Banking Regulator Played Advocate Over Enforcer

This article is striking in how it illustrates the effect of bad direction and permissiveness from nominal regulators:

OTS did not force the company to address the problem with reserves, though agency examiners worked full-time inside Washington Mutual's Seattle headquarters.

Polakoff said OTS closely monitored the company's allowance for loan losses and considered it sufficient. "They had good models in place calculating expected losses on the loan portfolio," he said.

But the agency did not fix a basic problem with how Washington Mutual predicted future losses. According to a confidential internal review in September 2005, the company had not adjusted its prediction of future losses to reflect the larger risks associated with option ARM loans. The review described those loans as "a major and growing risk factor in our portfolio." As a result, the company was not setting aside enough money to cover future losses.

This jibes with a common theme we have seen, which is that the regulatory structure established not "unfettered capitalism", but something more like "unmoored capitalism". In essence, the regulators "blessed" a variety of irresponsible (if not crazy) practices -- things which no sane company worried about its financial fate would otherwise do.

The article even mentions the important precedent-setting (but not lesson-learning) Superior Bank debacle, though not the interesting Pritzker/Obama connection:

On a hot Friday afternoon in June 2001, federal regulators swept into the suburban Chicago offices of Superior Bank and told stunned employees that it had been closed by OTS.

Superior was the largest thrift to fail since the savings and loans crisis in the early 1990s. Its demise foreshadowed the current upheaval. The company had made billions of dollars in mortgage loans to customers with credit problems but boosted profits instead of setting aside enough revenue to cover the eventual losses.

OTS regulators had not questioned the company's assurances about the quality of its loans. They had not required Superior to set aside more money. Even after the problems were identified, several federal investigators concluded that regulators had continued to rely on the company's promises rather than forcing it to take action.

"The whole Superior episode should have served as a warning," Ellen Seidman, then-director of OTS, said in a recent interview. Seidman acknowledged that she should have acted faster and more forcefully to address Superior's problems. Seidman, a Democrat, left her post shortly after the Bush administration began and had little role in revising the agency's approach.

Although the failure and disappearance of Superior triggered minor reforms, OTS did not learn the broader lesson. Thrifts were expanding into high-risk mortgage lending, but OTS was not requiring stronger safeguards.

And file this not only in "lessons not learned" but "S&L goons redux":

Countrywide Financial's decision to reconstitute itself as a thrift and come under the OTS umbrella was a victory for Darryl W. Dochow, the OTS official in charge of new charters in the Western region, home to Washington Mutual, IndyMac and other large thrifts.

In the late 1980s, Dochow had been the chief career supervisor of the savings-and-loan industry, and federal investigators later concluded he played a key role in the collapse of Charles Keating's Lincoln Savings and Loan by delaying and impeding proper oversight of that thrift's operations.

Dochow was shunted aside in the aftermath and sent to the agency's Seattle office. Several of his former colleagues and superiors say he eventually reestablished himself as a credible regulator and again rose in the organization. Dochow did not return a phone call requesting an interview, and OTS said he declined to give one.