- The art of the Con
Penn Square Crumbles
The Penn Square Bank of Oklahoma City got its start
in 1960 as a small financial institution and was located in a small shopping
center for 22-years. In 1972, William “Beep” Jennings took over control of
the bank and simultaneously OPEC started moving the price of oil higher. Nobodyâ€™s
fool, Jennings knew a good thing when he saw one, and created a new department
to make loans to the oil-and-gas-industry in Oklahoma. These were also times
when people did not care much what their return was going to be as long as they
were able to take a bite-sized write-off from their tax returns.
Thus, although Jennings was at the right place at
the right time, he did not realize that not everyone who claimed to be looking
for oil really was. There were many who were only looking for the opportunity
to leverage their investments in order to be able to find more tax deductions
and the more that they could leverage their write-offs, the less they would
have to pay Uncle Sam. Penn Square was also a dinky bank as far as banks go,
and had a lending limit that could not have accommodated the drilling of one
deep well. Thus, the bank had to either find a way to accommodate the real
players or concentrate on the mixed bag of not quite serious folks whom they
It did not take the aggressive new management of
Penn Square long before they found the right way to position themselves. Being
in the heart of oil country, they could act as an introducing agent to other
banks and sell them their overage loans. Thus, they could get into a market
where there were real players. This seemingly did a couple of really good things
for banks like Chicagoâ€™s Continental and New Yorkâ€™s, Chase. Both banks fancied
themselves as oil experts. All banks in the country were saddled by branch
banking restrictions. Thus, by buying loans instead of making them, they would
effectively acquire a branch in Oklahoma with evading the Banking Regulations.
In addition, who would know the oil field in Oklahoma better then a bank that
is right there? Little did they know.
In the meantime, Jennings did the same thing that
Lincoln Savings and Loan along with others had tried. He set up a department
to market jumbo CDs that paid substantially higher interest rates that the garden
variety. Considering the hot oil market and that Penn Squareâ€™s clientele was
really larger money-center banks, it didnâ€™t take a long time before a massive
amount of this highly questionable paper was walking out the door.
Penn Square soon stopped taking any part of the
loans they were making, and concentrated on turning them around to the city
slickers for the one-percent they got for making the loan and some additional
vigorish that they received for servicing the debt. However, Penn Square was
not being very careful about the loans they were making. Money was available
from the “big city boys” for all comers and rarely if ever was an oil loan refused.
Thus, Penn Square had a conflict of interest with the loan buyers. Penn Square
saw this deal is its second coming and the money center banking people relied
upon Penn Square for their due diligence. The people at Penn Square Bank had
never even learned how to spell the word.
To Penn Square, servicing a loan meant keeping the
pot boiling and getting the loans out the door. Loans were sold where literally
none of the documentation had been checked, there were contracts where documents
were missing, there were agreements that were never signed, there were contracts
where no UCC filings had been made, and just about every other egregious practice
that one bank can foist upon another was going on at Penn Square Bank. Jennings
would make oral commitments without any paperwork, fund the loans and then the
borrower had little interest in coming back to the bank to complete the papers.
He probably wasnâ€™t even liable because he never signed anything. Moreover,
the unfinished loans could not be resold in the secondary market because of
among other problems, their lack of uniformity.
If things looked bad at this point, they soon got
a lot worse. When the loans started backing up, Penn Square didnâ€™t want to
ruin their reputation by having their bank customers get stuck with defaulting
collateral so that a determination was made by the bank that rather than have
anyone ever know that a Penn Square loan had gone bad, they would make the payments
for the client and the funding bank would never be the wiser. Continental and
Chase never had a bad Penn Square credit, which made them even more contented
with the situation and they asked for more and more paper. Penn Square on the
other hand didnâ€™t have all of the ready funds to take on what was becoming an
avalanche of defaults, so they kicked the plot up a notch by making a new loan
to each defaulter, and selling that paper to the money center banks. Thus,
they had created their own cache of money to repay whatever went bad by sticking
the banks that didnâ€™t know that there already had been a default with more paper
from the same bad credit. “This was surely a wondrous idea,” said Jennings
in a moment of self-appreciation.
Some of Jenningsâ€™ loan officers just couldnâ€™t get
the paper out the door fast enough and so there were replaced with people that
would not need to carefully take the time to do things right. The top dog in
Jennings oil and gas department became Bill Patterson () who although he was still in his twentyâ€™s was entrusted with
the entire oil and gas department, which accounted for over 80% of Penn Squareâ€™s
business. This was a man that had been called “Monkeybrains,” by his friends.
However, Patterson married into a lot of money and it was in Texas style banking.
He was able to get a job working for one of his father-in-lawâ€™s institutions
but was not allowed to make a decision, loan out money or talk to clients of
the bank. Jennings must have seen something in Patterson that he admired and
brought him aboard at Penn Square with great fanfare. Patterson played his
role for Jennings to the hilt, Patterson soon became known by everyone for his
idiosyncrasies, such as “wearing a Mickey Mouse hat while doing business with
prospective clients and drinking beer from his cowboy boots at swank Oklahoma
City watering holes.” () His father-in-law, we are told, started celebrating the moment
he left his bank, and considering what happened, for all we know may still be
celebrating the event today.
Paterson did what Jennings wanted; he ran a truly
loose ship, an anathema in the banking fraternity. One of the major things
that Paterson never checked on was to see that the money that the bank gave
them went for what was agreed to in the loan documents. Thus, when the show
closed, in the cases of many loans that had been made by Penn Square, you couldnâ€™t
even find the drilling rig, the pipe, or the location of a well. Paterson always
said that he was loaning with his heart and no one could argue with that statement.
If that hadnâ€™t given the bank enough headaches, the oil blip did not last forever
and because of excellent conservation measures put in place by the administration
and over-production by OPEC, oil prices tanked. Even the occasional, well-documented,
legitimate loans soon became an anathema to Penn Square and their bank partners.
The world had gone from energy short to dramatically over produced in just a
few short years. Many projects, especially those that entailed deep drilling,
soon became economic dinosaurs.
The bank examiners and regulators were aware of
what was happening in the oil patch and forced Penn Square to tighten its controls
over loans. They also demanded that the bank bring in a full-time professional
president, increase its reserves, bring in addition executives with substantial
banking experience, and tighten up lending requirements. However, the game was
already a little “long in the tooth” and the regulators demands were too little
and too late. Seeing the handwriting on the wall, Penn Square attempted to lend
themselves out of trouble and only made things a hundred times worse. The quality
of borrowers continued to decrease and loan defaults sharply increased.
The borrowers were also hip to the fact that when
you owe a bank a small amount, they are your creditor. When the loan becomes
larger, they become your partner. Many perceptive Oklahomans kept edging their
loans right into the stratosphere and Paterson was always quick to oblige.
Penn Squareâ€™s money also went to political contributions.
One the large borrowers from Penn Square was J. D. Allen, the co-chairman of
the Finance Committee of the Republican National Committee. Allen went bust
after Penn Square collapsed and his debts in bankruptcy exceeded $300 million.
Continental or Chase must have eventually discovered that their money was literally
given away in political contributions. Robert Hefner III, listed as one of
the richest men in America, was another major customer of the bank. When the
banks started to look for collateral to grab, all they found was a man whose
debts exceeded his liabilities.
Continental Bank of Chicago, who was on the receiving
end of the Penn Square fiasco to the tune of $1 billion, went later went bankrupt
in large part because of that and because the bank was determined to be “too
big to fail” it became the recipient of a $5 billion government bailout. The
bank was never the same after that and even today, its character is drastically
different. Seattle First National had to be merged with Bank of America in
order to save it. Chase had problems that made these seem almost incidental
and managed to get by because of a much larger capital base that was needed
to survive Penn Square and it commando loan officers.
By the spring of 1982, regulators came back to Penn
Square for another look at what was going on. What they discovered was literally
unbelievable. The bank had now gotten into so much trouble that the Federal
Reserve arranged an emergency loan for the bank. This gave examiners a chance
to get some breathing room while they took a more critical look. It was determined
that there was literally no helping the bank and when Penn Squareâ€™s doors were
closed by the FDIC bank examiners on July 5, 1982, the bankâ€™s total assets had
risen from $29 million in 1974 to over $500 million at the time of closing and
it became the seventh largest shuttering of a bank by that institution. More
startling yet was the fact that a bank with only $500 million in assets
could lose more that $2 billion, the biggest single bank loss in the history
of the United States to that time.
Arthur Young had been the auditors in the banks earlier days
and for the years of 1976 through 1979, they gave the bank a clean bill of health.
In 1980, the auditors did not like what they were seeing and qualified its audit
relative to whether or not loan reserves were sufficient to cover potential
problems. Young found that the paper work backing up the bankâ€™s loans were literally
a mess. Jennings was not at all pleased with Youngâ€™s decision to qualify their
opinion and summarily dumped the accounting firm and replaced it with Peat Marwick
We know that it represents good business practice for the incoming
accounting firm to check with the outgoing firm to find out what the relationship
was between the client and the accounting firm and why they were leaving. At
this point we get two totally separate stories. Peat Marwick stated that they
had made such an inquiry and were told in no uncertain terms that Young had
told them that “free of significant problems”. Youngâ€™s position, which canâ€™t
really be refuted, is the fact that they had qualified the audit and whether
they brought it to Peat Marwickâ€™s attention or not, is really begging the issue.
Young really couldnâ€™t do more to wave a red flag than qualify their opinion.
In spite of the knowledge that they may be stepping
on a powder keg, Peat Marwick stepped into the breach. They joined the team
just in time to be hit by lightening and as such they came in for some really
rough treatment when congress tried to figure out what had occurred. Peat Marwick
enraged the house by making the statement that their audit (which had been clean)
was intended only for the bankâ€™s directors. Yet various members of the house
including a usually calm Fernand St. Germain, Chairman of the investigation.
He made the following comment:
are not aware of the fact that the people at Penn Square dealing with brokers
gave your reports … to people, credit unions, S&Ls around this nation who
put enormous sums of money into this institution based on your audit reports,
since that was all that was available… Did it come as a complete and total surprise
to you, like the fact that when you get to be 10 years old you find out that
there is no Santa Claus?”
Naturally, the Peat Marwick and Mitchell partner that had
given the stunningly imbecilic response to the House Committee had a really
bad hair day. Peat Marwickâ€™s situation is doubly troublesome because Arthur
Young & Company who had been doing the audit pre-1980 had determined in
1980 that they would be issuing a qualified opinion. In 1981, Jennings fired
Arthur Young and hired Peat Marwick. Peat Marwick was intimately aware that
the reason that Young wanted to qualify the audit was their opinion that loan
loss reserves were substantially low. This in turn meant that expected loan
failures, especially from Youngâ€™s point of view, were heading skyward.
Peat Marwick did not find doing Penn Squareâ€™s books
clear sailing. As a matter of fact they were bothered enough by the condition
of the bankâ€™s books and records to tell the Board of Directors at Penn Square
that they had better get their act together. However, in spite of that, Peat
Marwick neither qualified their opinion, footnoted the financials nor informed
the shareholders. A discussion on that subject was conducted during a meeting
of the congressional subcommittee examining the events leading to the Penn Square
debacle. This particular skirmish was between Congressman George Wortley and
Peat Marwickâ€™s Jim Blanton and it was indeed enlightening:
Congressman Wortley: Were Penn Squareâ€™s
internal controls adequate?
Mr. Blanton: No, sir.
We donâ€™t believe they were adequate.
Congressman Wortley: Well, did you criticize
them in the public statement?
Mr. Blanton: No, Sir.
Congressman Wortley: You only criticized
them in the management letter?
Mr. Blanton: That is
Congressman Wortley: Do you think that is
fair to the public? And is that a custom of the profession?
Mr. Blanton: I am not
sure that I can determine what is fair or unfair to the public. I can say that
it is a normal procedure to issue a management letter, and that we do not address
in the financial statements or in footnotes all of the problems of a client.
Congressman Wortley: Well, do you not
feel that you have a responsibility to someone other than your client, in this
case Penn Square? Is the whole purpose of an audit not to make certain that
things are verified and the public is adequately informed of it, and shareholders
and investors and depositor?
The Office of the Comptroller of the Currency (OCC) was also
introduced into the Congressional testimony and it certainly was not helpful
to Peat Marwickâ€™s position in view of the fact that both the OCC audit and that
of the accounting firm were undertaken simultaneously:
unqualified opinion was rendered despite the identification of excess collateral
exceptions, discovery of incidences where the bank was making payments of principal
and interest to the correspondent banks on certain participations without first
receiving payment from the borrowers, and acceptance of a reserve for possible
loan losses which was deemed inadequate by the examiners during their review
of the loan portfolio.”
Not only did Peat Marwick take the account, but they gave Penn
Square an unqualified report card. Moreover, they did it at a time when Peat
Marwickâ€™ s Oklahoma City partners had two million in loans outstanding to Penn
Square and a line of credit of a million dollars. Clearly, this represented
an unacceptable conflict of interest, but that didnâ€™t seem to both the Peat
Marwick people in the least. Penn Square did make an effort to get rid of the
loans and sold them off but four days before the bank closed, they were back
on the books. I must say that we are speechless, but as usual, the accountants
that do the kind of work Peat Marwick did in this case seem always to pay a
In the meantime, the shareholders got even, they
filed lawsuits totaling over $1 billion against the Peat Marwick firm and charged
them with just about every crime in the book. The U.S. Department of Justice
filed actions against a dozen of the accountantâ€™s current and former employees
and to wrap up the dirty details, the FDIC sued Peat Marwick for $90 million.
All of the incidents above were settled and the exact details are not public
information. On the other hand, there isnâ€™t much question that Peat Marwick
paid dearly for its short-term romance with the people at Penn Square Bank.
Patterson was found guilty of twenty-six counts bank fraud.
A similar case took place in federal court in Chicago, which ended in a mistrial.
When the day was over and a plea bargain had taken place, Patterson pled guilty
of misapplication of banks funds a was sent to federal prison for two years.
An associate of Patterson also was sent to jail for similar bank related problems.