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Tuesday, November 11, 2008

Fraud, Corruption, and Power: What Our Bailout Tax Dollars Are Really Going To

I am sure I am breaking news to no one in reporting that the government has recently passed a massive $700 Billion plus bailout. I am also certain that no one reading this doesn't know that AIG has already received and run through almost $100 billion on their own. In fact, In fact, AIG has recently requested extra funds. What may surprise some is that AIG has a long and dubious history of corruption. One of its cohorts, PNC, also has a long history of corruption. The very same PNC used federal bailout money to acquire troubled bank National City. We all know that the financial industry has disintegrated. We all know that tax Dollars will be used to prop it up. What many don't realize is the systemic level of corruption in the financial industry. What many don't realize is that we are about to give hundreds of billions of Dollars to crooks in three piece suits.

This brings me to the story of a company named Crudgington Tools. In early 2000, they were purchased by Davenport Machines. Davenport Machines used a $25 million loan from PNC to acquire Crudgington as part of a conglomerate purchase. Let's start at the most important part of the story. This is an internal memo I got my hands on from PNC Bank. (click download original pages 2-3) This memo is dated February 27th 2002. It references this very loan that PNC did for Davenport. The memo reveals several troubling things. First, this loan was bundled into a package of loans worth about $1.5 billion and sold from National Bank of Canada back to PNC. This loan was packaged in a bundle of loans referred to as "performing". This means that the loans were at the time supposed to be on time. Yet, the memo reveals that this particular loan was in default. Furthermore, the memo reveals that payments on the loan had been waived without reason given why payment had been waived. The most troubling aspect is that the original loan was done without ever providing any necessary tax documents.

Let's now start at the beginning. Back in 1992, Dallas businessman Rick San Soucie became a principle and manager in Crudgington Tools. At the time, Crudgington Tools was a traditional tool manufacturer, however the company had an idea to revolutionize tool making. The company had an idea to computerize machine tools that would eliminate the need for workers. This idea had a ton of potential but also needed just as much capital. Throughout the 1990's, the company continued to try and raise capital. In fact, according to testimony in a deposition, San Soucie himself at one point loan the company money. San Soucie eventually then brought in local businessman Don Lummus. (who is the witness in the deposition just linked) Lummus then brought in Rusty Rose and his company Cardinal Investment. Rose was the biggest power player of them all. He was a former part owner of the Texas Rangers and it was Rose that brought in George W. Bush to be a part owner in the Rangers. Rose then brought in one of his top "deputies" at Cardinal, Eric Stroud, to be his point person with respect to this company.

As Lummus own testimony indicated, Crudgington was in a constant struggle to stay afloat throughout the 1990's despite all the capital investment and all the new power players. Then, in 1999, San Soucie began divorce proceedings from his wife, Susan Diamond, (it's also how these documents wound up reaching me) In late 1999, the principles of Crudgington attempted a bold financial maneuver. They all formed Davenport and then they would procure a loan and buy several companies including Crudgington. The divorce is only important in that San Soucie never shared any of these business dealings with representatives for Diamond. In fact, as Richard Waggoner points out in testimony from a deposition, he was never made aware of the divorce. Waggoner is a corporate attorney with Gardere Wynne and he represented Davenport when they procured the loan from PNC among other transactions. Diamond was not only entitled from potential profits but as it turned out "community property" was used to secure the loan as well.

Now is when things get very complicated. Davenport was formed and the new company went seeking a loan. As Lummus mentioned in passing in his own testimony, he went to over forty banks before PNC agreed to lend them almost $25 million. This makes sense. Davenport was a brand new entity. They had no assets. A small business loan works like any other loan. Generally, you are required to provide collateral for anything you borrow. That is how a standard loan works. This loan worked in a different way though its not clear how. The internal memo makes clear that no income documents were provided. It's possible that the loan was secured by the personal assets of the principles, however if that is the case then there was no reason for the loan to ever go into default. In such a case, the assets would be held by the bank in case the loan began defaulting. Davenport eventually filed for bankruptcy and it's unclear how much if anything of this loan was eventually recovered.

Then, the loan got sold at least once, and at some point it got sold back to PNC. Though, even here it is unclear if it actually got sold. The internal memo indicates that PNC was taking over the duties of "loan servicing". Loan servicing is when a bank merely collects money for a loan and makes sure they reach the proper party, for a "small" fee. Yet, this loan was already in default and payment was waived by the time that they took over "loan servicing". There would have been no need for such a function. Furthermore, even though they were only taking over servicing of the loan, PNC was then guaranteeing payment of said loan within 18 months of taking it over. Why, we may never know. The most troubling aspect is that this loan, then in default, was bundled with all sorts of other loans into a portfolio of "performing loans". Were there any other loans in this portfolio like this one? Again, we may never know.

What is clear is to me at least is that the whole thing stinks. Brand new companies don't simply get $25 million from a bank without providing any documentation. It appears to me that all sorts of power players were able to game the system so that a bank provided them a $25 million bailout. Most of these folks were heavily tied into all entities, including loaning these entities money themselves, and this loan would have paid for all of it. Then, PNC, or even some other entity, wound up holding the bag on a bad loan that they thought was bundled into a package of transactions of performing loans. Finally, we, the tax payers, are in a position to bailout millions of transactions like this one to the tune of $750 Billion.

For more resources on this case, here are some other documents of note. Rick San Soucie's deposition, Rick San Soucie deposition part 2, Rick San Soucie deposition part 3.

Also, for some perspective on this case and the bailout check out this link.

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