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Where Will Colonial BancGroup End Up?

High price for fraud

There’s no stopping the spate of bankruptcies. Last month, Alabama-headquartered Colonial BancGroup was forced to sign a cease and desist order by the Federal Reserve after the discovery of massive illegal accounting practices. The Fed also noted the losses that bank suffered from home mortgages in Florida and Nevada. Apparently, the bank, once known to be a powerhouse in the lending business, adopted accounting irregularities to survive.

Hasn’t the ghost of WorldCom visited them in their nightmares? It’s a shame how ex-CEO Robert Lowder steered the company to this point. We can understand if it failed to weather the recession—but accounting anomalies? Oh please… Some people are just too hardheaded.

In his Ph.D. dissertation at the University of Chicago in 2005, Gil Sadka tested the economic consequences of accounting fraud. He found out that “… Based on the intuition that the firm’s actions and its financial statements must be consistent, the model shows that fraud will affect the true profitability of the fraudulent firm, the industry profits, consumer surplus, and social welfare. The paper illustrates that in the case of price taking competition, profitability falls, consumer surplus rises (in the short term), and social welfare decreases.”

The Associated Press reports that there seems to be no way for Colonial to recover except through acquisition by regional bank BB&T. It states, “… Colonial said early this month there was ‘substantial doubt’ it would be able to continue as a going business, following five straight quarterly losses. In addition to its financial woes, the company has been the subject of federal criminal and civil investigations over alleged accounting irregularities and other issues.” This clearly agrees with Sadka’s findings.

Here’s what I predict will be Colonial’s next move: Given how horrendous it was for the bank to have been shut down, they might now imitate Washington Mutual’s actions by filing suit against the FDIC for unjustified seizure—that is, after Colonial finds bogus justification in their accounting malpractice.

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