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Originally published April 16, 2010 at 3:35 PM | Page modified April 19, 2010 at 3:01 PM

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Turf battles distracted regulators from WaMu's troubles

Washington Mutual's primary regulator was so consumed with turf battles that for four months it denied its rival agency a desk in the Seattle offices from which examiners tracked the troubled thrift's deteriorating finances, a Senate panel heard Friday.

Seattle Times business reporter

Who are these guys?

Office of Thrift Supervision (OTS): WaMu's primary federal regulator. WaMu also was the biggest fish in OTS' shrinking pond, with its fees providing about 15 percent of the agency's budget.

Federal Deposit Insurance Corp. (FDIC): It insures the deposits at financial institutions and pays depositors if the institution fails.

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WASHINGTON — Washington Mutual's primary regulator was so consumed with turf battles that for four months it denied its rival agency a desk in the Seattle office where examiners tracked the troubled thrift's deteriorating finances, a Senate panel heard Friday.

The Senate panel berated Office for Thrift Supervision officials for taking a hands-off approach toward Washington Mutual while actively fending off tighter scrutiny by the Federal Deposit Insurance Corp.

Sen. Carl Levin, D-Mich., chairman of the Senate's Permanent Subcommittee on Investigations, read aloud a long list of criticisms of WaMu's lending practices and risk management expressed over a five-year period by examiners for the Office of Thrift Supervision (OTS).

"On and on and on," Levin exclaimed to John Reich, who headed OTS from 2005 until 2009. "So what do you do about it? Not one single formal enforcement action against WaMu from 2004 to 2008. You're the cop on the beat. Not a ticket? Not a fine?"

The hearing was the second of two this week using WaMu, which collapsed in September 2008, as a case study in how loose lending practices, and the failure of regulators to curb them, helped fuel the financial crisis.

The nine current or former regulatory officials who appeared generally agreed with Levin that the riskiest types of home loans should be banned or sharply restricted, and that banks should be required to retain an ownership stake in the loans they package and sell on Wall Street.

And FDIC Chairwoman Sheila Bair told the committee that WaMu's liquidity — the cash on hand to pay depositors and others — had "declined to $4.4 billion, a dangerously low level" for such a large bank, by Sept. 25, 2008, when regulators seized the bank.

But most of the hearing focused on the infighting between the two agencies overseeing banks and thrifts.

Bair told the committee that OTS regulators in 2006 and later blocked her examiners from accessing WaMu data.

After WaMu moved into its gleaming new headquarters building in downtown Seattle, OTS for months delayed making space available in its office there so an FDIC examiner could access the secure electronic library of the thrift's financial data, said FDIC deputy regional director George Doerr. "This dragged on and on ... I personally think they didn't want us there."

The following year, OTS refused to let FDIC examiners review WaMu loan files, Bair said.

She said an operating agreement between the FDIC and the OTS also thwarted FDIC efforts.

"It's circular in that it requires us to show risk before we can get access. And frequently you need access to prove the risk," Bair said. "We really need much broader authority."

Scolding the watchdog

Levin called OTS "a watchdog with no bite. At times it even acted like a WaMu guard dog to keep the FDIC at bay."

The OTS was WaMu's primary federal regulator, and until February 2008 it assigned the giant thrift a "2" risk rating, indicating satisfactory performance. That month it lowered the rating to a "3," indicating greater concern.

Even then, instead of publicly putting the bank on notice that it must tighten its standards, the agency allowed WaMu's board to adopt a nonpublic resolution that "addressed short-term liquidity issues but did not mention taking action to correct systemic problems," according to a joint report by the Treasury Department and the Federal Deposit Insurance Corp.

Despite raising $7 billion in new capital from outside investors that spring, WaMu's woes continued.

By July 2008, OTS' Reich concluded that a formal requirement for improvements at WaMu was needed; he informed CEO Kerry Killinger (whom he addressed as "Kerry") in an e-mail that Levin derided as "apologetic, deferential." Then, the formal notice was delayed — for reasons Reich said he was unable to explain — until September, mere weeks before WaMu's demise.

"It is not only feeble enforcement, it is pitiful enforcement," Levin said.

"Tense times"

The FDIC came in for criticism as well, though not as much. That agency, considered a backup regulator, did not challenge the OTS' risk ratings on WaMu until mid-2008, when it pressed for a "4," indicating serious concerns about the thrift's long-term viability; the OTS wanted to stick with a 3.

The FDIC also wanted to require WaMu to raise another $5 billion in capital to cover future loan losses. The OTS didn't think more capital was needed, and dismissed the FDIC's risk model as "based on inappropriate assumptions."

The two agencies sparred for weeks in the summer of 2008 about whether WaMu needed to raise cash and whether it could count on borrowing from such sources as the Federal Home Loan Bank System.

In an e-mail dated Aug. 1, the FDIC assistant regional director said in that agency's opinion, "the bank needs capital, and liquidity outflows cannot be sustained."

But the OTS' Reich wrote to FDIC chairwoman Bair the same day that "WaMu has both the capital and the liquidity to justify a 3 rating."

In fact, an internal WaMu forecast from around that time, only made public Friday, shows the bank already was on thin ice: In a "break the bank" scenario that could follow a downgrade to 4, WaMu projected that its cash would run out before the end of 2008.

When Bair told WaMu that her agency would downgrade WaMu on its own authority, without waiting for the OTS, Reich complained to a colleague: "I cannot believe the continuing audacity of this woman."

Questioned about that Friday, Reich said "these were tense times."

"People's blood pressure increases in situations like this, and sometimes we say things that we wish would not appear in print."

That comment got Levin's blood boiling.

"I don't see your blood pressure getting up against a bank which is engaged in the kind of dangerous practices that that bank was engaged in," he said. "Dangerous to their solvency, dangerous to their investors, dangerous to their depositors, dangerous to this economy."

Drew DeSilver: 206-464-3145 or ddesilver@seattletimes.com

Bloomberg News and Seattle Times business staff contributed to this report.

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