Senators blast regulators for ignoring WaMu risks

Arguing that bank regulators played a crucial role in creating the conditions for financial crisis, a Senate panel Friday blasted officials for lax oversight, infighting and inaction before the largest bank failure in U.S. history.

Lawmakers on the Permanent Subcommittee on Investigations directed withering criticism at officials from the Office of Thrift Supervision, the main regulator of Washington Mutual Inc. They demanded to know why OTS leaders gave executives at WaMu years to correct glaring problems.

The executives never addressed regulators' concerns about risky lending and weak management, but the regulators took no formal action until the global financial crisis already was taking shape, documents show.

"It is not only feeble enforcement, it is pitiful enforcement," said panel chair Sen. Carl Levin.

OTS "was more of a spectator on the sidelines, a watchdog with no bite, noting problems and making recommendations, but not trying to correct the flaws and failures it saw," Levin said.

Levin charged that OTS officials handled WaMu with kid gloves because the agency relied for its budget on fees collected from banks. Fees from WaMu made up about 15 percent of OTS' budget - more than any other bank's.

The Michigan Democrat pointed an e-mail in which then-OTS chief John Reich called WaMu CEO Kerry Killenger "my largest constituent assetwise." He said that and other e-mails showed the agency's submissive attitude toward the banks it was supposed to regulate.

Reich replied that he picked up the word "constituent" while working on Capitol Hill, and said it did not "reflect any sort of sinister or inappropriate relationship."

"I am by nature a humble person, I am a casual person and an informal person," Reich said. "It is not at all unusual that I address people ... by their first name, particularly if I am 10 years older than they are."

Reich ran the OTS during the mortgage boom and the bust that destroyed several large companies it oversaw - including IndyMac, American International Group Inc., WaMu and Countrywide Financial Corp. Companies regulated by OTS must keep at least 65 percent of their assets in mortgages and other consumer loans.

Fueled by the housing boom, Washington Mutual's sales to investors of subprime mortgage securities leapt from $2.5 billion in 2000 to $29 billion in 2006. The 119-year-old thrift, with $307 billion in assets, was sold for $1.9 billion to JPMorgan in a deal brokered by the FDIC.

The OTS is slated for elimination under a proposed overhaul of financial regulation being championed by the Obama administration. That overhaul saw a major setback Friday as all 41 Senate Republicans signed a letter opposing the bill.

There has been wide bipartisan agreement about eliminating OTS, which has become a symbol of regulators' incompetence since revelations that it wooed banks by offering them easier examinations and less red tape.

But some observers said the hearing still gave some answers about how failures like WaMu's might be prevented in the future.

"We see it as part of a push not only to pass the reform legislation in as tough a form as Democrats can get, but also to rewrite a lot of the rules under current law," Karen Shaw Petrou, an analyst with the consulting firm Federal Financial Analytics, wrote in a note to clients. She said the hearing exposed critiques of capital requirements and banks' practice of choosing the least-tough regulator.

Treasury Department inspector general Eric Thorson told the panel that the problems at WaMu and with the OTS were not unique. He said other regulators had demonstrated the same reluctance to act at other banks he had investigated.

In a joint report with the inspector general of the Federal Deposit Insurance Corp., Thorson wrote that OTS and FDIC officials spent weeks sparring with each other over WaMu as the credit markets seized up in 2008.

The FDIC has backup oversight of WaMu. Chairman Sheila Bair testified that her agency could not do anything about the bank's risky position because an earlier agreement blocked it from examining banks that were financially healthy.

The OTS refused for months to heed the FDIC's call that it downgrade WaMu so that the FDIC could take a more active role.

FDIC inspector general Jon Rymer disputed that, telling the panel, "FDIC could have taken enforcement action to remedy or prevent unsafe or unsound practices" given OTS reluctance to force changes.

WaMu engaged in increasingly risky lending starting in 2002. The bank originated some of the highest-risk mortgages - those that allow borrowers to pay so little their debt level actually increases over time.

It also bought loans from outside mortgage brokers, often without ensuring the loan applications were complete and accurate, bank examiners found.

The mortgages had high rates of default but WaMu nevertheless packaged them into investments and resold them through the financial system.

"Together, WaMu and (its mortgage lender) Long Beach dumped hundreds of billions of dollars of toxic mortgages into the financial system like polluters dumping poison in a river," Levin said.