but less risky than subprime loans. The interest rates for Alt-A loans fall in between prime and subprime as well. These Alt-A loans were handed out to buyers who had good credit scores but could produce little or no proof of income or assets besides the house they were planning on buying. Alt-A loans at the time were a "can't lose" proposition for IndyMac.
For example, if the bank handed out a loan to a buyer and that buyer defaulted, IndyMac would get the title for the home. Most of the time the home would be worth more then the amount owed. Because real estate values had been consistently ticking up for years, Alt-A loans seemed like a sure bet. This seemed to be confirmed when, in 2003, U.S. house prices had their biggest one-year jump in value in more than two years.
To understand just how big these Alt-A loans were we need to look at the numbers. Alt-A loans accounted for 2% of the overall U.S. mortgage market with $55 billion in loan productions in 2001. By 2006, Alt-A loans jumped to a whopping 13% of the overall U.S. mortgage market with a staggering $400 billion in loan production. And Alt-A loans accounted for 80% of IndyMac's business, making IndyMac the No.1 lender in Alt-A mortgages. (Learn more on subprime and Alt-A mortgages in the answer to our frequently asked question What is a subprime mortgage?)
The Double-Whammy
But loans were not the only way IndyMac and other banks made their money. IndyMac and many other banks were able to find investors eager to purchase pools of these types of mortgages that had been meshed together to create securities backed by future payments. Hedge funds and other investment houses were looking for ways to make more money quickly. These Alt-A loans were a great way to make a lot of money.
This did not last long, however, and when the real estate market started to collapse so did investor interest. Investors quickly pulled out, leaving the banks to suffer the loan losses without the investor funding needed to make new loans. (Read Why Housing Market Bubbles Pop to learn more about the collapse of the real estate market.)
Suspect No.2
The other problem bringing down IndyMac was the reverse mortgage business. Reverse mortgages are a certain type of loan in which a homeowner can convert a portion of the equity in the home to cash. In order to pay the cash, IndyMac needed money, but with the collapsing housing market as well as investors running away from the pools of loans, IndyMac found that it was unable to generate the cash needed. In 2007, investors saw a great stock price for IndyMac but this was the beginning of the fall for the bank.
The first year real estate prices were flattening was 2007. The real estate market crash was coming, but IndyMac didn't see it coming - neither did most other consumers, companies and investors. The year 2008 would prove to be disastrous for IndyMac. In April of 2008, both Moody's and Standard and Poor's downgraded the ratings of IndyMac's mortgage-backed security bonds. By that summer, the credit crisis was all over the news, housing prices were collapsing and IndyMac was in big trouble. The Alt-A mortgage business dried up and nearly disappeared. (To learn more about the crash, read The Fall Of The Market In The Fall Of 2008.)
The Devastating Consequences
In May of 2008, IndyMac announced job cuts to the tune of 4,000 employees. In late June of the same year, Senator Charles Schumer of New York in a letter he wrote to regulators said "IndyMac could face a failure." The letter was leaked to the public and, along with a collapsing housing market, caused a bank run. IndyMac banks were flooded with customers withdrawing their money. This run would see $1.3 billion being taken out of IndyMac banks in only 11 days.
This was far too much for IndyMac and on Friday July 11, 2008, with listing assets of $32 billion and deposits of $19 billion, the bank was seized by the federal government. The bank run had caused a liquidity crisis at the bank. The stock price reflected the bleak future of IndyMac when in July of 2008 the stock was valued for less than a dollar a share. That was a 99% drop in value since the peak price seen only three years earlier. IndyMac reopened on Monday July 14, 2008, as IndyMac Federal FSB, a bridge bank. This bridge bank was established and had taken control of IndyMac. Funds were guaranteed up to $100,000 per account.
IndyMac filed for Chapter 7 bankruptcy on August 1, 2008. (Read the answer to our frequently asked question What are the differences between chapter 7 and chapter 11 bankruptcy? to learn more about a business' liquidation.)
The Bottom Line
IndyMac's collapse was not an isolated incident. It was one of many, as other banks failed in its wake. The world economy also suffered; banks both within and outside the U.S. had to be bailed out. The collapse of IndyMac was one of the biggest dominoes in the banking world, but as one of the first banks to fail, it only provided a glimpse into the difficulties the U.S. banking system would go on to face in 2008 and 2009.
For further reading on IndyMac and other institutions that were destroyed by the subprime crisis, be sure to check out our Subprime Mortgage Meltdown Crisis Special Feature.
RELATED ARTICLES
What is an Alt-A Mortgage?
Too Good To Be True: The Fall Of IndyMac
By John Devcic
SHARE TWEET
The IndyMac bank failure on July 11, 2008, left many shocked and wondering how such a large and formidable bank could collapse. The banking giant rose rapidly and failed just as fast, but this story's intrigue goes beyond its dramatic rise and fall. Read on to learn more about one of the largest U.S. bank failures in history.
The Beginning
IndyMac was born in 1985 but it was originally called Countrywide Mortgage Investment by David Loeb and Angelo Mozilo. It was built to collateralize Countrywide Financial loans that were too large to be sold to Fannie Mae or Freddie Mac. In 1997, Countrywide Mortgage Investment was spun off and became IndyMac. The Mac in IndyMac is short for Mortgage Corporation. So, while the "Mac" may sound like Freddie Mac or some of the other government loan mortgage corporations, IndyMac was always a private company with no ties to the government. (These government agencies suffered problems of their own. See Fannie Mae, Freddi Mac And The Credit Crisis Of 2008 for more insight.)
In 1999, IndyMac loaned out record amounts - $1.6 billion in the first quarter alone. In July of 2000, IndyMac became IndyMac Bank when it acquired SGV Bancorp. The total acquisition cost was $62.5 million and it made IndyMac Bank into the ninth largest bank at the time. IndyMac was also the 28th biggest lender in the country. In 2004, IndyMac expanded by buying a company called Financial Freedom, a company in the business of creating and servicing reverse mortgage loans. Two more acquisitions for IndyMac came in 2007; first up was New York Mortgage Company, which was an East Coast mortgage bank. Later that year the company bought Barrington Capital Corporation, which was a mortgage bank located on the West Coast.
While it is usually difficult to pinpoint why certain companies failed when it came to IndyMac, there are two suspects: Alt-A loans and reverse mortgages. So, while IndyMac's meteoric rise is impressive, the questionable loans that help it get there are one of the biggest reasons it came crashing down.
Suspect No.1
IndyMac specialized in what are known as Alt-A loans. Alt-A is short for Alternative A-paper. Alt-A loans fall in between prime, which is A paper, and subprime. This means the loans are riskier than prime loans but less risky than subprime loans. The interest rates for Alt-A loans fall in between prime and subprime as well. These Alt-A loans were handed out to buyers who had good credit scores but could produce little or no proof of income or assets besides the house they were planning on buying. Alt-A loans at the time were a "can't lose" proposition for IndyMac.
For example, if the bank handed out a loan to a buyer and that buyer defaulted, IndyMac would get the title for the home. Most of the time the home would be worth more then the amount owed. Because real estate values had been consistently ticking up for years, Alt-A loans seemed like a sure bet. This seemed to be confirmed when, in 2003, U.S. house prices had their biggest one-year jump in value in more than two years.
To understand just how big these Alt-A loans were we need to look at the numbers. Alt-A loans accounted for 2% of the overall U.S. mortgage market with $55 billion in loan productions in 2001. By 2006, Alt-A loans jumped to a whopping 13% of the overall U.S. mortgage market with a staggering $400 billion in loan production. And Alt-A loans accounted for 80% of IndyMac's business, making IndyMac the No.1 lender in Alt-A mortgages. (Learn more on subprime and Alt-A mortgages in the answer to our frequently asked question What is a subprime mortgage?)
The Double-Whammy
But loans were not the only way IndyMac and other banks made their money. IndyMac and many other banks were able to find investors eager to purchase pools of these types of mortgages that had been meshed together to create securities backed by future payments. Hedge funds and other investment houses were looking for ways to make more money quickly. These Alt-A loans were a great way to make a lot of money.
This did not last long, however, and when the real estate market started to collapse so did investor interest. Investors quickly pulled out, leaving the banks to suffer the loan losses without the investor funding needed to make new loans. (Read Why Housing Market Bubbles Pop to learn more about the collapse of the real estate market.)
Suspect No.2
The other problem bringing down IndyMac was the reverse mortgage business. Reverse mortgages are a certain type of loan in which a homeowner can convert a portion of the equity in the home to cash. In order to pay the cash, IndyMac needed money, but with the collapsing housing market as well as investors running away from the pools of loans, IndyMac found that it was unable to generate the cash needed. In 2007, investors saw a great stock price for IndyMac but this was the beginning of the fall for the bank.
The first year real estate prices were flattening was 2007. The real estate market crash was coming, but IndyMac didn't see it coming - neither did most other consumers, companies and investors. The year 2008 would prove to be disastrous for IndyMac. In April of 2008, both Moody's and Standard and Poor's downgraded the ratings of IndyMac's mortgage-backed security bonds. By that summer, the credit crisis was all over the news, housing prices were collapsing and IndyMac was in big trouble. The Alt-A mortgage business dried up and nearly disappeared. (To learn more about the crash, read The Fall Of The Market In The Fall Of 2008.)
The Devastating Consequences
In May of 2008, IndyMac announced job cuts to the tune of 4,000 employees. In late June of the same year, Senator Charles Schumer of New York in a letter he wrote to regulators said "IndyMac could face a failure." The letter was leaked to the public and, along with a collapsing housing market, caused a bank run. IndyMac banks were flooded with customers withdrawing their money. This run would see $1.3 billion being taken out of IndyMac banks in only 11 days.
This was far too much for IndyMac and on Friday July 11, 2008, with listing assets of $32 billion and deposits of $19 billion, the bank was seized by the federal government. The bank run had caused a liquidity crisis at the bank. The stock price reflected the bleak future of IndyMac when in July of 2008 the stock was valued for less than a dollar a share. That was a 99% drop in value since the peak price seen only three years earlier. IndyMac reopened on Monday July 14, 2008, as IndyMac Federal FSB, a bridge bank. This bridge bank was established and had taken control of IndyMac. Funds were guaranteed up to $100,000 per account.
IndyMac filed for Chapter 7 bankruptcy on August 1, 2008. (Read the answer to our frequently asked question What are the differences between chapter 7 and chapter 11 bankruptcy? to learn more about a business' liquidation.)
The Bottom Line
IndyMac's collapse was not an isolated incident. It was one of many, as other banks failed in its wake. The world economy also suffered; banks both within and outside the U.S. had to be bailed out. The collapse of IndyMac was one of the biggest dominoes in the banking world, but as one of the first banks to fail, it only provided a glimpse into the difficulties the U.S. banking system would go on to face in 2008 and 2009.
For further reading on IndyMac and other institutions that were destroyed by the subprime crisis, be sure to check out our Subprime Mortgage Meltdown Crisis Special Feature.
RELATED ARTICLES
What is an Alt-A Mortgage?
