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Originally published April 15, 2010 at 2:00 PM | Page modified April 16, 2010 at 5:13 PM

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Examiners began worrying about WaMu's risks in 2005

Bank examiners were concerned as far back as 2005 that Washington Mutual was cutting corners and lending imprudently, but agency higher-ups repeatedly blocked attempts to rein in the giant thrift until it was too late.

Seattle Times business reporter

Bank examiners were concerned as far back as 2005 that Washington Mutual was cutting corners and lending imprudently, but agency higher-ups blocked efforts to rein in the giant thrift until it was too late.

Examiners from WaMu's primary federal regulator, the federal Office of Thrift Supervision (OTS), repeatedly identified significant problems with the Seattle thrift's lending practices, loan quality and risk management, a Senate investigative panel has found.

But the bank resisted changes, and regulators were at odds with each other, so little was done.

"Washington Mutual promised year after year to correct identified problems, but failed to do so," says the report, released Thursday ahead of a second day of testimony on Capitol Hill.

"OTS failed to respond with meaningful enforcement actions, resisted [Federal Deposit Insurance Corp.] recommendations for stronger measures, and even impeded FDIC examination efforts," the report goes on.

The OTS was plagued by an ineffective regulatory culture in which examiners are "frustrated and demoralized by their inability to stop unsafe and unsound practices [and] their supervisors are reluctant to use formal enforcement actions even after years of serious bank deficiencies," said the panel.

The Senate report parallels one to be released Friday by the inspectors general for the FDIC and the Treasury Department. That report finds the OTS repeatedly deferred to WaMu management, held off on issuing enforcement orders contrary to its established practice, and even relied on WaMu's own tracking system to monitor the thrift's compliance with its recommendations.

The FDIC's own examiners were consistently more critical of WaMu's operations and compliance actions. But both reports faulted that agency for, in essence, letting the OTS push it around.

Regulators to testify

Officials from the OTS and FDIC are to testify Friday before the Senate's Permanent Subcommittee on Investigations. It's the second of four hearings the panel has planned to look into the roots of the financial crisis in risky mortgage lending.

The first hearing, on Tuesday, used WaMu as a case study in how mortgage lenders' sloppy lending practices, short-term, sales-driven culture and inadequate risk controls combined to inject billions of dollars of dodgy home loans into the financial system.

Bank examinations, internal e-mails and memos show the OTS examiners had serious concerns at least as far back as August 2005, when a report stated: "We remain concerned with the number of underwriting exceptions and with issues that evidence lack of compliance with bank policy. ... [T]he level of deficiencies, if left unchecked, could erode the credit quality of the portfolio."


But because those practices hadn't yet caused actual losses, OTS examiner Lawrence Carter wrote in September 2005 to his supervisor, "it has been hard for us to justify doing much more than constantly nagging."

That helpless attitude was expressed two years later by another OTS examiner, discussing WaMu's resistance to a possible downgrade of its financial-condition rating. The scale used by federal bank regulators runs from 1 (strongest) to 5 (weakest); WaMu was then a 2, and the examiner was inclined to leave it there.

"Not up for a fight"

"I'm not up for the fight or the blood pressure problems," examiner Mary Clark wrote to her OTS colleagues. "It doesn't matter that we are right, what matters is how it is framed. And all we can do is point to the pile of complaints and say there is a problem."

When one OTS examiner tried in 2007 to restrict loans in which WaMu didn't verify the borrower's claimed income or assets, he was overruled by superiors in the agency's West Region office.

Sen. Carl Levin, D-Mich., who chairs the subcommittee, said Thursday that top OTS regulators treated WaMu more like a colleague than an object of regulation. WaMu was by far the nation's largest thrift, and the fees it paid to the OTS made up 12 to 15 percent of the agency's revenue.

Levin noted scornfully that during Tuesday's hearing, ex-CEO Kerry Killinger complained of a "clubby atmosphere on Wall Street" from which WaMu had been excluded.

"The evidence indicates that there was another club that he was very much a member of, and that's OTS thrifts, which were able to dodge tough oversight," Levin said Thursday.

Overall, Levin said, the "feeble" OTS supervision of WaMu bolsters the argument for abolishing the agency, as the overhaul of the financial regulatory system pending in the Senate would do.

Hostile relations

The FDIC, WaMu's backup regulator, urged the OTS to crack down on WaMu. But in 2006, the OTS began limiting FDIC staff's access to WaMu's loan files and other records.

At one point in January 2007, FDIC official George Doerr wrote to one of his examiners: "I'm just not relishing another round of 'No.' Well, let them (the OTS) make fools of themselves again!"

The FDIC has authority to take enforcement action against an insured institution on its own. But an unnamed senior FDIC official told the subcommittee's investigators it had never used that authority, against WaMu or any other bank, because that would be viewed by other banking agencies as "an act of war."

Toward the end, though, the FDIC became more willing to wage that war.

In his Tuesday testimony, Killinger said that at the time he was fired as CEO in September 2008, the OTS had not directed WaMu to raise more outside capital or seek a buyer.

What he didn't say was that on Aug. 1, the FDIC had told WaMu management they ought to "find a strategic partner" — bank-speak for putting the company up for sale.

Despite its concerns, the OTS only lowered its risk rating on WaMu to a "3" in late February 2008. Such a downgrade normally would be accompanied by a relatively modest enforcement action called a "memorandum of understanding" or MOU.

"We almost always do an MOU for 3-rated institutions, and if someone were looking over our shoulders, they would probably be surprised we don't already have one in place," the OTS director at the time, John Reich, wrote to Killinger in July — more than four months after the downgrade.

Such a memorandum, requiring WaMu to correct weaknesses identified in the OTS' most recent examination, was not issued to the bank until Sept. 7 — the same day Killinger was fired.

By that time, the FDIC was pushing hard for a downgrade to "4," indicating significant concern about WaMu's long-term viability. The OTS, however, yet again resisted.

Finally, on Sept. 10, FDIC Chairwoman Sheila Bair told WaMu that her agency would issue its own downgrade, bypassing OTS.

The reaction from Reich? "I cannot believe the continuing audacity of this woman," he wrote to a colleague.

Drew DeSilver: 206-464-3145 or

Director, Office of Thrift Supervision (OTS),

in Aug. 2008 e-mail

"It is clear from my experience that changes seem to progress slowly at WaMu."

Dennis Fitzgerald

WaMu's office that dealt with regulators "is a joke. The purpose of this group seems to be how can we give the regulators the bare minimum without them raising a fuss."

Susie Clark

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