In the summer of 2008, just months before giant mortgage lender Washington Mutual Bank flamed out and became the biggest bank failure in U.S. history, the thrift's regulators were squabbling over its financial condition.
The Office of Thrift Supervision, Washington Mutual's primary regulator, insisted on giving it a higher quality rating than the Federal Deposit Insurance Corp, which insured its deposits and was its backup regulator, according to a report released on Thursday by the Senate subcommittee on investigations.
When the FDIC finally decided to go ahead and downgrade Washington Mutual's rating just weeks before its failure, then-OTS director John Reich was furious.
I cannot believe the continuing audacity of this woman, he wrote in an e-mail message to a senior OTS official, referring to FDIC Chairman Sheila Bair.
The feuding between the two agencies over Seattle-based Washington Mutual had been going on for years, according to the Senate panel, which is examining the causes of the 2008 financial crisis and using Washington Mutual as a case study.
The OTS repeatedly blocked the FDIC's attempts to gain access to Washington Mutual's data and even obstructed attempts by its own examiners to rein in Washington Mutual's high-risk lending, the panel found.
These agencies, and particularly OTS, are supposed to be like fire inspectors to protect us from a fire calamity. Instead, they stood and watched idly while the incendiary threat grew higher and higher, Senator Carl Levin, chairman of the subcommittee, told reporters on Thursday.
The subcommittee, which will take testimony on Friday from current and former OTS and FDIC officials, including Reich and Bair, found the infighting between the agencies and OTS's unwillingness to crack down on Washington Mutual, contributed to its failure.
OTS allowed Washington Mutual and its affiliate Long Beach Mortgage Co 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, the subcommittee concluded.
The OTS in recent years has been painted by lawmakers as a poster child for lax regulation.
In the bubble years before the 2008 financial meltdown, critics say, financial firms shopping for the most flexible regulator sometimes found a home at the OTS. For instance, troubled insurer American International Group Inc
The OTS eventually agreed with the FDIC's lower rating for Washington Mutual, but by then the nation's biggest savings and loan was just days from collapse.
Depositors withdrew $17 billion from Washington Mutual following Lehman Brothers Holdings Inc's
The subcommittee's findings largely dovetail with those in a report by the inspectors general of the Treasury Department and the FDIC, also released on Thursday.
That report said that, while OTS examinations of Washington Mutual repeatedly identified concerns with its high-risk lending strategy, OTS's supervision did not adequately ensure that WaMu corrected those problems early enough to prevent a failure of the institution.
Among other recommendations, Treasury inspector general Eric Thorson said OTS needs to take more timely enforcement action, ensure that high bank ratings are properly supported and remind examiners of the risks associated with rapid growth and high-risk concentration of loans.
The recommendations may prove moot. Financial reform bills passed by the House and proposed in the Senate would eliminate the OTS as a stand-alone agency.
The turf fighting between the OTS and FDIC was generally well known, but the subcommittee's more than year-long investigation uncovered a nearly dysfunctional relationship between the two regulators.
The panel's report noted that Washington Mutual was the largest financial institution overseen by OTS and that fees paid by the thrift accounted for between 12 percent and 15 percent of OTS's budget between 2005 and 2008. In an email obtained by the subcommittee, Reich referred to then-Washington Mutual CEO Kerry Killinger as my largest constituent.
Regulations only work if the regulators stay at arms length from those that they regulate, Levin told reporters. And too often in this case, WaMu regulators were not at arms length, they were arm in arm.
Friday's hearing will be the second of four held by the subcommittee. The first, on Tuesday, also focused on Washington Mutual and examined the role of high-risk loans in the financial crisis.
The next hearing, on April 23, will look at the role of rating agencies. The final hearing, on April 27, will examine the role of investment banks.
(Reporting by Dan Margolies; editing by Andre Grenon)