I read the following press release a few weeks ago about how a banker who worked at La Jolla Bank, FSB admitted to conspiring with other senior executives at the bank in approving bad loans to unqualified borrowers. Ms. Martinez, along with others, accepted bribes and kickbacks in return for making loans to borrowers, known as “Friends of the Bank (FOB),” who were unable to repay the loans. When FOBs defaulted on a loan, “bank executives gave them more loans so they could make payments on the initial ones.”

An audit describes what caused the bank’s failure. The bank failed due to “significant asset quality deterioration and loan losses.” Not surprisingly, the control fraud involved LJB’s CEO and CCO. Who else could defeat a bank’s internal controls easily? The bank was set up to fail due to an environment fostering a Gresham’s dynamic in which the bank grew aggressively by originating bad loans. The bank’s officers were rewarded with compensation based on fictitious earnings and by receiving bribes/kickbacks, while the taxpayers bore the costs to the tune of $1 billion. Ultimately, the bank did not have enough capital to sustain a deteriorating loan portfolio–the Ponzi scheme began to crumble.

In the end, the Office of Thrift Supervision closed the bank in 2010 and assigned the Federal Deposit Insurance Company as receiver, which sold LBJ’s deposits and assets (through a loss-share agreement) to another financial institution.

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