WaMu failed because of run on bank, former regulatory chief says

The former head of the chief banking regulatory agency that oversaw failed Washington Mutual told lawmakers Friday that the giant savings and loan collapsed because of a run on the bank, not failures by him or other regulators.

The testimony of John Reich, who served as head of the Office of Thrift Supervision from 2005 to 2009, came as a Senate subcommittee released the results of an 18-month investigation that blasted regulatory supervisors for doing little to halt risky practices at WaMu that bank examiners had identified as early as 2003.

The criticism was echoed by a report this week on WaMu’s collapse, the largest bank failure in U.S. history, by the inspectors general of the thrift agency and the Federal Deposit Insurance Corp.

Reich said WaMu was seized by regulators on Sept. 25, 2008, because of a $16.4-billion run on deposits after the sharp decline in the economy throughout the year and the failure of Lehman Bros. and the bailout of American International Group Inc. just days earlier.

“The liquidity failure at WaMu was induced by the decline in public confidence in large financial institutions, brought on by a series of prior significant events in 2008,” Reich said in his prepared testimony.

But Sen. Carl Levin (D-Mich.), chairman of the Senate Permanent Subcommittee on Investigations, blasted Reich for his agency’s “pitiful enforcement” and for exacerbating the situation with a petty turf war with the FDIC, the bank’s secondary regulator. Levin said the Office of Thrift Supervision impeded attempts by the FDIC to independently examine WaMu as its condition worsened.

In a particularly heated line of questioning at the hearing Friday, Reich was unable to account for a six-month delay in issuing a memorandum of understanding to WaMu in 2008. The memorandum is an enforcement order meant to signal a bank’s declining situation and subject it to greater regulatory scrutiny. Levin accused Reich of being reluctant to take FDIC advice to downgrade WaMu.

“I do not know why it took so long to implement” the memorandum of understanding, Reich said. “I don’t know if apologetic is the right word, but I regret that there was a six-month delay.”

Further exacerbating the situation was WaMu’s large mortgage holdings in California and Florida, two states hit by the largest price declines after the housing bubble burst, Reich said. And WaMu was hurt by the federal law that requires savings and loans to invest two-thirds of their assets in real-estate-related loans.

In addition, the bank was the victim of bad timing, he said, as federal efforts to stabilize the financial system had yet to kick in.

“Had WaMu’s liquidity crisis occurred two weeks later, there would have been no failure,” Reich said.

Reich said regulators were on top of WaMu’s situation, and during the year before it collapsed, its problems were “discussed informally on virtually a daily basis” by officials at the thrift agency in Washington.

But the probe by the Senate investigations subcommittee said agency supervisors failed to act on concerns and warnings from bank examiners about shoddy lending practices, risky investments and substandard mortgage-backed securities sold into the market. The agency did little to stop the practices because it had too cozy a relationship with WaMu and other banks it regulated, Levin said.

“Instead of policing the economic assault, OTS was more of a spectator on the sidelines, a watchdog with no bite, noting problems and making recommendations, but not acting to correct the flaws and failures it saw,” Levin said.

“The bottom line,” he continued, “is that OTS never said no to any of the high-risk lending or shoddy lending practices that came to undermine WaMu’s portfolio, its stock price, its depositor base and its reputation. The result was a bank failure, a financial system poisoned with toxic mortgages and an economic meltdown.”

The findings of the subcommittee were bipartisan. Sen. Tom Coburn (R-Okla.) said WaMu’s failure was “a classic example of when a bank captures its regulator rather than a regulator doing its job.”

But Coburn also blamed Congress for not doing a better job of overseeing the Office of Thrift Supervision and warned that the Senate was preparing to act too quickly to overhaul the financial regulatory system before the subcommittee’s hearings were completed this month and a bipartisan commission investigating the causes of the financial crisis issues its report in December.

The subcommittee did not blame WaMu’s failure only on regulators. Its investigation slammed WaMu executives for risky practices driven by the quest for higher profit that led to the bank’s seizure and sale to JPMorgan Chase & Co. for $1.9 billion.

Turf battles between the Office of Thrift Supervision and the FDIC worsened the problems, the committee and inspectors general report said.

But Reich defended his former agency and said disagreements among regulators helped strengthen oversight.

“Some members of Congress seem to believe that disagreement among regulators is unseemly and an indication the process is broken and needs to be changed. I could not disagree more with that view,” Reich said. “Like the U.S. Congress, differences of opinion are desirable, productive, and usually result in the best policy being adopted.”