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IV. REGULATORY FAILURE: CASE STUDY OF THE OFFICE OF THRIFT SUPERVISION
A. Subcommittee Investigation and Findings of Fact
To analyze regulatory oversight of Washington Mutual, the Subcommittee subpoenaed documents from OTS, the FDIC, and WaMu, including bank examination reports, legal pleadings, reports, internal memoranda, correspondence, and email. The Subcommittee also conducted over two dozen interviews with OTS, FDIC, and WaMu personnel, including the FDIC Chairman, OTS Director, OTS and the FDIC senior examiners assigned to Washington Mutual, and senior WaMu executives. The Subcommittee also spoke with personnel from the Offices of the Inspector General (IG) at the FDIC and the Department of Treasury, who were engaged in a joint review of WaMu's failure. In addition, the Subcommittee spoke with nearly a dozen experts on a variety of banking, accounting, regulatory, and legal issues. On April 16, 2010, the Subcommittee held a hearing at which OTS, the FDIC, and IG officials provided testimony; released 92 hearing exhibits; and released the FDIC and Treasury IGs' joint report on Washington Mutual. |595|
In connection with the hearing, the Subcommittee released a joint memorandum from Chairman Levin and Ranking Member Coburn summarizing the investigation to date into the role of the regulators overseeing WaMu. That memorandum stated:
"Federal bank regulators are supposed to ensure the safety and soundness of individual U.S. financial institutions and, by extension, the U.S. banking system. Washington Mutual was just one of many financial institutions that federal banking regulators allowed to engage in such high risk home loan lending practices that they resulted in bank failure and damage to financial markets. The ineffective role of bank regulators was a major contributor to the 2008 financial crisis that continues to afflict the U.S. and world economy today."
On March 16, 2011, the FDIC sued the three top former executives of Washington Mutual for pursuing a high risk lending strategy without sufficient risk management practices and despite their knowledge of a weakening housing market. |596| "Chief Executive Officer Kerry K. Killinger ("Killinger"), Chief Operating The FDIC complaint states:
Officer Stephen J. Rotella ("Rotella"), and Home Loans President David C. Schneider ("Schneider") caused Washington Mutual Bank ("WaMu" or "the Bank") to take extreme and historically unprecedented risks with WaMu's held-for-investment home loans portfolio. They focused on short term gains to increase their own compensation, with reckless disregard for WaMu's longer term safety and soundness. Their negligence, gross negligence and breaches of fiduciary duty caused WaMu to lose billions of dollars. The FDIC brings this Complaint to hold these three highly paid senior executives, who were chiefly responsible for WaMu's higher risk home lending program, accountable for the resulting losses."
The Levin-Coburn memorandum contained joint findings of fact regarding the role of federal regulators in the Washington Mutual case history. Those findings of fact, which this Report reaffirms, are as follows.
1. Largest U.S. Bank Failure. From 2003 to 2008, OTS repeatedly identified significant problems with Washington Mutual's lending practices, risk management, and asset quality, but failed to force adequate corrective action, resulting in the largest bank failure in U.S. history.
2. Shoddy Lending and Securitization Practices. OTS allowed Washington Mutual and its affiliate Long Beach Mortgage Company to engage year after year in shoddy lending and securitization practices, failing to take enforcement action to stop its origination and sale of loans with fraudulent borrower information, appraisal problems, errors, and notoriously high rates of delinquency and loss.
3. Unsafe Option ARM Loans. OTS allowed Washington Mutual to originate hundreds of billions of dollars in high risk Option Adjustable Rate Mortgages, knowing that the bank used unsafe and unsound teaser rates, qualified borrowers using unrealistically low loan payments, permitted borrowers to make minimum payments resulting in negatively amortizing loans (i.e., loans with increasing principal), relied on rising house prices and refinancing to avoid payment shock and loan defaults, and had no realistic data to calculate loan losses in markets with flat or declining house prices.
4. Short Term Profits Over Long Term Fundamentals. OTS abdicated its responsibility to ensure the long term safety and soundness of Washington Mutual by concluding that short term profits obtained by the bank precluded enforcement action to stop the bank's use of shoddy lending and securitization practices and unsafe and unsound loans.
5. Impeding FDIC Oversight. OTS impeded FDIC oversight of Washington Mutual by blocking its access to bank data, refusing to allow it to participate in bank examinations, rejecting requests to review bank loan files, and resisting the FDIC recommendations for stronger enforcement action.
6. FDIC Shortfalls. The FDIC, the backup regulator of Washington Mutual, was unable to conduct the analysis it wanted to evaluate the risk posed by the bank to the Deposit Insurance Fund, did not prevail against unreasonable actions taken by OTS to limit its examination authority, and did not initiate its own enforcement action against the bank in light of ongoing opposition by the primary federal bank regulators to FDIC enforcement authority.
7. Recommendations Over Enforceable Requirements. Federal bank regulators undermined efforts to end unsafe and unsound mortgage practices at U.S. banks by issuing guidance instead of enforceable regulations limiting those practices, failing to prohibit many high risk mortgage practices, and failing to set clear deadlines for bank compliance.
8. Failure to Recognize Systemic Risk. OTS and the FDIC allowed Washington Mutual and Long Beach to reduce their own risk by selling hundreds of billions of dollars of high risk mortgage backed securities that polluted the financial system with poorly performing loans, undermined investor confidence in the secondary mortgage market, and contributed to massive credit rating downgrades, investor losses, disrupted markets, and the U.S. financial crisis.
9. Ineffective and Demoralized Regulatory Culture. The Washington Mutual case history exposes the regulatory culture at OTS in which bank examiners are frustrated and demoralized by their inability to stop unsafe and unsound practices, in which their supervisors are reluctant to use formal enforcement actions even after years of serious bank deficiencies, and in which regulators treat the banks they oversee as constituents rather than arms-length regulated entities.
Notes
595. See "Wall Street and the Financial Crisis: Role of the Regulators," before the U.S. Senate Permanent Subcommittee on Investigations, S.Hrg. 111-672 (April 16, 2010) (hereinafter "April 16, 2010 Subcommittee Hearing"). [Back]
596. The Federal Deposit Insurance Corporation v. Kerry K. Killinger, Stephen J. Rotella, David C. Schneider, et al., Case No. 2:11-CV-00459 (W.D. Wash.), Complaint (March 16, 2011), at http://graphics8.nytimes.com/packages/pdf/business/conformedcomplaint.pdf (hereinafter "FDIC Complaint Against WaMu Executives"). [Back]
Back to Contents IV. REGULATORY FAILURE: CASE STUDY OF THE OFFICE OF THRIFT SUPERVISION B. Background
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