By Dina ElBoghdady
Washington Post Staff Writer
Saturday, April 17, 2010; A09
In a testy exchange with senators Friday, the former head of the Office of Thrift Supervision denied that his agency fostered a cozy relationship with Washington Mutual that tempered oversight of the Seattle thrift and ultimately resulted in the largest bank failure in U.S. history.
A year-long Senate probe presented at a hearing Friday concluded that the OTS had identified a pattern of errors, poor risk management and even fraud at Washington Mutual. Yet it took no action to stop the bank from dumping toxic mortgages into the financial system because the bank was a huge moneymaker that paid fees amounting to 15 percent of the agency's budget, the panel said.
In effect, the OTS was a "watchdog with no bite" that failed to keep an arm's-length relationship with the bank it regulated, said Carl M. Levin (D-Mich.), chairman of the Governmental Affairs subcommittee on investigations.
But former OTS director John M. Reich told the panel that the fee factor was irrelevant. Reich said panic among Washington Mutual's depositors led to the bank's demise, not its poor loan quality.
"This was a liquidity failure, not a capital failure," Reich said.
Those customers withdrew about $16 billion from the bank in a 10-day period following a string of alarming developments in 2008, including the failure of Bear Stearns, IndyMac and Lehman Brothers., Reich said. The OTS seized Washington Mutual on Sept. 25, 2008, and sold it to J.P. Morgan Chase.
Had Washington Mutual's liquidity crises occurred two weeks later, there would have been no failure, because the Federal Deposit Insurance Corp.'s decision to increase deposit insurance to $250,000 per depositor would have "likely mitigated the run on deposits," Reich said.
The bank may have even qualified for a federal bailout under the "too big to fail" stress tests adopted in 2009, Reich said in written testimony. "WaMu was in fact a systemically important institution and should have been treated as such," he said.
But Reich conceded he was uncomfortable that borrowers could take out mortgages without fully documenting their income or assets. Those types of loans contributed to Washington Mutual's losses. Reich said he did nothing about them because he was swayed early on by their successful 20-year track record on the West Coast. "In hindsight, I regret it," he said.
Lawmakers marveled that Reich was unaware that 90 percent of the home equity loans originated by Washington Mutual were no- or low-documentation mortgages.
Levin chastised Reich's hands-off approach. He quoted from years of internal documents obtained by the subcommittee on investigations in which OTS examiners repeatedly raised red flags about the bank's exotic mortgages, but to no avail. The bank used to quickly sell those loans to investors, but when the credit market froze in 2007, it was stuck with the risky loans.
Levin said that the warnings fell on deaf ears because the OTS shed its proper "cop on the beat" role and created an unhealthy culture of collaboration with Washington Mutual. The agency took no formal action against the bank until it was too late, he said. It even relied on the bank to track its own progress in correcting problems flagged by the OTS, he said.
"Not only is it feeble enforcement, it is pitiful enforcement," Levin said.
The inspectors general of the OTS and the FDIC did a separate investigation that corroborated many of the subcommittee's findings.
OTS Inspector General Eric M. Thorson said that the agency spotted weaknesses in its relationship with mortgage brokers, middlemen who act as liaisons between borrowers and lenders. In 2007, only 14 Washington Mutual employees oversaw more than 34,000 third-party brokers.
Yet OTS examiners refused to lower Washington Mutual's asset quality ratings even though its practices were unsatisfactory because "WAMU was making money and loans were performing," Thorson said. This assessment runs counter to OTS guidelines, which state that demonstrating profitability is not sufficient if an institution has a high exposure to risk, Thorson said.
The inspectors general found that infighting between the agencies also hampered regulation of Washington Mutual.
The FDIC had identified risks and challenged the OTS's financial soundness ratings of the thrift in 2008, they said. That disagreement was not resolved until seven days before the bank's collapse.