Senate panel says regulators saw risk at WaMu but were too trusting and failed to act

Senate panel: Lax regulators helped doom WaMu

WASHINGTON — The chairman of a Senate panel investigating the causes of the financial crisis said federal bank regulators ignored mounting risk at Washington Mutual and then fought among themselves as the bank collapsed in the largest U.S. bank failure.

Sen. Carl Levin said regulators “saw the shoddy lending practices, saw the high-risk lending, saw the shoddy securitizations, understood the risk, but let the bank do it anyway.”

The Michigan Democrat chairs the Permanent Subcommittee on Investigations. Friday’s hearing focuses on regulatory failures that contributed to WaMu’s failure. It follows an 18-month investigation by the subcommittee.

Levin aimed his harshest criticism at the Office of Thrift Supervision, WaMu’s main regulator, which he said “was more of a spectator on the sidelines, a watchdog with no bite, nothing problems and making recommendations, but not trying to correct the flaws and failures it saw.”

“OTS wrung its hands as the bank sank into deeper and deeper waters,” he said.

A Treasury Department watchdog told the panel that regulators trusted the executives of Washington Mutual to correct risks at the bank but did little to force a change — leading to the biggest U.S. bank failure.

Treasury Inspector General Eric Thorson said that OTS officials “accepted assurances from WaMu management and its board of directors that problems would be resolved.”

Thorson said “OTS did not ensure that WaMu corrected those weaknesses.”

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, the Senate panel charges.

Thorson emphasized that the problem at WaMu was not unique. He said other regulators had made the same mistakes elsewhere.

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.

Decrying the cozy relationship between regulators and bankers, Levin pointed to an e-mail in which then-OTS chief John Reich called WaMu CEO Kerry Killenger “my largest constituent assetwise.”

OTS was funded with fees from WaMu and other regulated banks. WaMu’s fees made up 12 to 15 percent of the agency’s budget — more than any other bank’s.

Reich will testify later Friday. Also appearing will be OTS acting director John Bowman and Sheila Bair, chairman of the Federal Deposit Insurance Corp.

The hearing is part of a series of probes into the causes of the financial crisis. The panel sparred with WaMu executives Tuesday.

Documents released by the panel show OTS officials found glaring problems with WaMu’s lending and risk management starting in 2002 but relied on the bank to correct the issues voluntarily. WaMu repeatedly failed to do so, but the OTS never forced a change, documents show.

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 Chase & Co. in a deal brokered by the FDIC.

The FDIC administers the fund that insures regular bank deposits and has backup oversight of all insured banks. Like the OTS, the FDIC recognized problems with WaMu years before the bank’s failure. FDIC officials pressured OTS to take more aggressive action but did not invoke their enforcement authority.

FDIC officials have said they were constrained by a 2002 agreement under which FDIC examiners could enter banks only after they were deemed to be unhealthy. FDIC wanted OTS to downgrade WaMu’s rating but OTS refused to do so, documents show.

But the FDIC’s own watchdog said the agency could have done more.

“FDIC could have taken enforcement action to remedy or prevent unsafe or unsound practices” given OTS reluctance to crack down, FDIC inspector general Jon Rymer said.

The agency was critical of WaMu’s practices and pressed the OTS to take tougher action, the report said. It said OTS blocked the FDIC’s efforts to perform its own examinations.

A separate report issued jointly by Thorson and Rymer faulted the two agencies for infighting that delayed action. But it said OTS bears more blame because it blocked the FDIC’s examiner from accessing information needed to assess the bank’s strength.

“OTS’ supervision did not adequately ensure that WaMu corrected those problems early enough to prevent a failure of the institution,” the inspectors general wrote.

Former WaMu executives and regulators criticized the OTS’ oversight in interviews Thursday.

“The regulators did not possess the right technical resources or expertise to oversee the complexity of institutions” like WaMu, said Clifford Rossi, a top risk officer at WaMu in 2007 who worked at OTS in the 1990s.

As a result, Rossi said, OTS provided “by far the softest” oversight of any federal bank regulator.