What is to be said of a regulator that sees horrendous weaknesses in an institution it is charged to regulate, and yet is too timid, or worse, for decisive action? Not a great deal, which is why the Office of Thrift Supervision incurred the displeasure of the US Congress and is no longer with us, having been given the proverbial bullet for its lethargic performance in the case of the late lamented Washington Mutual (WaMu). Bloomberg cites Senator Carl Levin, the Chair of the Senate sub committee’s damning comment: “The Head of OTS knew his agency had been providing preferential treatment to the bank (WaMu). The OTS was abolished by Dodd-Frank, and for good reasons.”
WaMu was once the sixth biggest bank in America before becoming the biggest bank failure in US history. The OTS watched from the sidelines as WaMu’s board dived with ever-increasing enthusiasm into the sub-prime market, adopting one high risk strategy after another, to the point where the speed and volume of new business were the only metric management considered to be worth bothering with, and traditional concerns about the client’s ability to service his or her debt went out the window.
Long before the Senate sub committee completed its investigation into the causes of the crash, and shortly after WaMu’s failure in 2008, the Offices of the Inspector General (OIG), conducted an evaluation report into the OTC’s handling of WaMu. The OIG report also looked at the behaviour of the Federal Deposit Insurance Corporation (FDIC) since the FDIC is charged by law with protecting the deposit insurance fund by ensuring that banks perform sensibly so that they do not make unnecessary demands on the insurance fund, by failing through idiotic management errors. Therefore WaMu had not one, but two regulators overseeing its affairs, the OTC and the FDIC.
What the OIG report unearthed concerning the relationship between these two regulators amounts to a wonderful Catch 22. Here it is in the OIG’s own words:
“FDIC conducted its required monitoring of WaMu from 2003 to 2008 [the period during which WaMu concocted its own demise]. As a result of this monitoring, FDIC identified risks with WaMu’s lending strategy and internal controls. The risks noted in FDIC monitoring reports were not, however, reflected in WaMu’s deposit insurance premium payments. This discrepancy occurred because the deposit insurance regulations rely on OTS examination safety and soundness ratings and regulatory capital levels to gauge risk and assess related deposit insurance premiums. Since OTS examination results were satisfactory, increases in deposit insurance premiums were not triggered... FDIC challenged OTS’s safety and soundness ratings of WaMu in 2008. However, OTS was reluctant to lower its rating of WaMu from a 3 to a 4 in line with the FDIC’s view. OTS and FDIC resolved the 2008 safety and soundness ratings disagreement 7 days prior to WaMu’s failure, when OTS lowered its rating to agree with FDIC’s. However, by that time, the rating downgrade had no impact on WaMu’s insurance premium assessments and payments [unsurprisingly, since the bank tanked days later].”
In other words, the OTS was about as stupid as it could be. FDIC regulators could see that WaMu was flying into a wall, and the market could see it big time. But OTS, for reasons that have yet to be unearthed, could not or would not see it, and since the rules said it defined what constituted “safety”, WaMu was “safe”, even though the FDIC knew WaMu was anything but safe. The OTS compounded its pig-headedness by refusing to let officers from the FDIC get at WaMu’s books in what would by then have been an eleventh hour discovery of just how deep a hole the bank’s idiotic management had dug for it. In fact, since such out and out stupidity is actually rather rare, even amongst regulators – if it wasn’t there wouldn’t have been any turf war over WaMu with the FDIC, who could at least tell a duck when it quacked at them - more than a few people have whispered their view that it may have been made worthwhile for some in the OTC to believe that the good old folks at WaMu had it all under control.
In reality, of course, history has shown that WaMu management were clueless. They were flying along on a wing and a prayer and pocketing ludicrously inflated and wholly unearned bonuses, carved out at shareholder, client and US taxpayer expense until the meaning of high risk exploded around them. Again, you don’t need new economic thinking to solve an issue like this. You just need regulators to do the jobs assigned to them. Maybe a regulator to watch the regulators? And another to watch him/her? And another, and another, and another...
Further reading on market regulation and regulators:
- US Financial Regulation: A Hopeless Tangle, or Complexity for a Purpose? by Lawrence J. White
- How Much Independence for Supervisors in Financial Market Regulation? by Marc Quintyn
- Only White Swans on the Road to Revulsion, by James Montier
Tags: FDIC , Office of Thrift Supervision , OTS , regulators , Senator Carl Levin , Wall Street crash , Washington Mutual