In Brief: Bank Failure Settlement for Ernst & Young Ernst & Young LLP reached a $125 million settlement Friday with the Office of Thrift Supervision and the Federal Deposit Insurance Corp. stemming from the failure of Superior Bank FSB in 2001, regulators reported. December 28

Law and regulation Superior's Owners to Pay $460M; Suit Next? In the largest deal of its kind, the former owners of the failed Superior Bank FSB announced Monday that they had reached an agreement to pay $460 million to federal regulators as a result of the thrift's collapse, but admitted no liability for its fall. December 11

Pointing Fingers In Collapse Of Superior WASHINGTON - Senate Banking Committee Chairman Paul Sarbanes and Office of Thrift Supervision Director Ellen Seidman clashed Tuesday at a hearing over who was to blame for the failure of Superior Bank. October 17

Superior Protested Get-Tough Approach WASHINGTON — Just months before Superior Bank FSB failed, its president urged regulators to withdraw a proposal that would have required higher capital for the very assets that brought down the $2.3 billion-asset Hinsdale, Ill., thrift. August 8

WASHINGTON — When President Obama announced Thursday that he was nominating Penny Pritzker to head the Commerce Department, he praised her "extraordinary experience" in the real estate, finance and hospitality industries. What he didn't mention was her past as a banker.

That omission was no accident. Until Superior Bank's collapse in July 2001, Pritzker was actively involved in the management and oversight of the $2.1 billion-asset thrift — and regulators blamed her family for its failure.

In retrospect, Superior Bank's downfall should have been an alarm bell for regulators, Congress and the public that banks weren't equipped to deal with the risks of subprime lending. Many of the root causes of its collapse now sound familiar, including rapid growth in subprime assets combined with liberal underwriting, deficient management systems, unreliable loan-loss provisions and a "nonresponsive management to supervisory concerns," according to a Treasury Inspector General report in 2002.

Pritzker was at least partially responsible for several of those problems. Her family owned a substantial part of the Hinsdale, Ill., thrift and she took an active role in its management.

Her involvement with the thrift began in December 1988, when the Pritzker family, along with New York real estate developer Alvin Dworman, purchased the troubled Lyons Savings Bank, with Penny Pritzker serving as chairman starting in 1991.

Under her leadership, Superior in 1993 "embarked on a business strategy marked by rapid and aggressive growth into subprime home mortgages and automobile loans," according to the inspector general's report. That strategy proved to be devastating.

Pritzker stepped down as chairman in 1994, but the thrift continued that business plan and she remained involved as a member of the holding company's board and the thrift's audit committee.

By 1999 the thrift's rapid growth in subprime assets had attracted the attention of regulators, with the Office of Thrift Supervision worried about possible inaccurate loss reserves and accounting for so-called subprime residuals, which are retained interests left over from the sale of high-risk loan pools. Regulators concluded after an exam in 2000 that the thrift was inaccurately calculating the fair market value of those assets, sparking a battle with its executives.

Regulators tried to force the thrift to write down the value of certain subprime assets, but the institution and its board, which included Pritzker, fought back. After a battle with Superior's outside auditor, Ernst & Young, the thrift and its board of directors, regulators eventually forced Superior to write down $270 million in subprime assets in early 2001, which resulted in the thrift becoming undercapitalized.

The holding company — controlled by the Pritzkers and Dworman — agreed to recapitalize the thrift. But in July 2001, the Pritzkers abruptly told the OTS they were no longer going to honor the agreement. The OTS and FDIC tried to force the Pritzkers back to the table, but eventually the thrift agency shut Superior.

In the aftermath the OTS repeatedly blamed the Pritzkers and Dworman for the thrift's failure, with then-Director Ellen Seidman testifying in Congress in 2001 that the owners should not have walked away from the recapitalization deal.

Although the Pritzkers denied culpability, the family in December of that year agreed to pay $460 million as a result of the failure — still the largest such settlement of its kind.

Since then, Penny Pritzker has tried to distance herself from Superior. In 2008 the issue came up after then-candidate Obama made Pritzker the national finance chair of his presidential campaign.

The campaign said at the time that Pritzker was not involved in daily management of Superior Bank after 1994 and issued a statement in which she expressed regret for the failure — and tried to blame it on the regulators.

"Superior's failure was complex," she wrote, according to the Chicago Sun-Times. "In short, the bank failed in 2001 because regulators concluded that the valuation of certain assets in Superior's financial statements, which had been audited by Ernst & Young for many years and previously approved by regulators, was overstated and as a result the thrift was not capitalized sufficiently.

"My family voluntarily agreed to pay the FDIC $460 million to help defray costs incurred by the government and other losses in connection with the bank's closure. … I am proud of how my family responded to this situation."

But Pritzker's position is at odds with the official record and the recollections of several officials involved in Superior's failure at the time, all of whom spoke on condition of anonymity.

1. The Pritzkers caused the failure of Superior Bank

Pritzker is correct that regulators forced Superior Bank to write down its assets, which caused the thrift to become undercapitalized. But it's worth noting that regulators acted because the assets were, in fact, overvalued. Indeed, the history of the financial crisis suggests that if anything, regulators probably weren't harsh enough in their view of those assets. The thrift and its board also spent valuable time fighting the regulators' judgment, when it should have been working on a way to raise capital.

However, the thrift still would not have failed if the Pritzkers hadn't reneged on their recapitalization agreement. Regulators thought they had a deal to save the thrift, but the Pritzkers suddenly pulled the plug on it, claiming the value of the thrift was lower than expected.

2. Penny Pritzker was deeply involved in the recapitalization negotiation

Contrary to suggestions otherwise, Penny Pritzker was heavily involved in the negotiations between regulators and the thrift about the recapitalization agreement, according to multiple sources who were involved at the time. As a member of the holding company's board and the audit committee, Pritzker was her family's point-person during those talks.

Some suggested Thursday that she was acting at the time at the behest of other family members, but others disagreed. One former regulatory official was present at a meeting where the OTS and FDIC urged Penny Pritzker to live up to the recapitalization deal.

"She was not a figurehead," this official said. "She was keenly aware of the facts, keenly aware of the cost-saving equation. The meeting was very intense. … If she was representing her uncle or someone else, it did not appear that way."

Regulators explained to Penny Pritzker and her lawyers that it would be far less costly to recapitalize the thrift than to face potential FDIC litigation after the failure — an argument that proved prescient, given the eventual $460 million payout. Yet Pritzker didn't budge.

"She was the decision-maker and she made the decision to do the recapitalization — and she made the decision not to do it," said another former regulatory official with knowledge of the situation. "She called it off at the eleventh and a half hour."

3. The agreement with the FDIC was hardly "voluntary"

Perhaps the most laughable contention in Pritzker's 2008 statement was that the record agreement with the FDIC was done "voluntarily." The FDIC routinely pursues civil action against the former executives and board members of a failed bank — and it is particularly attuned to those who have deep pockets. In the aftermath of the failure of Superior, it was clear the FDIC would go after the Pritzkers, the Dwormans and Ernst & Young.

Cutting a deal with the FDIC, then, was not a "voluntarily" move, but a necessary one. If the Pritzkers hadn't agreed to that deal, the resulting court battle would have lasted years. Moreover, the sheer size of the payout indicates that the FDIC had a good case against the thrift's owners. Although the FDIC has pursued many cases before and since then related to other failed banks, the Superior Bank agreement is the largest from a single failure.

Although the Pritzkers did not acknowledge guilt in the agreement — a routine part of such deals — most others see it as a clear sign they faced significant liability.

"Anybody who is willing to engage in that kind of settlement tells me that they have culpability and responsibility for the bank failure," the former regulator said.

To be sure, sources made it clear that Penny Pritzker — a friend of the president that has raised millions of dollars for his campaigns — does not bear sole responsibility for the failure of Superior Bank. But they overwhelmingly suggested her involvement in its fall raises serious questions about her judgment — and certainly is a bad sign for a potential Commerce secretary.

"It's mind-boggling," said the second former regulatory official.

Given President Obama's years of criticism against bankers for the lapses that helped cause the financial crisis, particularly the subprime bubble, they noted it was odd that he chose a person who committed many of the same mistakes. Ultimately, the failure of Superior Bank is still estimated to cost the government nearly $300 million.

It is unlikely that the president would ever nominate Angelo Mozilo, the former head of Countrywide, for a cabinet post. Yet Pritzker's nomination has left many wondering if the president has done something almost as misguided.

Rob Blackwell is the Washington Bureau Chief for American Banker. He covered the failure of Superior Bank as a reporter for the paper in 2001.