The 2008 financial meltdown, fueled by excessive subprime lending, snared many Wall Street titans. But well before that, subprime lending tripped up a billionaire heiress who is now poised to be President Barack Obama's next Commerce Secretary.
Penny Pritzker, scion of the Hyatt hotel fortune, was a top executive at a holding company that owned Superior Bank, which failed in 2001 and was taken over by the government before being spun off to another bank. Superior paid the government $460 million to offset claims against the FDIC's bank insurance fund. Yet the failure also left about 1,400 depositors out about $15 million, mainly because they left money in the bank above the federally insured limit, which was $100,000 at the time.
Superior's failure left a lot of unanswered questions that Pritzker will probably have to address now, as part of her confirmation hearings in the Senate - and there's a detailed paper trail providing plenty of ammunition for critics. Pritzker, who was Obama's top fundraiser during the 2008 presidential campaign, has previously blamed the bank's failure on inaccurate audits and inattentive regulators. But there's a lot of evidence that Superior's poor lending practices are what sunk the bank.
Superior Bank was privately owned by the interests of two wealthy families: the Pritzkers, and the Dwormans of New York, whose fortune came from real estate. Penny Pritzker was chairwoman of the bank from 1991 to 1994, then a board member at the bank's holding company. The Chicago Sun-Times reported that Pritzker took a "leadership role" in the late 1990s as the bank tried to expand its profitability with an aggressive push into subprime lending.
It's important to note that subprime lending - loans granted to buyers with weak credit - is a normal part of banking. Such borrowers typically pay higher interest rates to account for the higher risk of lending to them, which is perfectly appropriate. Problems have typically developed only when banks underestimate the riskiness of such loans and fail to prepare for higher-than-normal loss rates.
That's what happened at Superior.
In testimony before the Senate Banking Committee in 2001, financial expert Bert Ely argued, "it appears that Superior became a dumping ground for low-quality, and possibly predacious, mortgages." He also contended that Superior aggressively sought deposits beyond the insured limits - even when it was on the verge of failure - and that it filed "flawed and clearly erroneous" reports on its financial condition with federal regulators. Ely also faulted regulators for failing to recognize and correct Superior's shoddy practices in time to prevent the bank's failure.
A 2002 report by the General Accounting Office found that "primary responsibility for the failure of Superior Bank resides with its owners and managers. Its strategy resulted in a high concentration of extremely risky assets. This high concentration of risky assets and the improper valuation of these assets ultimately led to Superior's failure."
Nobody knew it then, of course, but the problems at Superior were a preview of the breakdown in lending standards that become widespread in the banking system a few years later, leading to gargantuan losses at many of the world's biggest financial institutions. Pritzker was an early incarnation of the "fat-cat bankers" Obama would come to deride after taking office in 2009. .
The extensive documentation generated by the 2001 Senate hearing and other investigations into Superior's failure could make Pritzker's confirmation as Commerce Secretary quite difficult. Republicans are likely to attack her for poor management that led to a government takeover of the bank. Democrats could zero in on claims that Superior exploited vulnerable borrowers and devoured the savings of unsuspecting customers. Pritzker's other political liability - her hostility toward unions - won't win her any respite from fellow Democrats.
Pritzker may counter by pointing out that she and her family lost a lot of money on Superior. Yet the family initially acquired Superior in 1988 by taking over a failed savings bank, in a deal greased by $645 million in tax breaks and other types of aid from the government. By that measure, Superior's owners got more from the government than they paid back. It's good to be rich, except when you have to explain your dealings to the public.
Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.