How FIRREA Became a Powerful Tool to Bust Bad Banks

The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), when launched, was seen as a bailout for failed savings and loans banks. It has become a powerful anti-fraud tool to prosecute banks making intentionally bad loans.

FIRREA allows the Department of Justice (DOJ) to sue for civil penalties in cases of fraud within federally insured banks. There are 14 criminal statutes, making it a broad tool that captures almost any kind of fraud. Examples include bank fraud, false statements, mail fraud, and wire fraud. The DOJ can ask for penalties that equal the total gain or loss resulting from the fraud.

FIRREA and the Savings and Loan Crisis

Congress passed FIRREA on August 9, 1989, to respond to the savings and loan (S&L) crisis. It provided $50 billion to close failed banks and stop further losses. Its goal was to restore trust in the banking system.

These S&Ls had been set up to safely provide mortgages. They paid below-average interest rates on deposits. In return, they offered below-average mortgage rates. 

The crisis began in 1982, when the Reagan administration deregulated these banks. Many of them soon invested in speculative real estate and commercial loans.

When these banks collapsed, state and federal insurance funds refunded depositors. But so many banks failed that the insurance funds began to run out of money. The biggest, the Federal Savings and Loan Insurance Corporation (FSLIC), spent billions to insure depositors of the failed banks. That bankrupted it. Without FIRREA, depositors in bankrupt S&Ls would have lost all their money.

FIRREA also prohibited S&Ls from making any more unsound investments and engaging in fraud. It improved accounting procedures and capital requirements. It also replaced the Federal Home Loan Bank Board with the Office of Thrift Supervision. It is under the Department of the Treasury.

Powers of the DOJ Under FIRREA

FIRREA is now a useful tool for the DOJ in probing poor-quality bank loans. Section 951 gives prosecutors the ability to show the burden of proof needed for civil cases, not criminal ones. They only have to show "a preponderance of evidence" instead of going "beyond a reasonable doubt." The statute also carries a ten-year statute of limitations.

Congress enacted the Financial Institutions Anti-Fraud Enforcement Act of 1990 to reward confidential whistleblowers of FIRREA violations. If the government recovers at least $10 million from the case, the whistleblower could receive as much as $1.6 million.

FIRREA increased enforcement of the Community Reinvestment Act. It sought to eliminate bank “redlining” and racial segregation of poor neighborhoods, which had contributed to the growth of ghettos in the 1970s. Regulators now publicly ranked banks as to how well they “greenlined” neighborhoods. Fannie Mae and Freddie Mac reassured banks that they would securitize these subprime loans. It was the “pull” factor that complimented the “push” factor of the CRA.

FIRREA in Recent Years

The DOJ successfully used FIRREA to prosecute banks that made bad loans during the subprime mortgage crisis. The six largest banks had paid $175 billion in fines by 2018. They also had to buy back tens of billions of bad mortgage-backed securities sold to investors on the secondary market. FIRREA was also used to prosecute rating agency Standard & Poor's for saying that those bad loans were safe investments.

FIRREA allows the government to subpoena any documents it wishes and call witnesses, including the person under investigation. Evidence gathered under FIRREA civil cases can be used in any subsequent criminal case. The government can also investigate anyone who may damage a federally insured bank, including the bank itself.

In 2014, federal and state prosecutors went after subprime auto loans. They issued subpoenas to GM Financial and Santander Consumer and requested documents related to violations of FIRREA. These, and other, banks may have issued auto loans to unqualified borrowers. Many had recently filed for bankruptcy. Some of the loans were for cars that were clearly "lemons."

The Bottom Line

FIRREA grew out of necessity in the wake of the savings and loan crisis of the 1980s, but it has proved to be a resilient and essential piece of legislation for prosecuting bad lending practices. It enabled the DOJ to prosecute banks during the subprime mortgage crisis of 2008 and has continued to be useful over the previous decade.