naked capitalism

By Rolfe Winkler, a former hedge fund analyst

Alexi Giannoulias — the whippersnapper IL State Treasurer and basketball buddy of the President — won the Democratic primary for Senate Tuesday night. Given Giannoulias’ troubling background, including ties to a bank that received a rebuke from FDIC just a week ago, how much political capital will Obama now want to spend defending his old Senate seat?

The Giannoulias story is classic Chicago. He was elected Treasurer at 29 with no substantial experience that would qualify him for the job. All he’d ever done was work as a loan officer and VP at Giannoulias family-owned Broadway Bank of Chicago.

How did he get elected Treasurer? Because Obama endorsed him. Why did Obama endorse him? Because the Giannoulias family had been big financial supporters for Obama’s Senate campaign (Alexi continued his financial support for presidential candidate Obama).

Broadway Bank has long been under the microscope, in particular for lending to known mafiosos. The bank also lent to convicted influence-peddler Tony Rezko….points emphasized by Giannoulias’ opponent in the Democratic primary, David Hoffman.

The latest twist in the story came a week ago, when FDIC issued a consent order to Broadway Bank instructing it to raise capital and cease unsafe and unsound lending practices. These are detailed in the order, but Crain’s Chicago Business has a helpful summary:

Under the terms of the consent order, Broadway must add at least $19 million to its reserves for losses from mounting delinquent loans. Subtracting that $19 million from the bank’s capital as of Sept. 30, it must raise $50 million or more within 90 days to achieve the capital ratios the order requires.

Among the ways to restore the bank’s fiscal health, the order lists “the direct contribution of cash by the directors and/or shareholders of the bank.” The Giannoulias family owns 100% of the bank’s shares.

Neither Mr. Giannoulias nor his older brother Demetris, CEO of Broadway, have commented to date on the family’s willingness to put their own money into the bank to save it.

The story notes that Broadway was one of the most profitable and fastest growing banks in Chicago during the 2000s. How did they do it?

Established three decades ago as a lender to small businesses in Chicago, many of them Greek-owned, Broadway evolved into an aggressive commercial real estate lender, making development loans all over the U.S. and funded mainly by high-rate brokered deposits.

When the real estate markets tanked, Broadway saw its loan quality deteriorate rapidly.

Brokered deposits to fund speculative lending…a shady tactic that has led to many a bank blow-up ever since the S&L crisis. There’s a reason FDIC regulates brokered deposits so closely — though not closely enough. Banks like Broadway get it in their head that they want to grow fast, so they collect deposit funding by offering above-market interest rates. Protected by FDIC insurance, depositors couldn’t care less if their savings end up funding speculative real estate deals, which is what Alexi and family did with the money.

When the consent order was released, AP asked Giannounlias about it. Considering he’d been a loan officer and VP at the bank, it was highly sensible to ask him about the bank’s lending. But he refused to provide details, saying such questions could wait till after the primary.

To its credit, the Obama White House appears to have realized that Giannoulias wasn’t a guy it wanted to see rise any higher politically. The White House tried to recruit State Attorney General Lisa Madigan to run for the senate seat though it knew Giannoulias was angling for it.

Illinois is a very blue state, but has had Republican senators before, most recently Peter Fitzgerald. And the Republican candidate is beating Giannoulias in early polls. The big question is how much political capital Obama will spend campaigning for Giannoulias. He’ll endorse him since he is the party’s candidate. But will he campaign heavily for him despite Giannoulias questionable background and qualifications?

Another question is whether politics will be allowed to trump bank regulation here. The consent order gives Broadway Bank 90 days from 1/26/10 to raise capital, but the family hasn’t said it will pony up (and where else is the money going to come from? Who would want to buy equity in this bank?). Anyway, the general election is 268 days away. If new equity isn’t forthcoming, there’s no reason the bank should survive to election day. If it is closed and put into receivership, it could be a death blow for the Giannoulias candidacy. There are numerous examples of politicians pressuring bank regulators not to close community banks in their districts. Might Dems pressure regulators not to close Broadway, lest it cost them another senate seat?

If they’re smart, Dems will let bank regulators close Broadway. At that point they may be able to pressure Giannoulias to get out of the race. Whoever replaces him would have a much better shot at retaining the senate seat…

Rolfe Winkler is a Reuters columnist. The views expressed here are his own.