[Senate Hearing 111-672, Volume 2]
[From the U.S. Government Publishing Office]
S. Hrg. 111-672
WALL STREET AND THE FINANCIAL CRISIS:
THE ROLE OF BANK REGULATORS
=======================================================================
HEARING
before the
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
HOMELAND SECURITY AND
GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
__________
VOLUME 2 OF 5
__________
APRIL 16, 2010
__________
Available via http://www.gpoaccess.gov/congress/index.html
Printed for the use of the Committee on Homeland Security
and Governmental Affairs
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COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii TOM COBURN, Oklahoma
THOMAS R. CARPER, Delaware JOHN McCAIN, Arizona
MARK L. PRYOR, Arkansas GEORGE V. VOINOVICH, Ohio
MARY L. LANDRIEU, Louisiana JOHN ENSIGN, Nevada
CLAIRE McCASKILL, Missouri LINDSEY GRAHAM, South Carolina
JON TESTER, Montana ROBERT F. BENNETT, Utah
ROLAND W. BURRIS, Illinois
PAUL G. KIRK, JR., Massachusetts
Michael L. Alexander, Staff Director
Brandon L. Milhorn, Minority Staff Director and Chief Counsel
Trina Driessnack Tyrer, Chief Clerk
Patricia R. Hogan, Publications Clerk and GPO Detailee
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
CARL LEVIN, Michigan, Chairman
THOMAS R. CARPER, Delaware TOM COBURN, Oklahoma
MARK L. PRYOR, Arkansas SUSAN M. COLLINS, Maine
CLAIRE McCASKILL, Missouri JOHN McCAIN, Arizona
JON TESTER, Montana JOHN ENSIGN, Nevada
PAUL G. KIRK, JR., Massachusetts
Elise J. Bean, Staff Director and Chief Counsel
Allison F. Murphy, Counsel
Jennifer D. Auchterlonie, DOJ Detailee
Nina E. Horowitz, GAO Detailee
Christopher J. Barkley, Minority Staff Director
Anthony G. Cotto, Counsel to the Minority
Mary D. Robertson, Chief Clerk
C O N T E N T S
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Opening statements:
Page
Senator Levin................................................ 1
Senator Coburn............................................... 8
Prepared statements:
Senator Levin................................................ 93
WITNESSES
Friday, April 16, 2010
Hon. Eric M. Thorson, Inspector General, U.S. Department of the
Treasury....................................................... 10
Hon. Jon T. Rymer, Inspector General, Federal Deposit Insurance
Corporation.................................................... 12
John M. Reich, Former Director, Office of Thrift Supervision, and
Former Vice Chairman, Federal Deposit Insurance Corporation.... 36
Darrel Dochow, Former West Regional Director, Office of Thrift
Supervision.................................................... 37
Lawrence D. Carter, Former Examiner-in-Charge (2004-2006), and
Current National Examiner, Office of Thrift Supervision........ 39
John Corston, Acting Deputy Director, Division of Supervision and
Consumer Protection, Complex Financial Institution Branch,
Federal Deposit Insurance Corporation.......................... 66
J. George Doerr, Deputy Regional Director, San Francisco Region,
Federal Deposit Insurance Corporation.......................... 67
Hon. Sheila C. Bair, Chairman, Federal Deposit Insurance
Corporation.................................................... 80
John E. Bowman, Acting Director, Office of Thrift Supervision.... 82
Alphabetical List of Witnesses
Bair Hon. Sheila C.:
Testimony.................................................... 80
Prepared statement........................................... 156
Bowman, John E.:
Testimony.................................................... 82
Prepared statement........................................... 181
Carter, Lawrence D.:
Testimony.................................................... 39
Prepared statement........................................... 149
Corston, John:
Testimony.................................................... 66
Prepared statement........................................... 153
Dochow, Darrel:
Testimony.................................................... 37
Prepared statement........................................... 147
Doerr, J. George:
Testimony.................................................... 67
Prepared statement........................................... 155
Reich, John M.:
Testimony.................................................... 36
Prepared statement........................................... 134
Rymer, Hon. Jon T.:
Testimony.................................................... 12
Prepared statement........................................... 119
Thorson, Hon. Eric M.:
Testimony.................................................... 10
Prepared statement........................................... 101
EXHIBIT LIST
1.a. Memorandum from Permanent Subcommittee on Investigations
Chairman Carl Levin and Ranking Minority Member Tom Coburn to
the Members of the Subcommittee................................ 189
b. Washington Mutual Practices That Created A Mortgage Time
Bomb, chart prepared by the Permanent Subcommittee on
Investigations................................................. 198
c. Office of Thrift Supervision Comments on WaMu and Long
Beach Underwriting/Lending Deficiencies, chart prepared by the
Permanent Subcommittee on Investigations....................... 199
d. Excerpts from Documents Showing OTS Repeatedly Identified
Washington Mutual and Long Beach Underwriting/Lending
Deficiencies, chart prepared by the Permanent Subcommittee on
Investigations................................................. 200
e. Excerpts from Documents Showing OTS Repeatedly Identified
Washington Mutual and Long Beach Risk Management Deficiencies,
chart prepared by the Permanent Subcommittee on Investigations. 202
f. Excerpts from Documents Showing Slow and Weak OTS
Enforcement at Washington Mutual, chart prepared by the
Permanent Subcommittee on Investigations....................... 204
g. Excerpts from Documents Showing OTS Impeding FDIC's
Oversight, chart prepared by the Permanent Subcommittee on
Investigations................................................. 206
h. Excerpts from Documents Showing OTS Internal Views on
Inability to Stop Poor Quality Lending Practices, chart
prepared by the Permanent Subcommittee on Investigations....... 208
i. WaMu Dodging Compliance with Tougher Lending Standards:
Nontraditional Mortgage Guidance, chart prepared by the
Permanent Subcommittee on Investigations....................... 210
j. Washington Mutual Regulators Timeline, chart prepared by
the Permanent Subcommittee on Investigations................... 211
Documents Related to OTS Failure to Address Long Term Safety and
Soundness:
2. Office of Thrift Supervision, 2004 Examination Handbook
(Proactive regulatory supervision should evaluate future needs
and potential risks to ensure the success of the thrift system
in the long term.)(excerpt).................................... 213
3. OTS internal email, dated June 2005, re: Revised ALLL
Finding Memo Response (In summary, the extended time frames (1-
2 month extensions) for implementation of various portions of
the response to not appear to be significant due to the fact
that they are only 1-2 month extensions of management's own
initiatives and we don't want to penalize management for their
own initiatives.).............................................. 218
4. OTS internal email, dated July 2005, re: Mortgage Survey (I
would not send this to WAMU without more preparation. . . . But
the bottom line is that we reviewed the risk and communicated
our concerns to management already. To ask for this similar
information in the survey would almost be like one hand didn't
know what the other was doing. My preference would be shorten
the survey quite a bit and start with higher level information,
and then drill down on individual exams.)...................... 219
5. OTS internal email, dated September 2005, re: WSJ Article:
re: tightening mtg stds (As I have mentioned to some, by the
time we come out with regulatory guidance, moral suasion and
market/media attention will have already done the trick, at
least for the regulated entities!)............................. 220
6. OTS internal email, dated September 2005, re: Meeting (It
has been hard for us to justify doing much more than constantly
nagging (okay, ``chastising'') through ROE and meetings, since
they have not been really adversely impacted in terms of
losses.)....................................................... 224
7. OTS internal email, dated June 2006, re: Talk (My own fear
is that we may not have done enough to communicate to you why
we feel that the few negative things we have brought up through
findings memos and meetings, . . . are not so serious they . .
. negate the ongoing good progress in making improvements in a
manner that seems reasonable given the size, complexity, and
status of the institution.).................................... 228
8. OTS internal email, dated May 2007, re: Fair Lending
Findings Memo (Apropos the lack of tools--that is a reality.
I'm willing OK with your changes, but you need to realize that
I feel very strongly about this. If the agency could be subject
to criticism for the lack thereof, my feeling is that is
appropriate and it is high time we got such tools. . . . I do
not believe that sweeping this under the rug is necessary.).... 230
9. Draft OTS Exam Findings Memo of Washington Mutual Bank,
dated May 31, 2007, re: Compliance Management Program (WaMu's
compliance management program has suffered from a lack of
steady, consistent leadership. Dick Stevenson . . . is the
bank's ninth compliance leader since 2000.).................... 231
10. OTS Exam Findings Memo of Washington Mutual Bank, dated June
7, 2007, re: Broker Credit Administration (There are 14 FTEs in
BCA handling approximately 34,283 brokers.).................... 233
11. OTS internal email, dated October 2007, re: May 3 memo (. .
. I sent out an email on May 3, 2007, that announced a number
of changes. . . . Now that we are 5 months into this new
process, I am not yet comfortable that we have made sufficient
progress toward accomplishing these goals.).................... 244
12.a. OTS Exam Findings Memo of Washington Mutual Bank, dated
June 19, 2008, re: Loan Fraud Investigation (. . . ``control
gaps were identified . . . that did not sufficiently mitigate
loan fraud exposure.'' . . . raised questions as to whether
similar conditions are systemic throughout the organization,
particularly since many of the issues raised have either
previously been raised internally or have been noted at the
current or at prior OTS examinations. . . .)................... 246
12.b. Meeting with Board of Directors, July 15, 2008, OTS
Comprehensive Examinations of Washington Mutual Bank,
(Management/Board Performance and Oversight Unsatisfactory . .
. performance exacerbated by conditions within management's
control.)(excerpt)............................................. 249
13. OTS correspondence to Washington Mutual Bank, dated
September 25, 2008, re: Appointment of a Receiver.............. 254
14. OTS internal email, dated October 2008, re: West Region
Update (You know, I think that once we (pretty much all the
regulators) acquiesced that stated income lending was a
reasonable thing, and then compounded that with the sheer
insanity of states income, subprime, 100% CLTV, lending, we
were on the figurative bridge to nowhere.)..................... 261
Documents Related to Slow and Weak OTS Enforcement:
15. OTS internal email, dated June 2003, re: OTS Memo 7 (It is
clear from my experience that changes seem to progress slowly
at WAMU so I don't know if we can expect faster progress.)..... 265
16. OTS High Risk Meeting Notes, West Region, undated, (The
Director (while pacing) was very concerned over all the
management changes and putting inexperienced people in charge
of critical areas. Region agreed with concerns.)............... 267
17. OTS Exam Findings Memo of Washington Mutual Bank, dated May
12, 2004, re: SFR Loan Origination Quality (Several of our
recent examinations concluded that the Bank's single family
loan underwriting was less than satisfactory due to excessive
errors in the underwriting process, loan document preparation,
and in associated activities.)................................. 269
18. OTS internal email, dated April 2004, re: Locale (In any
event, a paragraph very clearly tells WAMU they need to
identify originated subprime in both home and consumer loans
and demonstrate compliance with the interagency policy
statement as amended Jan 31 2001.)............................. 275
19. OTS internal email, dated April 2005, re: Fitch--LBMC Review
(Some insight on the subprime product at LBMC for ALLL and high
risk lending initiative.)...................................... 277
20. OTS internal email, dated May 2005, re: LBMC Fair Lending (I
would not, however, say that we could feel comfortable with
their moving LBMC under the thrift without some conditions. . .
. Completion of that plan--and satisfactory corrective
actions--would be an appropriate condition.)................... 278
21. FDIC/Washington State Exam Findings Memo of Washington
Mutual Bank, dated May 20, 2004, re: Single Family Residential
Review (The loan file review reflected inconsistencies in
underwriting and documentation practices, particularly in the
brokered channel. Additionally, examiners noted that Washington
Mutual's SFR portfolio has an elevated level of risk due to a
significant volume of potential negative amortization loans,
high delinquency and exception rates, and a substantial volume
of loans with higher risk characteristics, such as low FICO
scores.)....................................................... 280
22. OTS Exam Findings Memo of Washington Mutual Bank, dated May
20, 2005, re: Allowance for Loan and Lease Loss Modeling
(Management is in process of validating and calibrating LPRM
version 3.1, but the validation continues to show a significant
disparity in actual and projected SFR loss rates.)............. 285
23. OTS Exam Findings Memo of Washington Mutual Bank, dated June
1, 2005, re: Corporate Risk Oversight (Corporate Risk Oversight
(CRO) is responsible for independently evaluating credit and
compliance risk across the company and assessing the
effectiveness of risk management processes relative to
established strategic and risk tolerance objectives. . . . Most
of the findings are considered ``criticisms'' due to the
overall significance of CRO activities and the fact that we
have had concerns with quality assurance and underwriting
processes within home lending for several years.).............. 290
24. OTS Exam Findings Memo of Washington Mutual Bank, dated June
2, 2005, re: LBMC Underwriting Review (Our review disclosed
underwriting deficiencies that require management's
attention.).................................................... 297
25. OTS internal email, dated June 2005, re: LBMC downgrades (.
. . this business is simply too high profile for us not to be
sure that processes are in place to assure there will be no
repeat of the performance of these earlier vintages . . . both
in securitizations and in the originations they will hold for
investment.)................................................... 303
26. OTS Exam Findings Memo of Washington Mutual Bank, dated June
3, 2005, re: Single Family Residential Home Loan Review (We
continue to have concerns regarding the number of underwriting
exceptions and with issues that evidence lack of compliance
with Bank policy.)............................................. 304
27. OTS Exam Findings Memo of Washington Mutual Bank, dated June
3, 2005, re: Loan Origination Quality (The redesigned incentive
compensation program for LFCs still does not satisfactorily
reward excellence in loan origination quality. Finding 3 in the
2004 OTS Memo No. 5 was closed because an improved design for
the incentive compensation program was devised. However, the
program was not implemented as designed.)...................... 311
28. OTS internal memorandum, dated June 3, 2005, re: Long Beach
Mortgage Corporation (LBMC) Review (Because of the high profile
nature of the business of LBMC and its problematic history, we
believe that any and all concerns regarding the subprime
operation need to be fully addressed prior to any move.)....... 314
29. OTS internal email, dated June 2005, re: S-S 2 response
(They agree to take all action required to correct the problem.
The Target Completion Dates are not real timely but fine for
WAMU.)......................................................... 317
30. OTS internal email, dated November 2005, re: Meeting (While
we may (and have) questioned the reasonableness of these
standards, they are all we have at this time. If our tolerance
for some reason is now a lot lower than our handbook standards,
it would be nice to have this clarified.)...................... 318
31. OTS internal memorandum, dated December 21, 2005, re: (Long
Beach Mortgage Corporation (LBMC))............................. 320
32. OTS internal email, dated January 2006, re: WAMU Commitment
letter (At some level, it seems we have to rely on our
relationship and their understanding that we are not
comfortable with current underwriting practices and don't want
them to grow significantly without having the practices cleaned
up first.)..................................................... 328
33. OTS Exam Findings Memo of Washington Mutual Bank, dated May
23, 2006, re: Home Loan Underwriting (. . . we did note various
underwriting errors that continue to require management's
attention.).................................................... 329
34. WaMu internal email, dated May 2006, re: OTS Memo 12--Home
Loans Underwriting (. . . John was able to get the OTS to see
the light and revise the Underwriting rating to a
Recommendation.)............................................... 335
35. OTS Exam Findings Memo of Washington Mutual Bank, dated May
25, 2006, re: Loan Underwriting Review--Long Beach Mortgage
(Overall, we concluded that the number and severity of
underwriting errors noted remain at higher than acceptable
levels.)....................................................... 337
36. OTS internal email, dated June 2006, re: Findings Memos (We
gave them the benefit of the doubt based on commitments and
some progress when we allowed them to bring LBMC into the bank,
but if I am understanding the finding from this exam correctly,
we have the same type of concerns remaining 6 months later.)... 342
37. Draft OTS Exam Findings Memo of Washington Mutual Bank,
dated May 31, 2007, re: Compliance Management Program.......... 344
38. OTS Exam Findings Memo of Washington Mutual Bank, dated June
19, 2007, re: Allowance for Loan and Lease Losses on the 1-4
Single Family Residential Loan Portfolio....................... 349
39. OTS internal email, dated June 2007 re: Compliance rating
(They aren't interested in our ``opinions'' of the program.
They want black and white, violations or not.)................. 357
40. OTS internal email, dated November 2007, re: Wamu appraisal
review (The fact that coo rotella runs the business units, was
the champion of cost cutting and use of third party appraisal
outsourcing, and continues to downplay the various business
units' failing (compliance, bsa, flood and now maybe appraisal)
by diverting blame to others (risk management and now counsel)
leaves me uncomfortable.)...................................... 358
41. OTS correspondence to Washington Mutual Bank, dated February
27, 2008 (This letter is to advise you that the Office of
Thrift Supervision (OTS) is adjusting downward the composite
rating for Washington Mutual Bank . . . from a ``2'' to a
``3,'' effective today.)....................................... 360
42. OTS internal email, dated February 2008, re: Kerry Killinger
(. . . my feeling that OTS would be reasonable in providing
adequate time over the business cycle for WAMU management to
make improvements, particularly in earnings, and that it would
be my hope that we would not place unrealistic expectations or
demands to make changes/improvements over unrealistic time
periods.)...................................................... 362
43. OTS internal email, dated June 2008, re: Call from Killinger
(I further told Kerry that as a matter of policy, OTS believes
that ``3'' rated institutions, especially repeat ``3''s,
warranted informal supervisory action and consideration of
formal action.................................................. 364
44. OTS/WaMu email, dated July 2008, re: MOU vs. Board
Resolution (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.)........................................................ 366
45. OTS internal email, dated July 2008, re: WAMU MOU (It is,
unfortunately, another example of a benign supervisory
document.)..................................................... 368
46. OTS internal email, dated August 2008, re: Wamu MOU-Board
provisions (He [Ben] is concerned that the board is not getting
sufficient, consistent, or understandable information/reports
from management. This was confirmed by the board's self-
assessment where they acknowledged that they did not have a
full understanding of the bank's risks.)....................... 370
47. OTS internal email, dated August 2008, re: WAMU (What is the
status of the ROE? When will it be mailed? What is the status
of the MOU? I feel like we are stuck in quicksand here.)....... 371
48. OTS, WaMu Ratings of 3/343432, September 11, 2008 (The
bank's overall unsatisfactory condition is primarily the result
of the poor asset quality and operating performance in the
bank's major Home Loan Group line of business. . . . The
deteriorating asset quality in the Home Loans Group is
accompanied by inadequacies in risk management, internal
controls, and oversight that made the bank more vulnerable to
the current housing and economic downturn. The examination
criticized past liberal home loan underwriting practices and
the concentrated delivery of nontraditional mortgage products
to higher risk geographic markets.)............................ 374
Documents Related to OTS Impeding FDIC's Oversight:
49. OTS internal email, dated January 2006, re: FDIC
participation (The message was crystal clear today. Absolutely
no FDIC participation on any OTS 1 and 2 rated exams.)......... 389
50. OTS internal email, dated June 2006, re: wm board meeting
(Didn't even cross my mind that we would have an issue with
their attendance at the board meeting.)........................ 390
51.a. FDIC internal memorandum, dated June 14, 2005, re:
Potential Impact of a Possible Housing Bubble on Washington
Mutual Bank.................................................... 392
51.b. FDIC internal memorandum, dated July 5, 2005, re: Insured
Institutions' Exposure to a Housing Slowdown................... 398
51.c. FDIC internal email, dated September 2006, re: OTS re:
WAMU (The OTS must really be afraid of what we might come
across, but bottom line is we need access to the information.). 404
52.a.-d. Correspondence between FDIC and OTS, dated October
2006-January 2007 regarding FDIC participation in OTS
examinations of Washington Mutual Bank....................... 406-410
53. FDIC internal email, dated October 2006, re: wamu quarterly
(Please read info about OTS denying us space and access to
information. The situation has gone from bad to worse.)........ 411
54. FDIC internal email, dated January 2007, re: wm exam (I'm
just not relishing another round of ``No.'' Well, let them make
fools of themselves again!).................................... 413
55. FDIC internal email, dated February 2007, re: wamu (. . .
here we go again. This is unnecessary hair splitting by OTS
Seattle, and does not comport with the approval we got from RD
Finn on participation.)........................................ 414
56. OTS internal email, dated March 2008, re: Call from Shelia
this evening (Shelia was complimentary of OTS's presentation
and commented about our being on top of the issues. I would
like to think she meant it, but I'm always a bit skeptical of
her compliments.).............................................. 415
57. FDIC internal email, dated April 2007, re: Meeting with OTS
Regional Management (. . . Finn pushed back on his previous
approval of our participation in the 2007 exam targets,
specifically as to our ability to work loan files alongside OTS
examiner, and we were particularly interested in WAMUs
compliance with nontraditional mortgage guidance.)............. 416
58. OTS internal email, dated March 2008, re: WAMU (. . . could
you . . . have someone on your staff put together a position
paper on the need for Treasury to stay removed from the
supervision of wamu, including any attempt to influence our
supervision of wamu's capital raising process.)................ 417
59. OTS internal email, dated July 2008, re: Updates (I have
read the attached letter from the FDIC [to OTS, dated July 21,
2008] regarding supervision of Wamu and am once again
disappointed that the FDIC has confused its role as insurer
with the role of the Primary Federal Regulator. Its letter is
both inappropriate and disingenuous.).......................... 419
60. OTS internal email, dated July 2008, re: Response to July 21
letter RE: WAMU (attaching July 22, 2008 letter from OTS to
FDIC).......................................................... 424
61. FDIC internal email, dated July 2008, re: WAMU Briefing
Paper (The bank's credit culture emphasized home price
appreciation and the ability to perpetually refinance,
including the ability to sell non performing assets. The bank's
underwriting standards were therefore lax as management
originated loans under a securitization model to transfer risk
to the market.)................................................ 427
62. OTS internal email, dated August 2008, re: WaMu (Sheila Bair
just reported on a conference call that there was a rating
difference on this exam. Can you fill us in.).................. 429
63. FDIC/OTS email, dated August 2008, re: WaMu Rating (You
asked me to hear out wamu. I hope that you would also hear out
our examination staff if it comes to that)..................... 431
64. FDIC internal email, dated August 2008, re: WAMU (Major ill
will at WAMU meeting yesterday caused by FDIC suggestion in
front of WAMU management that they find a strategic partner.
Reich reportedly indicated that was totally inappropriate and
that type of conversation should have occurred amongst
regulatory agencies before it was openly discussed with
management.)................................................... 432
65. OTS internal email, dated August 2008, re: WAMU Update and
FW: FDIC Ratings (The headbutting is currently going on in DC
between myself and Shelia Bair.)............................... 433
66. FDIC/OTS email, dated August 2008, re: W (I should not have
to remind you the FDIC has no role until the PFR (i.e. the OTS)
rules on solvency and the PFR utilizes PCA.)................... 435
67. FDIC internal email, dated August 2008, re: Updated Earnings
Assessment/Capital Analysis (FYI, it looks like the region will
be well armed for Thursday's discussion with the OTS. . . . I
find it troubling that the primarily [sic] regulator is able to
conclude on capital without digging into these numbers. We have
been asking for the forecasted balance sheet for months now and
this is the first we have them. Our skeptical assessment is
essentially forcing them to dig deeper behind the numbers.
Which they should have done in the first place before deciding
on a capital rating.).......................................... 437
68. FDIC/OTS email, dated September 2008, re: Rating
Disagreement (I cannot believe the continuing audacity of this
woman.)........................................................ 439
69. OTS internal email, dated September 2008, re: Wamu--need
your help (The purpose of the meeting would be to discuss the
various views of the institutions's risk profile, current
actions under consideration by the FDIC, and possible capital
considerations. We would control the meeting and ensure that we
have no repeat of the inappropriate behavior displayed by some
of the FDIC in our last session with the bank. This is my idea,
not the FDIC's idea.).......................................... 440
Documents Relating to Nontraditional Mortgage Guidance:
70. OTS internal email, dated March 2006, (I am nervous about us
putting disproportionate pressure on institutions to increase
start rates and decrease the start rate/fully-indexed rate
differential.)................................................. 441
71. OTS internal email, dated July 2006, re: NTM Open Issues (We
should consider going on the offensive, rather than defensive
to refute the OCC's positions:)................................ 443
72. OTS internal email, dated August 2006, re: Latest AMP
Guidance (Market impact--MTA hybrid IO ARMS are a huge product
for Wamu (I'm trying to get current stats as we speak). I would
imagine there would be a fairly big impact on their lending in
this product if they were required to underwrite to full neg-am
over the life of the loan, assuming borrower makes minimum
payment ALWAYS. We have dealt with this product longer than any
other regulator and have a strong understanding of best
practices. I just don't see us taking a back seat on guidance
that is so innate to the thrift industry. I wouldn't feel one
bit disappointed if we had to go it alone on this one.)........ 448
73. Washington Mutual, Alternative Mortgage Guidance
Implementation Plan, October 2006 (Recap of OTS Meeting--A: OTS
is still gathering FAQ from their constituency and expects they
may issue a position paper (at some undetermined future date),
however their initial response was that they view the guidance
as flexible. They specifically pointed out that the language in
the guidance says ``should'' vs. ``must'' in most cases and
they are looking to WaMu to establish our own position on how
the guidance impacts our business processes.).................. 453
74. OTS Option ARM Neg Am Review, Workprogram 212A(1) &
Nontraditional Mortgage Guidance Review, undated, (Wamu states
that they do not engage in underwriting practices that heighten
the need for a borrower to rely on the sale or refinancing of
the property to make amortizing payment on the loans; and
therefore they are not making collateral based loans. However
the liberal use of the Low-Doc/Stated Income loans raises the
question of reliability of the declared income as being the
primary repayment source.)..................................... 462
75. WaMu internal email, dated March 2007, re: Follow-up
information to last evening's call regarding subprime
interagency guidance, etc. . . . (If we implement the NTM
changes to all loans, then we'll see additional drop of 33% of
volume.)....................................................... 469
76. OTS internal email, dated March 2007, re: NTM Gap Analysis
(I noted that several of our institutions make NINA loans.
That, in my humble opinion is collateral dependent lending and
deemed unsafe and unsound by all the agencies.)................ 472
77. OTS internal email, dated April 2007, re: Wamu NTM Gap
Analysis (. . . it's only been a few months since the guidance
came out so they may need more time to make the necessary
adjustments.).................................................. 474
Other Documents:
78. OTS internal email, dated May 2007, re: Lunch Friday (Kerry
Killinger, the CEO of Washington Mutual (WaMu) will be in town
Friday and wants to have a lunch meeting. He's my largest
constituent assetwise.)........................................ 477
79. OTS internal email, dated May 2007, re: NINA Loans (I note
that WAMU makes a significant amount of No-doc loans. OTS
policy states that no-doc loans are unsafe and unsound.)....... 478
80. SEC correspondence to OTS, dated June 24, 2008, re: In the
Matter of Washington Mutual, Inc. (. . . the SEC staff was
advised by Washington Mutual's counsel, Josh Levine, that the
OTS instructed Washington Mutual not to provide documents to
the Commission relating to the OTS's review of Washington
Mutual's appraisal processes or any communications between the
OTS and Washington Mutual.).................................... 481
81. FDIC internal email, dated April 2008, re: Findings from
Review of WAMU Basel II models (HELOC and credit cards) (It is
clear, however, that OTS at all levels is very aware of the
political clout of WAMU within their agency.).................. 483
82. Office of Inspector General, Department of the Treasury/
Federal Deposit Insurance Corporation, Evaluation of Federal
Regulatory Oversight of Washington Mutual Bank, Report No.
EVAL-10-002, April 2010........................................ 484
83. U.S. overnment Accountability Office Testimony, FINANCIAL
REGULATION: Review of Regulators' Oversight of Risk Management
Systems at a Limited Number of Large, Complex Financial
Institutions, March 18, 2009, GAO-09-499T, (. . . regulators
had identified numerous weaknesses in the institutions' risk
management systems before the financial crisis began. . . .
However, the regulators said that they did not take forceful
actions to address these weaknesses, such as changing their
assessments, until the crisis occurred because the institutions
had strong financial positions and senior management had
presented the regulators with plans for change.)............... 582
84. Center for Responsible Lending Report, The Second S&L
Scandal--How OTS allowed reckless and unfair lending to fleece
homeowners and cripple the nation's savings and loan industry,
by Michael Hudson and Jim Overton, January 2009................ 614
85. WaMu internal email, dated, February 2005, re: Moving to
Closure on Alliance Agreement (We agreed that the Freddie 65%
minimum share (100% of option arms) proposal offers us between
26MM and 37MM on benefit depending on volume. . . . 39% of our
2005 home loans gain on sale comes from conforming option arms
sales.)........................................................ 643
86. Washington Mutual, Pre-Meeting for Fannie Mae, March 12,
2004........................................................... 644
87. Freddie Mac--WaMu Meeting, July 28, 2005.................... 656
88. WaMu internal email, dated December 2004, re: Risks/Costs to
Moving GSE Share to FH......................................... 659
89. WaMu internal email, dated April 2006, re: Business
Arrangement w/Freddie Mac (Highlights of 2006 Freddie Mac
Business Proposal)............................................. 662
90. Washington Mutual, Fannie Mae Alliance and Freddie Mac
Business Relationship Proposal................................. 663
91. GSE Forum, September 29, 2005 (Objectives of the Freddie/
Fannie Business Agreement)..................................... 667
92. WaMu--Excess Liquidity Forecast--`Break the Bank' (Total
excess liquidity was $47BN at the end of June 2008 which is
consumed by the end of October as a result of significant
deposit runoff and loss of wholesale funding sources).......... 680
93. Correspondence from FDIC to the Permanent Subcommittee on
Investigations, dated September 17, 2010, regarding Memorandum
of Understanding among the FDIC and other bank regulators...... 681
94. SEALED EXHIBIT: 2004-07 OTS Reports of Exam; 2007-09 FDIC
Large Insured Depository Institution (LIDI) Reports; and 2008
FDIC Board Transcripts......................................... *
* Retained in the files of the Subcommittee.
WALL STREET AND THE FINANCIAL CRISIS:
THE ROLE OF BANK REGULATORS
VOLUME 2 OF 5
----------
FRIDAY, APRIL 16, 2010
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Homeland Security
and Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 9:37 a.m., in
room SD-106, Dirksen Senate Office Building, Hon. Carl Levin,
Chairman of the Subcommittee, presiding.
Present: Senators Levin, Kaufman, and Coburn.
Staff Present: Elise J. Bean, Staff Director/Chief Counsel;
Mary D. Robertson, Chief Clerk; Allison F. Murphy, Counsel;
Zachary I. Schram, Counsel; Adam Henderson, Professional Staff
Member; Nina E. Horowitz, Detailee (GAO); Jennifer
Auchterlonie, Detailee (DOJ); Christopher Barkley, Staff
Director to the Minority; Anthony G. Cotto, Counsel to the
Minority; Ted Schroeder and Nhan Nguyen (Senator Kaufman); and
Clark Porter (Senator McCaskill).
OPENING STATEMENT OF SENATOR LEVIN
Senator Levin. Good morning, everybody. This is the second
in a series of four Subcommittee hearings examining some of the
causes and consequences of the 2008 financial crisis. Earlier
this week, our first hearing used Washington Mutual Bank
(WaMu), as a case history to illustrate how from 2004 to 2008
U.S. financial institutions loaded up on risk and churned out
hundreds of billions of dollars in high-risk, poor-quality home
loans to Wall Street in exchange for big fees. Together they
initiated the economic assault.
As regulated entities, most of these financial firms could
not have done what they did unless their regulators let them.
Today's hearing asks why Federal bank regulators saw the shoddy
lending practices, high-risk lending, and substandard
securitizations, understood the risk, but let the banks do it
anyway.
Washington Mutual was a thrift, so its primary Federal
regulator was the Office of Thrift Supervision (OTS). WaMu was
the largest single financial institution that OTS oversaw, with
$300 billion in assets, $188 billion in deposits, and 43,000
employees. WaMu's fees alone paid for 12 to 15 percent of the
OTS budget. Because WaMu's deposits were insured, the Federal
Deposit Insurance Corporation (FDIC), served as a back-up
regulator whose focus was on safeguarding the Deposit Insurance
Fund.
Like other bank regulators, OTS was supposed to serve as
our first line of defense against unsafe and unsound banking
practices, but OTS was a feeble regulator. 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 the
failures that it saw. At times, it even acted like a WaMu guard
dog trying to keep the FDIC at bay.
To document what happened, we are releasing today another
big book of documents as well as a joint report by the Treasury
and FDIC Inspectors General examining shortcomings in OTS and
FDIC oversight of Washington Mutual. Together they disclose an
ineffective bank regulatory culture, hindered by weak
standards, lax oversight, and agency infighting.
Before its fall, Washington Mutual held itself out as a
well-run, prudent bank that was a pillar of its community. But
Tuesday's hearing showed that behind closed doors, the bank's
management was surrounded by deep-seated problems, including
shoddy lending practices and poor-quality loans.
This chart, which is Exhibit 1i from Tuesday's hearing,\1\
shows how over a 5-year period from 2003 to 2008, Washington
Mutual and its subprime lender, Long Beach, loaded up with
risk. The bank dumped low-risk, 30-year fixed loans in favor of
high-risk, subprime, Option ARM, and home equity loans. Low-
risk loans shrunk, as we can see from that chart, from two-
thirds of the bank's originations to one-quarter. High-risk
loans grew from one-third to three-quarters of the bank's home
loan business.
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\1\ See Exhibit No. 1i, which appears in the Appendix on page 210.
---------------------------------------------------------------------------
Those high-risk loans were problem plagued. Tuesday's
hearing examined voluminous evidence of WaMu internal reviews
finding poor-quality loans, fraud, errors, and other
deficiencies. In one instance, a year-long internal WaMu probe
found that two of WaMu's top loan producing offices were
issuing loans with fraud rates of 58 percent and 83 percent.
Another WaMu investigation 2 years later found that one of the
office's fraud rate was 62 percent. At still another loan
office, a sales associate acknowledged ``manufacturing''
documents to support quick loan closings.
Washington Mutual's shoddy lending practices affected more
than its own operations. WaMu and Long Beach sold or
securitized most of their loans. As this chart shows, from 2000
to 2007 WaMu and Long Beach securitized at least $77 billion in
subprime loans, stopping only when the subprime secondary
market collapsed in September 2007. WaMu sold another $115
billion in Option ARM loans. Together WaMu and Long Beach
dumped hundreds of billions of dollars of toxic mortgages into
the financial system like polluters dumping poison in a river.
So where were the bank regulators? The painful fact is that
they had a front-row seat to Washington Mutual's high-risk
lending strategy, its poor-quality loans, and substandard
securitization practices but did little to stop it. The
documents reviewed by the Subcommittee show that OTS knew all
about Washington Mutual's high-risk lending strategy. In fact,
it was OTS that required the bank to get board approval of it
in January 2005. OTS knew about WaMu's shoddy lending
practices, having repeatedly identified problems with the banks
operations and examination reports year after year. Every time
OTS listed a problem, it also told WaMu to take corrective
action. But when the problem did not get fixed, OTS failed to
force change. Instead, OTS wrung its hands as the bank sank
into deeper and deeper waters.
This chart, Exhibit 1c,\1\ provides a quick summary of some
of the findings made by OTS over the years regarding failings
in the underwriting--meaning lending--practices at Washington
Mutual.
---------------------------------------------------------------------------
\1\ See Exhibit No. 1c, which appears in the Appendix on page 199.
---------------------------------------------------------------------------
Now, these are not all of the findings, but here are a few.
Let us start with the year 2004. ``Underwriting . . . remains
less than satisfactory.'' ``[N]ot . . . successful in effecting
change.'' Then in 2005, ``Underwriting exceptions evidence lack
of compliance with bank policy. Our concerns are increased with
the risk profile of the portfolio. Deterioration in these [Long
Beach] older securitizations is not unexpected.''
Now, those 2005 findings came from a report on examination
which stated more broadly, ``We remain concerned with the
number of underwriting exceptions and with issues that evidence
lack of compliance with bank policy.''
``The level of deficiencies, if left unchecked, could erode
the credit quality of the portfolio. Our concerns are increased
with the risk profile of the profile is considered, including
concentrations in Option ARM loans to higher-risk borrowers, in
low and limited documentation loans, and loans with subprime or
higher-risk characteristics.''
Now, unfortunately, the level of deficiencies were left
unchecked. In fact, those deficiencies continued to run
rampant. Here is 2006. ``[C]ontinuing weakness in . . . loan
underwriting at Long Beach.'' ``Numerous instances of
underwriter exceeding guidelines . . . [and] errors.''
Now 2007, ``[T]oo much emphasis on loan production . . . at
the expense of loan quality.'' ``[S]ubprime underwriting
practices remain less than satisfactory.'' ``[U]nderwriting
exceptions and errors remain above acceptable levels.''
And then, finally, in 2008, the year the bank failed,
``[N]ot in compliance with the Interagency Guidance on
Nontraditional Mortgages.'' ``High SFR [single family
residential loan] losses due in part to poor underwriting.''
``[A]ctions should have been taken sooner.''
Those are all OTS' observations about problems at WaMu year
after year. In 2008, the year the bank collapsed, OTS said,
``[A]ctions should have been taken sooner.'' Well, actions
should have been taken sooner also by OTS. OTS raised the
concerns listed on this chart with WaMu's top executives and
board of directors for 5 straight years. Each year, WaMu
promised to do better, but it did not, and OTS never took
action to change that.
At our Tuesday hearing, even WaMu officials expressed
surprise at OTS' reluctance to act. WaMu's chief risk officer,
Jim Vanasek, testified that, ``What I cannot explain is why the
superiors in the agencies did not take a tougher tone with the
bank given the degree of negative findings.'' Now, this is
WaMu's own risk officer.
``There seemed to be a tolerance there or a political
influence on senior management of those agencies that prevented
them from taking a more active stance. By a more active
stance,'' he said, ``I mean putting the bank under letters of
agreement and forcing change.''
Mr. Vanasek's successor as chief risk officer at WaMu, Ron
Cathcart, testified on Tuesday: ``The approach that the OTS
took was much more light-handed than I was used to. It seemed
as if the regulator was prepared to allow the bank to work
through its problems and had a higher degree of tolerance than
I had seen with other regulators.''
Now, regulations work best when regulators stay at arm's
length from those that they regulate. But too often in this
case, WaMu's regulators were not at arm's length. They were arm
in arm. Over time OTS allowed Washington Mutual and Long Beach
to load up on risk and engage in a host of unsafe and unsound
practices. This chart, which is Exhibit 1b,\1\ lists some of
them: targeting high-risk borrowers; steering borrowers to
higher-risk home loans; offering teaser rates, interest-only,
and negative amortizing loans; not verifying income; offering
higher pay for making higher-risk home loans--that is, to their
staff. That is just a few that I have read.
---------------------------------------------------------------------------
\1\ See Exhibit No. 1b, which appears in the Appendix on page 198.
---------------------------------------------------------------------------
Now, the documents show that more than one OTS examiner
expressed misgivings about these lending practices but never
got the support of OTS management to end them. One WaMu
examiner wrote that stated income loans--those are loans in
which borrowers state their income without any verification--
were ``a flawed product that can't be fixed and never should
have been allowed in the first place.''
Another OTS examiner tried to object to so-called no income
and no assets (NINA) loans. That means loans in which there is
no income and no assets numbers required to be provided by the
borrower. An OTS policy official agreed, writing in a 2007
email that NINA loans are ``collateral dependent'' lending and
deemed unsafe and unsound by all the agencies. But the OTS West
Region dismissed that analysis, allowing NINA loans, and called
the OTS policy official a ``Lone Ranger.''
Still another example involves Washington Mutual's flagship
product, the Option Adjustable Rate Mortgage. WaMu engaged in a
host of shoddy lending practices that vastly increased the
risks associated with its Option ARMs, such as permitting
virtually every Option ARM borrower to make minimum payments
which resulted in negatively amortizing loans in which the loan
principal actually increased over time. Washington Mutual
relied on rising house prices and refinancing to avoid payment
shock and loan defaults. For years, OTS said that WaMu should
reduce the increased risks while watching the bank originate
$30 to $60 billion or more on Option ARMs each year. It never
took action to enforce its judgment.
In 2004, OTS found that WaMu's incentive compensation for
loan officers failed to provide any money for loan quality.
Volume and speed were king, and loan officers got paid more
money for more risk. OTS recommended that WaMu ``enhance its
system to emphasize loan quality'' and closed the finding based
on WaMu's promise to redesign its pay system. In 2005, OTS
discovered that WaMu had not changed its compensation plan and
again asked the bank to fix it.
Well, 2008 came and WaMu discovered rampant fraud at one of
its top loan producing offices, and its own staff faulted pay
incentives that put loan speed before loan quality. In 4 years,
WaMu had not fixed the problem.
OTS had multiple enforcement tools to force change at WaMu.
It could have required, for example, private board resolution
or a public memorandum of understanding. It could have imposed
a monetary fine or issued a cease-and-desist order. But OTS did
not take any of those steps. It acted like a spectator,
chronicling the bank's failures rather than preventing them.
OTS did not take enforcement action on its criticisms of the
bank until 2008, which is the year that WaMu failed.
Why was OTS so reluctant to act? Well, a 2007 email by OTS
Director John Reich, Exhibit 78,\1\ supplies part of the
answer. He wrote to his staff, ``Kerry Killinger, the CEO of
Washington Mutual (WaMu) will be in town Friday and wants to
have a lunch meeting. He is my largest constituent. . . .''
---------------------------------------------------------------------------
\1\ See Exhibit No. 78, which appears in the Appendix on page 477.
---------------------------------------------------------------------------
OTS viewed WaMu as its constituent, losing sight of the
fact that OTS' real constituents were not the banks that it
oversaw but the American people that it was supposed to protect
from unsafe and unsound banking practices.
A 2005 email by the OTS examiner-in-charge at Washington
Mutual is also telling. The examiner-in-charge wrote to his
bosses, ``[T]his is just one of several symptoms of the ongoing
broader problem of getting their house in order from an
underwriting standpoint. It has been hard for us to justify
doing much more than constantly nagging--OK, `chastising'--
through ROE on examination and meetings, since they have not
been really adversely impacted in terms of losses.''
Think about that. The WaMu bank examiner felt he could not
do more than nag the bank unless WaMu was losing money.
The OTS Handbook, by the way, states explicitly that losses
are not necessary for an examiner to take action, but the OTS
examiner saw himself not just as a civil servant enforcing the
law and protecting the banking system but as a nag.
Still another part of the answer may be that WaMu was OTS'
largest bank and supplied the largest amount of fees of any
bank. WaMu's downfall began in 2006 when the value of its
subprime loans began falling. In July 2007, after two credit
rating agencies suddenly downgraded hundreds of subprime
mortgage-backed securities, the subprime market froze and banks
like WaMu were left holding billions of dollars of suddenly
unmarketable home loans. The value of those assets began
plummeting. Washington Mutual recorded a $1 billion loss in the
fourth quarter of 2007 and another $1 billion loss in the first
quarter of 2008.
Finally, in late February 2008, OTS downgraded the bank
from a 2 to a 3 so-called ``capital, asset quality, management,
earnings, liquidity, and sensitivity'' (CAMELS) rating. Now the
CAMELS rating system is used by all the Federal bank regulators
to rate the safety and soundness of financial institutions and
measures capital, asset quality, management, earnings,
liquidity, and sensitivity to market risk. It uses a scale of 1
to 5, with 1 being the best rating and 5 the worst. The ratings
are normally not made public. Washington Mutual had a 2 rating
for many years, which signifies a fundamentally sound bank.
Once OTS assigned the 3 rating, which signifies a troubled
bank, OTS policy required it to issue a public memorandum of
understanding at the same time to correct the bank's
deficiencies. But OTS inexplicably did not. Instead, OTS waited
until the next month and accepted a non-public board resolution
in which WaMu's board promised to fix problems but provided no
specific plans or deadlines for doing so. It was a kid-gloves
approach that made absolutely no sense given the bank's
problems, the intensifying financial crisis, and OTS' own
policy.
In the meantime, the FDIC expressed increasing concerns
about the bank with its internal Large Insured Deposit
Institution (LIDI) reports showing the bank to be
deteriorating. FDIC told the OTS that the bank should consider
an outside purchaser. In March 2008, WaMu invited potential
buyers to the bank to review its internal data. In April, WaMu
announced it had lost another $3.2 billion in the second
quarter. JPMorgan Chase made an offer to buy the bank, but WaMu
turned it down after raising $7 billion in capital to reassure
the market.
In July 2008, IndyMac, another high-risk thrift on the West
Coast, closed its doors. WaMu's large depositors, fearing a
similar fate at Washington Mutual, withdrew about $9 billion in
a quiet run on the bank. Two months later, on September 15,
2008, Lehman Brothers declared bankruptcy, and over the next 8
days WaMu depositors withdrew another $17 billion from the
bank, triggering a liquidity crisis.
On September 7, 2008, OTS took its first formal enforcement
action against the bank, but it was way too little too late.
After more than a month of trying to persuade OTS that WaMu
should be downgraded to a 4 rating, the FDIC independently
downgraded the bank on September 18, and OTS reluctantly
followed suit that same day. By then the FDIC was contemplating
whether the $300 billion thrift, if it failed, might exhaust
the entire Federal Deposit Insurance Fund, which then contained
a total of about $45 billion.
On September 25, 2008, due to the bank's intensifying
liquidity problems, the regulators finally pulled the plug.
They felt the bank could not even make it to the end of the
week, as their usual practice, instead moved on a Thursday. OTS
closed Washington Mutual and appointed the FDIC as its
receiver. That same day, the FDIC sold the bank's assets and
deposits to JPMorgan Chase for about $1.9 billion.
Critics complain that WaMu should not have been shut down,
that it should have received a taxpayer bailout under the TARP
program, emergency lending from the Federal Reserve, and SEC
protection from short selling. Our focus, however, here is not
on the regulators' decision to close the bank, but on how
regulators let the bank deteriorate to the point where its
failure threatened to bust the Deposit Insurance Fund.
The fact is that our bank regulators failed us. OTS failed
to stop Washington Mutual from engaging in high-risk lending
practices that created a mortgage time bomb. It failed to force
the bank to correct years-long deficiencies. It failed to
cooperate with efforts by the FDIC to evaluate the bank's
operations. And it failed to stop the bank from sending toxic
mortgages into the financial system and poisoning the secondary
market. These failures were not limited to Washington Mutual
but were symptomatic of sectorwide failures that played a major
role in the 2008 financial crisis.
The Washington Mutual case history makes it clear that OTS
had bought into the view that as long as Washington Mutual was
profitable, the bank could continue its high-risk lending
strategy. OTS management saw no reason to tighten lending
standards even after its fellow regulators decided to issue
joint guidance to strengthen lending standards for so-called
nontraditional mortgages. OTS argued against strong
restrictions, noting internally that they needed to go ``on the
offensive'' to stop them, and then presenting data supplied by
WaMu showing how stronger lending standards would reduce the
bank's business. The guidance was promulgated by all the
banking regulators in October 2006. Other agencies told their
financial institutions to comply promptly, but OTS did not. In
2007, when the FDIC asked OTS to review WaMu loan files to
evaluate its compliance with the guidance, OTS refused and
disclosed it was giving its thrifts more time to comply.
Meanwhile, WaMu had calculated that complying with the
guidance would reduce its loan volume by 33 percent because
fewer borrowers would qualify for loans. In an email to
colleagues, WaMu's chief risk officer argued ``in favor of
holding off on implementation until required to act for public
relations or regulatory reasons.'' By the time OTS made the
guidance effective for its thrifts, the subprime secondary
market had frozen and WaMu's loan originations had already
dropped.
At the same time the documents show that OTS' reluctance to
say no to WaMu, they show that OTS did have a backbone when it
came to saying no to a fellow regulator. For many years, OTS
and FDIC had shared a cooperative relationship in regulating
Washington Mutual. In 2006, however, OTS practices abruptly
changed. The West Region director told his staff, ``The message
was crystal clear today: absolutely no FDIC participation on
any OTS 1 and 2 rated exams.'' Since WaMu had a 2 rating, OTS
rejected the FDIC's request to participate in a WaMu exam.
OTS went further. It actually impeded FDIC's examination
efforts. It denied the FDIC examiner access to WaMu data,
refused for several months to assign him space on site at the
bank, and rejected his request to review bank loan files. When
the FDIC urged OTS to lower WaMu's rating, OTS resisted. OTS
fought this turf war at the same time the largest financial
institution it was supposed to regulate was losing value,
capital, and deposits.
Now, OTS also took a narrow view of its responsibility to
the U.S. banking system as a whole. The documents show that OTS
allowed Washington Mutual to engage in high-risk lending in
part because the bank did not plan to keep the high-risk loans
on its books, but sold them into the marketplace. OTS never
considered how dumping billions of dollars in toxic mortgages
into the stream of commerce would weaken the financial system
and even come back to harm its own institutions.
One OTS examiner commented on the agency's approach in a
2008 email as follows: ``We were satisfied that the loans were
originated for sale. SEC and Fed were asleep at the switch with
the securitization and repackaging of the cash flows,
irrespective of who they were selling to.''
OTS examiners knew that Washington Mutual and Long Beach
were notorious for selling bad loans. As early as 2005, an OTS
examiner sent an email to colleagues with this description of
Long Beach's mortgage-backed securities:\1\ ``[I]ssues
[securitizations] prior to 2003 have horrible performance. LBMC
finished in the top 12 worst annualized NCLs [net credit
losses] in 1997 and 1999 thru 2003. . . . At 2/05, LBMC was #1
with a 12% delinquency rate. Industry was around 8.25%.'' Yet
OTS took no steps to require Long Beach or Washington Mutual to
clean up their securitizations or the bad loans underlying
them. OTS just did not see it as part of its job, even while
the flood of those toxic mortgages was slowly poisoning the
secondary markets, leading to their collapse in the financial
crisis of 2008.
---------------------------------------------------------------------------
\1\ See Exhibit No. 19, which appears in the Appendix on page 277.
---------------------------------------------------------------------------
Finally, our bank regulators were not blind to the problems
building up in the mortgage banking system. They knew. Instead
of getting in the game, they sat on the bench. OTS in
particular did not act on what it knew. It appeared to have
been too close to the banks that it oversaw. The bottom line 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
that it helped to poison with toxic mortgages, and an economic
meltdown.
Today we are examining what happened in this case history.
The question for Congress is: How do we strengthen our
regulatory culture?
On that somber note, I turn to my Ranking Member, Senator
Coburn, for his insights, and I thank him again and his staff
for their great support in this investigation. Dr. Coburn.
OPENING STATEMENT OF SENATOR COBURN
Senator Coburn. Well, Mr. Chairman, thank you for the great
work the Subcommittee staff in a bipartisan way have done on
this. I will summarize my thoughts about this so that we can
get to business, and then I have a comment that I think we
ought to pay attention to, because what we heard from your
testimony is that regulators are not necessarily any better
than the virtuous banks that they have been regulating, because
both WaMu and OTS, by the record we have established, failed
miserably and motivations can be questioned on both of their
parts.
The story of Washington Mutual's relationship with OTS is a
classic example of when a bank captures its regulator rather
than a regulator doing its job. OTS had done over 31,000
examination hours at WaMu, the equivalent of 15 full-time
employees per year. The institution was not lacking in Federal
regulators. Between 2003 and 2008, 545 separate findings of
problems with WaMu were discovered and noted. Forty-one percent
of those were still outstanding at the time of WaMu's failure.
OTS noted weak risk management and poor underwriting in
2003. They never even took one informal enforcement action
against WaMu until 2008, and that was only after experiencing
losses on the products. And they never took a formal
enforcement action against WaMu.
OTS is the primary regulator of 780 thrifts with assets of
$1.07 trillion and approximately 452 thrift holding companies
with assets of $5.5 trillion. OTS budget is derived from the
fees it is charging its banks. WaMu was, by far, OTS' largest
regulated thrift, $330 billion, during the time in question.
The lesson of OTS is not that we necessarily need more
regulators, because clearly regulators can suffer the same
flaws as banks--selfishness, shortsightedness, ineffectiveness.
We need better incentives for both good investments and good
regulation.
Now, the questions that need to be raised. Where was the
Congress in looking at OTS? What was the last time Congress did
an oversight hearing on the effectiveness of the OTS or the
FDIC prior to this downfall? You see, next week, we are going
to put a financial reform bill on the floor and we won't have
even completed these hearings until April 27, which are
critical to understanding what is going on. We have asked a
formal commission, for which we are spending a lot of taxpayer
money, to give us a report on what happened with the bank
failures and the run and the economic collapse that we
experienced, and its report isn't even done until 8 months from
now. I would put forward that we are about to make the same
mistakes that we are claiming and accusing those that are
coming before us of.
So with that, Mr. Chairman, I look forward to hearing what
our witnesses have to say. I will be in and out because of an
ongoing Judiciary hearing at the same time and appreciate again
the work that you have done and the other staff.
Senator Levin. Thank you very much, Senator Coburn.
Let me call on Senator Kaufman, who we are so delighted to
have with us here on this Subcommittee.
Senator Kaufman. I think the two of you have pretty well
summed up the problem and I am really looking forward to the
testimony and the questions and answers, so I pass.
Senator Levin. Thank you so much, Senator Kaufman.
Now we call on our first panel of witnesses for this
morning's hearing, Eric Thorson, the Inspector General at the
Department of the Treasury, Jon Rymer, Inspector General of the
Federal Deposit Insurance Corporation. Thank you both for being
with us today and for your work. We look forward to your
testimony.
As you both know, pursuant to Rule 6, all witnesses who
testify before this Subcommittee are required to be sworn, so
we would ask you both to stand up and raise your right hand.
Do you swear that the testimony that you are about to give
will be the truth, the whole truth, and nothing but the truth,
so help you, God?
Mr. Thorson. I do.
Mr. Rymer. I do.
Senator Levin. Thank you very much. We will be using a
timing system, so that a minute before the red light comes on,
you will see the lights change from green to yellow, giving you
an opportunity to conclude your remarks. Your written testimony
will be printed in the record in its entirety. We would hope
that you would attempt to limit your oral testimony to 5
minutes, and I think, Mr. Thorson, we are going to have you go
first and then Mr. Rymer.
TESTIMONY OF HON. ERIC M. THORSON,\1\ INSPECTOR GENERAL, U.S.
DEPARTMENT OF THE TREASURY
Mr. Thorson. Chairman Levin, Senator Coburn, and Members of
the Subcommittee, we thank you for the opportunity to be here
today with my colleague, Mr. Rymer, to testify about our joint
evaluation of the failure of Washington Mutual Savings Bank.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Thorson appears in the Appendix
on page 101.
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Over the past 2 years, our country has found itself
immersed in a financial crisis that started when housing prices
stopped rising and borrowers could no longer refinance their
way out of financial difficulty. Since then, we have seen
record levels of delinquency, defaults, foreclosures, and
declining real estate values. As a result, securities tied to
real estate prices have plummeted. Financial institutions have
collapsed. In many cases, these financial institutions seemed
financially sound, but the warning signs were there as they
were in the case of WaMu. At the time of its failure in
September 2008, WaMu was one of the largest federally insured
financial institutions, operating 2,300 branches in 15 States
with assets of $307 billion.
A very brief background. My office performs audits and
investigations of most Treasury bureaus and offices and that
includes OTS. We are required to conduct what is known as a
material loss review (MLR), whenever a failed Treasury
regulated bank or thrift results in a loss of $25 million or
more to the FDIC's Deposit Insurance Fund. These MLRs determine
the causes of an institution's failure and assess the
supervision exercised over that failed institution.
Since the WaMu failure did not result in a loss, it did not
trigger a MLR by my office. Nonetheless, given the size of
WaMu, Mr. Rymer and I decided that a MLR-like review was
warranted. We completed that review on April 9, 2010. I will
discuss the principal findings regarding the causes of WaMu's
failure and OTS' supervision of WaMu. Mr. Rymer will then
follow with a discussion of FDIC's role.
WaMu failed because its management pursued a high-risk
business strategy without adequately underwriting its loans or
controlling its risks. WaMu's high-risk strategy, combined with
the housing and mortgage market collapse in mid-2007, left WaMu
with loan losses, borrowing capacity limitations, and a falling
stock price. In September 2008, WaMu was unable to raise
capital to counter significant depositor withdrawals sparked by
rumors of WaMu's problems and other high-profile failures at
the time.
Mr. Chairman, as you pointed out in your opening statement,
during the 8 days following the collapse of Lehman Brothers in
2007, they experienced net deposit outflows of $16.7 billion.
With the severity and swiftness of the financial crisis,
while that contributed to WaMu's failure, it is also true that
WaMu was undone by a flawed business strategy. In 2005, it
shifted away from originating traditional single-family homes
towards the riskier subprime loans and Option Adjustable Rate
Mortgages, also known as Option ARMs. They pursued this new
strategy in anticipation of higher earnings and to compete with
Countrywide Financial Corporation, who it viewed as its
strongest competitor.
To give the Subcommittee a sense of the profits that could
be made, at least in the short term, with the type of non-
traditional loan products that WaMu pursued, in 2006, WaMu
estimated that its internal profit margin on Option ARMs was
more than eight times that of government-backed loans, FHA or
VA, and nearly six times that of normal fixed-rate 30-year
loans. WaMu saw these riskier loan vehicles as an easy way to
substantially increase its profitability. Unfortunately, they
expanded into these riskier products without the appropriate
level of risk management controls needed to effectively manage
that risk.
With respect to OTS' supervision, WaMu was the largest
institution under OTS' regulation. At the time, it represented
as much as 15 percent of OTS' fee revenue, and I should point
out that like the other bank regulators, OTS is not taxpayer
funded. It is funded with fees collected from those that it
regulates. So that meant that OTS was collecting more than $30
million from WaMu annually.
OTS conducted regular risk assessments and examinations
that rated their overall performance satisfactory through the
early part of 2008, though supervisory efforts, however, did
identify the core weaknesses that eventually led to WaMu's
demise--high-risk products, poor underwriting, and weak risk
controls. Issues related to poor underwriting and weak risk
controls were noted as far back as 2003, but the problem was
OTS did not ensure that WaMu ever corrected those weaknesses.
We had a hard time understanding why OTS would allow these
satisfactory ratings to continue given that, over the years,
they found the same things over and over. Even in WaMu's asset
quality in their reports of examination, they wrote, ``We
believe the level of deficiencies, if left unchecked, could
erode the credit quality of the portfolio. We are concerned
further that the current market environment is masking
potentially higher credit risk.'' And despite what I just read
to you, which was out of their own reports, it was not until
WaMu began experiencing losses in 2007 and into 2008 that they
began to downgrade their rating.
When we asked OTS examiners why they did this, why they
didn't lower it earlier, they told us that even though
underwriting risk management practices were less than
satisfactory, they were making money and loans were performing.
As a result, they thought it would be difficult to lower the
asset quality rating, and this position surprised us because
their own guidance states, ``If an association has high
exposure to credit risk, it is not sufficient to demonstrate
that the loans are profitable or that the association has not
experienced significant losses in the near term.'' Given this
guidance, those things should have been done much sooner.
In fact, OTS did not take a single safety and soundness
enforcement action until 2008, and even then, what they took
was quite weak. As troubling as that was, we became even more
concerned when we discovered that OTS West Region Director
overruled issues raised by his own staff with regard to one of
those enforcement actions, which you mentioned, Mr. Chairman,
the March 2008 Board Resolution. The Board Resolution only
addressed WaMu's short-term liquidity issues and did not
require it to address systemic problems repeatedly noted by
OTS.
Despite the concerns of his own staff, the OTS West Region
Director approved the version of the Board Resolution written
by WaMu. And as previously reported by my office, this was the
same OTS official who also gave approval for IndyMac to
improperly backdate a capital contribution to maintain its
well-capitalized position just 2 months before IndyMac
collapsed.
As a final note, I just want to make one comment quickly
about the contributions of our outstanding staff, which I
always do in these things. I want to mention Marla Freedman,
Bob Taylor, Don Benson, Jason Madden, and Maryann Costello,
because it is their work that allows me to come here and read
these statements.
I thank you for the opportunity to be here and will answer
whatever questions you have.
Senator Levin. Thank you. Your appreciation of staff, I
know, comes from long experience on Capitol Hill some years
ago. We remember you well.
Mr. Rymer.
TESTIMONY OF HON. JON T. RYMER,\1\ INSPECTOR GENERAL, FEDERAL
DEPOSIT INSURANCE CORPORATION
Mr. Rymer. Good morning, Mr. Chairman, Ranking Member
Coburn, and Senator Kaufman. Thank you for the opportunity to
appear here today and present the results of the Federal
Deposit Insurance Corporation Office of Inspector General work
relating to Washington Mutual Bank.
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\1\ The prepared statement of Mr. Rymer appears in the Appendix on
page 119.
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WaMu represents the largest bank failure to date. At the
time of its failure, WaMu operated over 2,300 branches in 15
States and had assets of $307 billion. Because of WaMu's size,
the circumstances leading up to the failure, and the non-
Deposit Insurance Fund losses, such as shareholder value, we
initiated a review of WaMu to evaluate the actions of the
Office of Thrift Supervision and the FDIC. We very much
appreciate the cooperation we received from the OTS and the
FDIC in conducting our work, and we appreciate the
contributions by my colleagues at the Department of Treasury
OIG.
As Mr. Thorson did, I would like to recognize key members
of my staff who participated in this review. They are Peggy
Wolf, Ann Lewis, Diana Chatfield, and Andriana Rojas, and they
were led by Marshall Gentry. This is a very important project
for our staff.
Our resulting report is unique. It provides a comprehensive
look at a failed institution from both the primary and back-up
regulatory perspectives and has resulted in significant
insights regarding the effectiveness of each and the interplay
between the two. We released the report yesterday afternoon on
our public Website.
As you just heard Mr. Thorson say, Treasury OIG focused on
the causes of WaMu's failure and the OTS supervision of the
institution. My office focused on the FDIC's role as insurer
and back-up supervisor. My statement discusses an over-reliance
on an institution's safety and soundness, or CAMELS, rating and
capital levels for the purpose of assessing the risk that the
institution may pose to the Insurance Fund. My statement will
also highlight the FDIC's regulatory tools to mitigate risk,
noting significant limitations in the interagency agreement
related to information sharing and back-up examination
authority.
The FDIC was the deposit insurer for WaMu and was
responsible for monitoring and assessing WaMu's risk to the
fund. Prior to its failure, WaMu was the eighth-largest
institution insured by the FDIC.
The FDIC conducted its required monitoring of WaMu for the
period covered for our review, and that is 2003 to 2008, and it
identified risks with WaMu that ultimately caused its failure,
namely a high-risk lending strategy, liberal underwriting, and
inadequate internal controls.
FDIC monitoring indicated more risk at WaMu than was
reflected in the OTS CAMELS ratings. FDIC also identified the
significance of those risks earlier than OTS. However, the
risks noted in the FDIC monitoring reports were not reflected
in WaMu's deposit insurance premium payments. This discrepancy
occurred because the deposit insurance regulations rely on the
CAMELS ratings and regulatory capital levels to gauge risk and
assess related deposit insurance premiums.
Because OTS examinations results rated WaMu as
fundamentally sound from 2003 to 2007, increases in deposit
insurance premiums were not triggered. Additionally, because of
statutory limitations and congressionally-mandated credits,
WaMu paid $51 million, or only about a quarter of the $216
million in deposit premiums it was assessed during the period
of 2003 to 2008. The FDIC estimates that WaMu's failure could
have caused, as you said earlier, Mr. Chairman, a $41.5 billion
loss to the Deposit Insurance Fund.
The FDIC has three primary tools at its disposal to address
the risk that it identified at WaMu. One is back-up examination
authority. Two is challenging the OTS CAMELS ratings. And three
is regulatory enforcement actions. The FDIC made use of some,
but not all, of these tools.
Back-up examination authority allows the FDIC to conduct
its own examination of non-FDIC supervised institutions when
the FDIC believes it is necessary to determine the condition of
the institution for insurance purposes. The FDIC, OTS, Office
of the Comptroller of the Currency, and the Federal Reserve
entered into an interagency agreement in 2002 that provided
guidance on invoking back-up examination authority, including
the sharing of institution information.
According to the terms of the interagency agreement, the
FDIC needed to request permission from OTS to begin back-up
examination authority. This would have allowed FDIC examiners
to review information on-site at WaMu so they could better
assess WaMu's risk to the fund. The interagency agreement
required FDIC to prove to OTS that WaMu exhibited one of the
following: A heightened level of risk, meaning WaMu was rated a
3, 4, or 5, and was undercapitalized, or material deteriorating
conditions, or other adverse developments that could result in
WaMu's becoming troubled in the near term.
The logic of this interagency agreement is circular. The
FDIC must show a specific level of risk at an institution to
receive access, but the FDIC needs access to the information to
determine the risk to the fund. OTS resisted providing FDIC
examiners greater on-site access to WaMu information because
they didn't feel that the FDIC met the requisite need for
information, according to the terms of the interagency
agreement, and believed that the FDIC could rely on the work
performed by the OTS examiners. OTS did grant FDIC greater
access at WaMu, but limited FDIC's review of WaMu's residential
loan files. The FDIC wanted to review these files to assess
underwriting and WaMu's compliance with the Non-Traditional
Mortgage Guidance.
In May 2008, FDIC began for the first time using its second
regulatory tool, challenging the CAMELS rating, to challenge
the OTS safety soundness ratings at WaMu. However, OTS was
reluctant to lower its rating of WaMu from a 3 to a 4, in line
with FDIC's view. OTS and FDIC resolved the ratings
disagreement 6 days prior to WaMu's failure, when OTS lowered
its rating to agree with FDIC's rating. By that time, the
rating downgrade had no impact on WaMu's insurance premium
assessment or payments.
Finally, the FDIC chose not to invoke its third tool, its
enforcement powers. FDIC has statutory authority to impose its
own enforcement actions on an institution to protect the fund,
provided statutory and regulatory procedures are followed.
According to the FDIC, it did not use those powers for WaMu
because it believed the steps to use those powers were too
cumbersome.
Key conclusions, our report highlighted two major concerns
related to the deposit insurance regulations and the
interagency agreement governing back-up authority. We made two
recommendations to address these concerns. The FDIC has
concurred with both recommendations and is working to implement
these recommendations by year end.
Mr. Chairman, this concludes my statement and I would be
happy to answer any questions you may have. Thank you.
Senator Levin. Thank you both, and thank you for your
reports, which, of course, will be made part of the record.
They are invaluable and very objective assessments which are
important for Congress as we consider regulatory financial
reform, so those reports of yours are going to be very helpful
to us.
In Exhibit 14,\1\ Mr. Franklin, one of WaMu's former
examiners, said that stated income loans were ``a flawed
product that can't be fixed and never should have been allowed
in the first place.'' OTS management told them that was not
OTS' policy. Now, those stated income loans are where income is
stated on an application, but there is no verification for it.
If you look at Exhibit 14, that letter from Mr. Franklin, not
only does he say these loans are a terrible mistake, but he
also says, ``I concur totally on the W-2 borrowers. The worst
cases I saw were instances where the W-2 was in the file and
the information was redacted out.'' How is that for
unbelievability? You have got a W-2 in the file and the income
is redacted. That is what was going on here.
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\1\ See Exhibit No. 14, which appears in the Appendix on page 261.
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Then you look at Exhibit 79.\1\ Another OTS official voiced
his concern over another kind of loan where there is no income
and no asset figures that are shown--this was May 2007--saying
that these are unsafe and unsound. We had Mr. Vanasek on
Tuesday, WaMu's former Chief Risk Officer, testifying that loan
application forms without verification led to fraud. And in
fact, on some loan application forms, he also testified that
WaMu loan officers were coaching the people who were filing the
forms.
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\1\ See Exhibit No. 79, which appears in the Appendix on page 478.
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Do any banking regulators now ban the practice of no stated
loans and these NINA loans, in other words, where income is not
stated, the so-called stated income loans but there is no
proof, and where NINA loans are allowed? Do you know of any
current regulator that disallows those kind of loans?
Mr. Rymer. Sir, it was not in the Non-Traditional Mortgage
Guidance, so other than that, I am not aware of any.
Senator Levin. Do you know of any, Mr. Thorson?
Mr. Thorson. I am not aware of anybody doing that now.
Senator Levin. Is there now significant proof that stated
income and NINA loans are risky loans?
Mr. Thorson. The ability to state your own income is--
especially I had not seen it before about redacting out W-2s.
We talk a lot about risk here. You are just increasing the risk
exponentially when you do something like that. I guess it still
comes down, if I were on the other side trying to argue, well,
the strength of the borrower, etc. But the problem is, you
can't assess the strength of the borrower and that has got to
be at the foundation of underwriting, risk assessment, risk
management of any of this.
Senator Levin. Without that information?
Mr. Thorson. Right.
Senator Levin. Right. Do you agree with that, Mr. Rymer?
Mr. Rymer. Yes, sir, I do. I really can see no practical
reason from a banker's perspective or lender's perspective to
encourage that. That is just, to me, an opportunity to
essentially encourage fraud.
Senator Levin. Now, on the Option ARMs issue, OTS allowed
Washington Mutual to originate hundreds of billions of dollars
in these Option Adjustable Rate Mortgages, these Option ARMs.
OTS was also allowing the bank to engage in a set of high-risk
lending practices in connection with the Option ARMs. Some of
these high-risk lending practices included low teaser rates as
low as 1 percent in effect for as little as a month to entice
borrowers; qualifying borrowers using lower loan payments than
they would have to pay if the loan were recast; allowing
borrowers to make minimum payments, resulting in negatively
amortizing loans; approving loans presuming that rising housing
prices and refinancing would enable borrowers to avoid payment
shock and loan defaults.
Now, it was the Option ARM loans in 2008 that was one of
the major reasons that investors and depositors pulled their
money from the bank, and did those Option ARMs, particularly
when connected with those other factors, raise a real safety
and soundness problem at WaMu? Mr. Thorson.
Mr. Thorson. Well, the first thing they do is, of course,
they lead to a negative amortization or building up of the
principal. That is one. Second of all, they mask the ability of
the borrower to repay. If I can elect, as the borrower, a
payment that is even less than the interest, what does that
really tell me about my ability to make normal payments or to
pay down the principal?
The other thing, and one that I think you all are dealing
with in the regulatory reform, is the fact that you are not
doing the borrower any favor here, either. They may be very
tempted to take this loan with this, I think you termed it a
teaser rate. But many of these rates jumped up 6 months, a
year, a very short period of time, and while a lot of people
may believe that they could handle that or they would figure a
way around it or refinance or whatever, the truth is, they
couldn't. And the only people who really benefitted from these
loans were the people who made the commissions off them.
Certainly the borrower, and you see it today in all these
foreclosures, they didn't get benefit from those loans.
Senator Levin. Mr. Rymer.
Mr. Rymer. I think what you have here is a combination of
not only very aggressive loan products, the Option ARMs, the
purchase of subprime loans that they did, the home equity line
of credit (HELOC) loans that they did, coupled with lax
underwriting standards, and then over that very lax enterprise
risk management processes. So I think the products themselves
were risky. The administration of those products, the
underwriting of those products were risky. And then the
management and control after those loans were originated was
really inadequate.
Senator Levin. I think regulators banned negatively
amortizing credit card loans about 5 years ago. Should we do
the same thing relative to home loans?
Mr. Rymer. Sir, I certainly think it should be considered.
I think there could be cases where, if there is sufficient
collateral, sufficient loan-to-value circumstances, that a
negatively amoritizing loan might be considered, but certainly
as we saw here, these loans were extraordinarily risky, and
coupled with the Option ARM, they were extraordinarily risky
for the banks. I think you should consider that.
Senator Levin. Any comment, Mr. Thorson?
Mr. Thorson. I agree completely with that. I think the
truth is, the strength of the borrower, tremendous strength of
a borrower may make in some odd situation that I can't really
think of, make that worthwhile. But in that case, you would
have a borrower so strong they wouldn't need that. Yes, sir, I
would agree with Mr. Rymer on that.
Senator Levin. All right. Take a look at Exhibit 1c,\1\ if
you would. Now, this chart summarizes some of the key
criticisms that OTS made of WaMu each year from the years 2004
to 2008. That chart is really not the half of it. I want to
read you what those excerpts come from. This is what OTS found
in those years.
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\1\ See Exhibit No. 1c, which appears in the Appendix on page 199.
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In 2004--this is Exhibit 1d \2\--``Underwriting of SFR
loans remains less than satisfactory.'' One of the three causes
of underwriting deficiency was ``a sales culture focused on
building market share.'' Further down, ``The level of
underwriting exceptions in our samples has been an ongoing
examination issue for several years and one that the management
has found difficult to address.'' The ``review of 2003
originations disclosed critical error rates as high as 57.3
percent of certain loan samples. . . .''
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\2\ See Exhibit No. 1d, which appears in the Appendix on page 200.
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In 2005, single-family residential loan underwriting,
``This has been an area of concern for several exams.'' The
next quote on Exhibit 1d, ``[Securitizations] prior to 2003
have horrible performance. . . . At 2/05 Long Beach was #1 with
a 12% delinquency rate.'' Next, ``We continue to have concerns
regarding the number of underwriting exceptions and with issues
that evidence lack of compliance with Bank policy.''
The next quote, ``[T]he level of deficiencies, if left
unchecked, could erode the credit quality of the portfolio. Our
concerns are increased when the risk profile of the portfolio
is considered, including concentrations in Option ARM loans to
higher-risk borrowers, in low and limited documentation loans
and loans, with subprime or higher-risk characteristics.''
Then in 2006, first quote on that exhibit, near the bottom,
``[U]nderwriting errors [] continue to require management's
attention.'' Next, ``Overall, we concluded that the number and
severity of underwriting errors noted remain at higher than
acceptable levels.'' Next, ``The findings of this judgmental
sample are of particular concern since loans with risk layering
. . . should reflect more, rather than less, stringent
underwriting.''
In 2007, ``Underwriting policies, procedures, and practices
were in need of improvement, particularly with respect to
stated income lending.'' Next, ``Based on our review of 75
subprime loans originated by LBMC, we concluded that subprime
underwriting practices remain less than satisfactory. . . .
Given that this is a repeat concern, we informed management
that underwriting must be promptly corrected or heightened
supervisory action would be taken.''
Next, 2008, ``High single-family losses due in part to
downturn in real estate market but exacerbated by: geographic
concentrations, risk layering, liberal underwriting policy,
poor underwriting.''
Year after year after year, we have these kind of findings
by the OTS. Would you agree these are serious criticisms, Mr.
Thorson?
Mr. Thorson. What it points out is that they were actually
finding things. The people on the ground, the people in the
banks were finding things. I wrote down two points you made in
your opening statement. You talked about arm's length and you
talked about action sooner, and that is what this is really all
about is they were finding these things. They just were
hesitant to do anything about it.
Senator Levin. Were they serious criticisms?
Mr. Thorson. Are they serious?
Senator Levin. Yes.
Mr. Thorson. Absolutely.
Senator Levin. Mr. Rymer, would you agree?
Mr. Rymer. Yes, sir. I agree with what Mr. Thorson said. I
think that the examiners, from what I have seen here, were
pointing out the problems, underwriting problems, riskier
products, concentrations, distributions, and markets that may
display more risk--they were all significant problems and they
were identified. At the end of the day, though, I don't think
forceful enough action was taken.
Senator Levin. But they are serious enough that enforcement
action was needed because management was not addressing it. Is
that a fair conclusion?
Mr. Rymer. Yes, sir, it is.
Senator Levin. Mr. Thorson, do you agree with that?
Mr. Thorson. Yes.
Senator Levin. We cannot find a single formal enforcement
action that OTS took against WaMu from 2004 to 2008, no board
resolutions, no memoranda of understanding, no fines. Now, the
question is whether or not that is typical for OTS, and I would
ask you on this, Mr. Thorson, as you are Treasury IG, you have
done, I think, a number of similar reviews. What were your
findings relative to the speed with which examiners were
reacting?
Mr. Thorson. As you have said, we have completed 17 of
these, and we have 33 in progress, and this is both Office of
Comptroller of the Currency and OTS. And one of the things that
we have seen here is the fact this is not unusual. This is
pretty commonplace. It is more than OTS. And it is a matter of
they find these things, they hesitate to take any action,
whether it is because they get too close after so many years or
they are just hesitant or maybe even the amount of fees enters
into it. I do not know. But whatever it is, this is not unique
to WaMu and it is not unique to OTS.
Senator Levin. Does the FDIC want to comment on this? Do
you have similar findings at FDIC?
Mr. Rymer. Well, sir, we have done 56 material loss reviews
so far. I would say that the comment made earlier about
examiners' ability to identify problems is consistent, and I
think they have done a good job. I would not necessarily say
that of those 56 that we have not seen enforcement actions. We
have seen enforcement actions in many of them. So I would not
say that the FDIC was not taking or not acting on enforcement
actions.
Senator Levin. In that regard, you have a somewhat
different conclusion or experience than does Mr. Thorson. That
is fair enough.
Now, if you look at Exhibit 32,\1\ here you will see
Lawrence Carter, who is the examiner-in-charge at WaMu, writing
to his boss, Darrel Dochow, who will be testifying later,
writing in 2006, ``At some level, it seems we have to rely on
our relationship and their understanding that we are not
comfortable with current underwriting practices and don't want
them to grow significantly without having the practices cleaned
up first. I'm sure we made that very clear.''
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\1\ See Exhibit No. 32, which appears in the Appendix on page 328.
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What is your reaction to the comment of the examiner-in-
charge that OTS has to rely on its relationship with WaMu to
get them to clean up their underwriting practices? Does it have
to rely on its relationship? What about enforcement power? What
about the tools that it has to enforce?
Mr. Thorson. You are exactly right, and we pointed out, I
think, in the testimony that one of the problems here was when
they would point these things out, they relied on WaMu's
systems to tell them whether these actions were ever taken. And
clearly, in any oversight role, that is unacceptable. So the
very foundation of how they were approaching whether or not
these actions were ever corrected or these recommendations were
ever corrected is improper.
Senator Levin. And as I think you just testified a moment
ago, you observed a similar reluctance to use enforcement tools
at other banks overseen by OTS.
Mr. Thorson. Correct.
Senator Levin. Now, if you look at Exhibit 6,\1\ OTS
apparently felt it could not force WaMu to change its ways as
long as it was profitable. We have already commented on that,
and you have commented on that. Exhibit 6, the OTS examiner-in-
charge, Lawrence Carter, wrote on page 2, ``It has been hard
for us to justify doing much more than constantly nagging--
(okay, `chastising')--through ROE and meetings, since they have
not been really adversely impacted in terms of losses.'' And I
think you have already testified to this, but I think it has
got to be really driven home.
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\1\ See Exhibit No. 6, which appears in the Appendix on page 224.
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Is it proper for an examiner to say that we really cannot
do much more than jawbone or nag because they have not yet
really adversely been impacted in terms of losses by the flaws
and the mistakes that we have identified? Is that proper?
Mr. Thorson. No. In fact, I think I quoted a small excerpt
from their own guidance that mentioned the fact that
profitability and performance of loans is not a qualification
to withhold any enforcement action.
Senator Levin. All right. And, Mr. Rymer, do you have a
comment on that?
Mr. Rymer. Yes, sir, just to follow up, I mean, Mr. Thorson
was alluding to the guidance. The OTS guidance says, ``If an
association has a high exposure to credit risk, it is not
sufficient to demonstrate that the loans are profitable or that
the association has not experienced significant loan losses in
the near term.'' That is directly from the OTS Handbook.
Senator Levin. Now, in a departure from its usual
practices, OTS did not independently track its finding in
WaMu's responses. Instead, it relied on WaMu's ERICS tracking
system. Didn't that make OTS dependent on WaMu, Mr. Thorson?
Mr. Thorson. I believe it does.
Senator Levin. Did you have trouble, both of you, tracking
OTS' findings and whether WaMu implemented them? In other
words, because of the use of a different tracking system, did
that give you trouble to track the OTS findings?
Mr. Thorson. It would in any case because of the fact that
it is not an independent system, and I think to really be
effective it has to be independent. I cannot tell you why OTS
does not have an independent system for tracking these measures
of compliance. I do not know.
Senator Levin. OK. Do you have any comment on that, Mr.
Rymer?
Mr. Rymer. Just to follow up, sir, there were, I think, as
you mentioned, 548 criticisms or observations or
recommendations that were made by OTS examiners, and we tried
to track most of those down. I think there were 50 or so that
we really could not determine what had happened with them,
again, because they were in the books and records of the bank
and not OTS.
Senator Levin. And not independently able to track them?
Mr. Rymer. Yes, sir, that is correct.
Senator Levin. Thank you. Dr. Coburn.
Senator Coburn. Thank you all for your testimony. As I sat
here and listened to both the opening statement of the Chairman
and to your statements, I come to the conclusion that actually
investors would have been better off had there been no OTS
because, in essence, the investors could not get behind the
scene to see what was essentially misled by OTS because they
had faith the regulators were not finding any problems, when,
in fact, the record shows there are tons of problems, just
there was no action taken on it. Was OTS' behavior that we see
in the record, and as outlined by the Chairman, worse than not
having--or not doing anything? I mean, we had people
continually investing in this business on the basis--as a
matter of fact, they raised an additional $7 billion before
they collapsed, on the basis that OTS said everything was fine,
when, in fact, OTS knew everything was not fine and was not
getting it changed. Would you agree with that statement or not?
Mr. Thorson. Yes, sir. I think I pulled back a point in my
statement that said basically assigning a ``satisfactory''
rating when conditions are not is contrary to the very purpose
for which regulators use a rating system. I think that is what
you are saying.
Senator Coburn. Any comments on that, Mr. Rymer.
Mr. Rymer. I would agree with Mr. Thorson.
Senator Coburn. OK. Mr. Thorson, in your testimony you say
that WaMu failed because its management pursued a high-risk
business strategy that loosened underwriting too much. It is
your belief that the high-risk strategy could have been OK with
proper controls in place?
Mr. Thorson. I think almost any system, by definition,
proper risk controls would say, yes, we can control that. So I
guess to some degree, yes, you could say that. But the real-
life examples are once you begin to institute those kind of
policies and become much more lax, and especially in
underwriting, which is really your safeguard, your final look
before you do these packages, it is pretty hard to really
understand what kind of a system you would put in place to
control that. But definition-wise, yes. In the real world,
probably not.
Senator Coburn. And also the amount as relative to the risk
of the risky instruments that you are procuring and selling.
Mr. Thorson. Right.
Senator Coburn. On page 6 of your testimony, you said,
``OTS relied largely on WaMu management to track progress in
correcting examiner-identified weaknesses and accepted
assurances from WaMu management and its board of directors that
problems would be solved.'' Do you mean to imply by this that
OTS had no system in place to find out if WaMu was correcting
the problems it said it was? And was there any evidence that if
WaMu said it was correcting the problem, they went back in to
see if, in fact, that happened?
Mr. Thorson. It is my understanding that they relied on
WaMu's system for tracking.
Senator Coburn. So there was no secondary follow-up by OTS
to changes that were requested by OTS. They took the assurance
that WaMu had completed the changes and they trusted WaMu.
Mr. Thorson. Not to my knowledge, but I will check that to
make sure, because I want to give them credit. If they did have
a system and I am just not aware of it, I want to make sure you
know that. So I will certainly double-check that and provide it
for you. But I am not aware of one.
Senator Coburn. To your knowledge, was it common practice
at OTS to issue recommendations to banks and then simply take
their word?
Mr. Thorson. Yes.
Senator Coburn. OK. Was WaMu an exception to that? In other
words, did they do that with the rest of the thrifts?
Mr. Thorson. I would prefer to make sure I am accurate on
that. I would like to give you a follow-up answer on that
because I want to make sure I am correct.
[The information follows:]
INFORMATION PROVIDED FOR THE RECORD
``OTS tracked the status of WaMu's progress in correcting
findings in WaMu's own Enterprise Risk Issue Control System
(ERICS). According to OTS, WaMu was the only thrift OTS
monitored in this manner. Other thrifts under OTS superision
are monitored using OTS' internal Examination Data System/
Reports of Examination (EDS/ROE).''
Senator Coburn. Mr. Rymer, join in here.
Mr. Rymer. I believe, sir, that as far as I can tell, WaMu
was unique in the fact that OTS does have a tracking system, at
least in place now, and perhaps it was put in place recently.
But WaMu was the only bank, I believe, OTS said that it was
allowing to track its own recommendations.
Senator Coburn. Well, I would have no doubt that OTS has a
system today, especially in light of the hearings that have
been held. It would be important if you all could give us what
your findings were in terms of when you saw that, because if,
in fact, you are looking at WaMu, you have got to be looking at
OTS as you did that. When, in fact, did they institute that
system? Or did they have that system in place all along and
ignored it with WaMu? Because now we have become criminally
negligent if, in fact, we are using selective tools of
enforcement for one thrift organization as to another.
Is it true in your findings that there was no internal
tracking system at OTS to look at all of their enforcement
actions against WaMu?
Mr. Thorson. No. In fact, as I go back and look at the
longer statement, one thing I think I can make pretty clear
with that is the examiners told us they had a process for
reviewing the corrective actions, but they took, as you termed
it, the ERICS reports, they divided them up among the OTS
examiners based on each examiner's area of responsibility. Then
each examiner was responsible for determining whether the ERICS
reports--in other words, WaMu's internal reports--properly
reflected the status of the findings and then, if satisfied,
they just sign off.
Senator Coburn. Without a follow-up check-up.
Mr. Thorson. Right.
Senator Coburn. Mr. Rymer, you note in your testimony some
of the parallels between IndyMac, which failed in July 2008,
and Washington Mutual. How should the IndyMac failure have
informed the FDIC's handling of Washington Mutual?
Mr. Rymer. I think the IndyMac failure and the issues that
we raised with access to information and back-up examination
authority at WaMu were similar to the issues we raised at
IndyMac. That is why we made that comparison.
Senator Coburn. Now for both of you, and I will finish up
here real quick, Mr. Chairman. In your joint report today, you
lay out the problem of third-party brokers. WaMu had only 14
employees overseeing 34,000 third-party mortgage brokers. What
would have been the right amount of supervising employees for
that number of third-party brokers?
Mr. Thorson. Well, the one thing to remember is that each
one of those brokers was certainly providing more than one
loan, so you can multiply that by another some unknown factor,
depending on whatever the average number of loans is that those
brokers provided. So now you are way above 34,000. I cannot
even guess as to what the supervisory number would have to be,
but it probably would have required them moving to a building
roughly the size of the Pentagon.
Senator Coburn. We see over and over again that OTS
dedicated a great number of hours and personnel to the
supervision of WaMu, yet problems never got truly addressed. In
other words, the folks were on the ground identifying the
problems, but the problems essentially were not getting solved.
And that is not to say that some were not, but, obviously, the
fundamental problems that led to their demise were not getting
solved.
Any summary of where you look or where the breakdown was at
OTS? Was it the western manager? Was it guidelines? Was it the
failure to follow guidelines that would account for the
ineffectiveness of the OTS?
Mr. Thorson. We talked about asset quality, and we talked
about underwriting and also management, all three of those. It
is not any one thing. I mean, it was really something
pervasive, and it really comes down to following a greater
desire to do whatever you could do to increase profits. When
you really get down to it, that is what this was all about. We
are going to increase the risk in order to increase our
profitability, and it does not matter what----
Senator Coburn. Yes, but I am talking about OTS. I am not
talking about WaMu. By your statement, it would imply almost
that OTS is an enabler of this effort rather than an enabler of
making sure that the American people's taxpayer dollars and the
trust in institutions that are supposed to be regulated by an
agency of the Federal Government can be trusted.
Mr. Thorson. Right.
Senator Coburn. In both of your assessments, as you looked
at this and you look at OTS--and this is a huge example of
regulatory failure. Where was it? Is it in their guidelines? Is
it in their management? Is it in their upper management? Is it
in their auditing of their own processes? Where is the failure
that allowed them to allow their largest ``customer''--which I
reject--to continue to do things that were to the detriment of
the institution they were supposed to be safeguarding?
Mr. Thorson. I think that question really comes down to the
core of what all this is about, because the truth is it starts
at the bottom where there is interaction between the regulators
and the banks, and this gets back to, again, whether you have
an arm's-length relationship, whether the proper regulations,
policies for OTS, or any regulator, for that matter, are in
place, and whether or not from the bottom up are those policies
enforced, and when people are becoming lax, does somebody in
the supervisory role come down and say these are the policies,
these are what you are going to do, that is why we regulate.
And in this case, clearly that was not done.
Senator Coburn. But the data that we showed showed that the
people on the ground, the ones that are actually doing the
auditing, actually were following guidelines, were they not?
Mr. Thorson. Yes, at least in the instances you pointed
out.
Senator Coburn. So that would exclude the people on the
ground, so the problem is above them. So where is it? Where was
it in this instance? Maybe you are hesitant to point a finger,
but the fact is you all have looked at this. You have done a
study. Where was the problem? If it was not with the people on
the ground reporting and identifying the problems, where was
the problem? I am trying to get you all to say it. We are going
to eventually say it, but you all have looked at this.
Mr. Thorson. Right, and I am certainly not hesitant to say
I found exactly that. We did point out the one case which was
very much a concern to us where the regional director did
override his own people and accepted what they saw as a much
more lax board resolution that was written by the bank itself.
That is a good example of what you are talking about. Whether
that continued above them or below them, I cannot tell you, but
that is certainly one example. And as I pointed out, we found
that same example, that same individual, involved in IndyMac.
Senator Coburn. Mr. Rymer.
Mr. Rymer. Dr. Coburn, I think you have made the point very
well that the examiners in the field in my view were
identifying problems. This was a very large institution, and
the ultimate determination about what the CAMELS rating was
going to be would be made at least at the regional level, if
not at the national level.
Senator Coburn. All right. Thank you, Mr. Chairman.
Mr. Thorson. And if you do not mind, I would like to just
add that one piece. I was being generic when I said it starts
at the bottom with--that is an overall in any regulatory group.
That was not aimed at the people here at OTS.
Senator Coburn. No, I understand that, and the record is
pretty clear. I am sure there is some of that that goes on even
within bank examiners, etc. But overall I think the management
of the regulatory framework failed miserably in this case.
Mr. Thorson. And I think in the Chairman's documents you
point out a whole list of finding after finding after finding.
Those would not have come forward if you did not have good
people on the ground.
Senator Coburn. That is right.
Senator Levin. If I could add a comment, if Senator Kaufman
will forgive me for just throwing in my own comment here in
response to the question that Dr. Coburn raised, the culture is
set at the top, and this culture here was that these banks are
constituents. They are not constituents of the regulator. They
are supposed to be regulated by the regulator. They are
supposed to be the cop. And when you deal with folks as though
these are your constituents, it sets exactly the wrong tone.
And when you revise documents which have teeth in them, as they
did at the top, and pull those teeth out of the documents, that
sets a tone which is transmitted to people below in the field.
Would you agree with that?
Mr. Thorson. Absolutely, yes.
Senator Levin. Thank you. Mr. Rymer, do you agree with
that?
Mr. Rymer. Yes, sir, I would.
Senator Levin. Thank you. Senator Kaufman.
Senator Kaufman. I would like to make a statement. We have
trouble sometimes getting bipartisan agreement. I would say
without a doubt we have incredible bipartisan agreement on this
specific issue. I think Senator Coburn has put his finger on
something, and I would like to go into it a little deeper
because the other day when we had hearings, the risk managers
repeatedly said that the examiners on the ground were doing a
great job of pointing out what the problems were and
reinforcing opinions that they were presenting to the
management of WaMu. And they said uniformly that people higher
up the level at OTS were not following up what the examiners
were saying.
Now, I think when we are starting to talk about what the
problem is here, that is a big problem. And so I think that
Senator Coburn is right on point, and I would like you just to
search your mind one more time. Why did this happen? We have
got the examiners on the ground saying their problems one year
after another, and yet every time it goes up the chain, there
is a lot of allegations about what went wrong, but I would
really like the two of you to say what you think are the one or
two reasons why the risk managers yesterday said that as we go
up the chain, we have more and more of a problem at OTS
repeatedly over all these years.
Mr. Rymer. Senator Kaufman, let me start by saying I think
the problem in 2005, 2006, and into 2007, the problem was the
bank was profitable. I think there was a great reluctance to,
even though problems were there in underwriting, the product
mix, the distribution process, the origination process, all in
my view extraordinarily risky, not things perhaps that should
not be done, but certainly if they are done, they need to be
done in some moderation, certainly with some control
environment. And I did not see in this bank's case an adequate
control of its environment.
Senator Kaufman. Mr. Rymer, if you were running OTS, and
your largest customer was having reports like this from your
examiners, and they were making money. Let us say we are a year
from now. What would you do? Would you say, well, they are
making money, it is going to be very difficult politically to
move forward on this?
Mr. Rymer. My view is that often times in examinations, if
asset quality is sufficient in the CAMELS rating, the A being
the asset quality, the M being management, and if a bank is
profitable and is not yet showing significant delinquency in
the charge-offs, the asset quality piece is sometimes hard to
downgrade if it is profitable.
But the management piece, even despite the fact that the
bank is showing current profitability, the management piece
should be, in my view, downgraded if management has not
demonstrated that it has built the adequate systems and control
processes and governance processes to help manage problems when
they eventually do occur in assets. So in this case, I can see
really no reason at all, once the problems were identified and
the concentrations were identified in the types of assets, the
distribution processes, all those things, once those were
identified, I find it difficult to understand why the
management rating at a minimum was not lowered much earlier on.
Senator Kaufman. Mr. Thorson.
Mr. Thorson. The other part here, too, I think--and you put
it an interesting way. What would you do if you were head of
it?
One of the things that would touch on what Senator Levin
said, too, is I would tell them forget about the earnings, that
is not our--it is part of what we measure as far as the
solidity, but it also, unfortunately, lends to the fact I am
looking at these guys as a constituent because I think in my
testimony I mentioned they pay us, OTS, $30 million a year. So
we want to kind of be careful about that. That should be made
very clear from top to bottom that is not a factor. It just is
not.
Second of all, you want to look at what is guidance and
what is regulation, and maybe you need to tighten some of that
up. Guidance is optional. Maybe we do not necessarily have to
do this if we do not want to take this action. Regulation needs
to be enforced--emphasized that enforcement of those
regulations is also mandatory. That is why it is called a
regulation. And maybe that is something that, as you look at
regulatory reform, you look at as to what should be guidance
and what should be an actual regulatory reform.
Senator Kaufman. Is it important who you pick to head up
these agencies with their state of mind? Isn't that an
important part of whether they are going to be successful? I
mean, someone that has the internal makings to say I know you
are making money, but what you are doing is really bad and you
have to stop doing it. How much of a role does that play in how
we get around solving this problem in the future? Mr. Rymer.
Mr. Rymer. I think that people in leadership positions have
to be willing to make the tough calls and be experienced enough
to know that today's risky practices may show today
profitability, but to explain to management and enforce with
regulatory action that risky profitability is going to have a
cost. It either has a cost in control processes an institution
would have to invest in now, or it is going to have a cost
ultimately to the bank's profitability and perhaps eventually
to the Deposit Insurance Fund. So that is the tough decision I
think that has to be made, that has to be enforced constantly.
Senator Kaufman. And, Mr. Thorson, I have been around this
place for a long time, not as a Senator but as a staff person,
and we can only write the laws so much. But it is truly scary
when you read this report--where it seems to me clear that the
problem here was that we had good Federal examiners out there
saying there is a problem here, and the management not doing
it. And I just do not see it in the report, and I think it is
key as we move forward--we have good people out there doing the
jobs and being the examiners, the career employees that we
have. But if you put the wrong people in charge, we can write
the laws any way we want to, but if they are not going to go
after a company because they are making money.
I want to shift to something a little different, but it is
all on the same point, and that is, I read your causes of
WaMu's failure, and I see WaMu failed because its management
pursued a high-risk business strategy without adequately
underwriting its loans or controlling its risks.
That sounds great. I do not think that is what went on
here. I really do not. And I think unfortunately you were not
here for the hearing the other day, but I think if you sat
there and watched what went on and listened to the Chairman's
questioning and went through the exhibits, you would say that
is not why they failed. Right, Mr. Chairman? They did not fail
because management pursued a high-risk business strategy
without adequately underwriting its loans or controlling its
risks.
Would both of you comment on what you believe happened
here?
Mr. Thorson. It certainly is a contributing factor.
Senator Kaufman. No, but the thing is that is the sentence
right here. It does not say, ``A contributing factor was . .
.'' It says--and I am not parsing words, I am not trying to
parse words.
Mr. Thorson. No. I understand.
Senator Kaufman. And I am not even critical. I am just
trying to say it seemed to me there were all kinds of things
going on here that were--I will get into characterizing it a
little later. They were doing things that were reported up
here--this was not high-risk business strategy. They were doing
bad things. And the examiners were saying they were doing bad
things.
Do you understand my frustration with reading ``pursuit of
the high-risk business strategy.'' Isn't that kind of a cold-
blooded way of letting everybody off the hook? This was a bad
business decision. Nothing went on here.
Mr. Thorson. I appreciate your very much straightforward
language on that, and certainly I can tell you from myself on
down, it is not to let anyone off the hook.
I appreciate what you are saying, and I guess what I am
saying is I completely agree with you and your frustration,
because, I mean, this is what we deal with every day, is we go
and measure against the regulations and the rules and how did
they do this and how did they do that.
But the bottom line is just what you are talking about, and
especially the comment you made to Mr. Rymer, which was, did
they have the guts to say knock it off, stop it? And that is
really what it comes down to. When you are hiring regulators,
that is what you want. And I think what obviously all this
paper really says is, No, it did not happen.
Senator Kaufman. Mr. Rymer, same thing.
Mr. Rymer. Yes, sir.
Senator Kaufman. But, in retrospect, maybe there is another
sentence that would have gone in there? It was a failure by
management to police what they were doing. There were all kinds
of things that went on that were highly questionable. And the
people at the top of the Office of Thrift Supervision really
did not do what you would have done faced with a similar
situation with a record like this. This was not just a 6-month
record. This was years of people knowing what it is doing. And
for whatever reason, they did not move forward. Is that a
fair--and I am looking for an honest correction if I am saying
something that is not----
Mr. Thorson. No. It is. And, in fact, in the report I
believe it mentions the fact--a very small amount because we do
not get into that, but we do talk about fraud indicators and
that those are being investigated, and we leave it at that.
Senator Kaufman. Right.
Mr. Thorson. But I think that is part of what you are
talking about, too.
Senator Kaufman. That is kind of what I am talking about. I
mean, the first time I heard that, I thought somebody was
kidding me. I go into a bank, and they say, ``How much do you
make?'' And I say, ``$500,000 a year.'' They say, ``OK. You can
get a $2 million mortgage.'' Moving right along, what is the
next question?
I would just like to review a little bit of what you said
earlier because I want to put it in context. But both of you
said stated income loans. What do the two of you think about
stated income loans?
Mr. Rymer. I do not think they should be allowed. I think
that if a bank is going to advance funds, secured or unsecured,
they certainly need to verify who they are lending to and
verify the repayment sources.
Senator Kaufman. Mr. Thorson
Mr. Thorson. At the very core of this is the ability to
repay, and that is a big part of the ability to repay, is how
much income does this individual have. And if I just tell you,
I do not think that--I was very surprised when I first saw
these, too. Nobody has ever given me that opportunity, so I
just figured there is no way. But it evidently has occurred a
lot.
Senator Kaufman. OK. I am going to do something a little
tricky here. In your report, what percentage do you think of
all WaMu's home equity loans were stated income loans? Take a
wild guess. No, not allowed to look, Mr. Rymer. Take a wild
guess.
Mr. Rymer. As I remember, that number was somewhere in the
70-percent range.
Senator Kaufman. And, Mr. Thorson, what do you think?
Mr. Thorson. Sixty percent?
Senator Kaufman. Would you be surprised if I told you that
approximately 90 percent of all WaMu's home equity loans were
stated income loans. Now, folks, when you are writing a
report--and, again, I have spent a lot of time on this, plus I
have the advantage of hearing the witnesses the other day and
the rest of it, so I have a different view. And you are doing
your report, and you are doing a good job, and I am not being
critical. But if you have a company where 90 percent of their
home equity loans are stated loans, a practice which you both
define as just exactly--I mean, you did it much more
articulately, but just you should not be doing that in a bank.
You have got to think maybe that was one of the causes that
things went the way they did.
Let me ask you, the Option ARMs, these are high-risk loans,
Option ARMs, right? I will not do the same thing. Seventy-three
percent of all Option ARMs were stated income loans.
Mr. Rymer. I wish you had asked me that one, Senator. I
knew that one.
Senator Kaufman. You had that one. [Laughter.]
Mr. Thorson. So did I.
Senator Kaufman. I am going to shut up for a minute, just
for a minute, and in 50 percent of subprime loans--I mean, here
you are dealing with someone who comes into your office and is
classified as a subprime loan, and you say to them, ``What is
your income?'' And you write it down, and that is it. Would you
say that is one of the causes of this meltdown?
Mr. Thorson. No, I mean, clearly--in any professional
banking operation--that is not acceptable. You have to be able
to verify, and I think all of us have experienced loans
throughout our lives where the verification process of almost
everything, every piece of paper that we submitted was
rigorous. And where we parted ways with that philosophy I am
not sure, but I do remember now the 90-percent number, and it
is staggering. That is the only way to say it.
Senator Kaufman. Mr. Rymer, I mean, isn't that a systemic
problem?
Mr. Rymer. Taken together, all those products were very
risky, and certainly when you look at the fact that was the
bank's business, certainly it created a very risky
organization.
Senator Kaufman. When you have something like this where 90
percent of the home equity loans, 73 percent of the Option
ARMs, and 50 percent of the subprime are stated income loans,
that has to be policy right at the very top of the
organization, right? I mean, that is not just happening because
somebody down in Long Beach decided that is what they were
going to do. This is the very top of the organization. And when
you have cases like the Chairman stated where they redacted the
W-2, they got a stated income loan to begin with. Now they get
the W-2. Now they redact the W-2.
What do you do as a regulator when you detect fraud? First
off, do you think at least there is the potential for fraud
when you find 90 percent, 73 percent, and 50 percent? Is that
on its face----
Mr. Thorson. I think you could easily--what was the term? A
target-rich environment.
Senator Kaufman. Yes, target-rich. That is good. I like
that. That is a target-rich environment. What do you do as a
regulator when you find a target-rich environment in one of the
institutions that you are regulating?
Mr. Rymer. In this case, because of the stated income
program--the numbers were huge. The bank was the victim of the
fraud because of their lax controls.
Senator Kaufman. Right.
Mr. Rymer. Now, the fix to that is to increase the
controls. All the recommendations that were made of the 500 or
so findings were to improve those controls.
Senator Kaufman. Right.
Mr. Rymer. But the bank was the victim of that fraud. But
fraud in that case is an indicator of just how lax the controls
were.
Senator Kaufman. Well, when you say the bank, people get
the indication like it was the people running the bank who
somehow are suffering. I think the CEO made--because of the
fact they were able to expand their mortgages, have more
mortgages, do more mortgage-backed securities, everybody in the
bank was making a lot more money.
Mr. Rymer. Well, let me explain. I mean, the bank was the
initial victim, but certainly as those mortgages passed through
the system, there were lots more people harmed from that fraud
than just the bank.
Senator Kaufman. Correct.
Mr. Thorson. And we commented in the report that in 2007,
WaMu itself identified fraud losses of $51 million for subprime
loans and $27 million for prime loans. That is a big number,
and at some point, as you say, top management--I mean, you are
talking about $78 million right there. Somebody is going to
want to take a look at how that happened and what are we doing
to stop it.
Senator Kaufman. But even beyond that, I mean, don't you
have kind of an obligation at some point, when you get
numbers--I mean, that was in good times. God only knows when we
went back and looked at what happened to mortgage-backed
securities that ultimately went toxic, as the Chairman says. I
mean, at some point you just say, yes, the bank is getting hurt
and this and that, but there are some people involved and those
who were committing fraud.
Mr. Thorson. Yes.
Senator Kaufman. Now, at some point when you come across a
fraud, you refer it to the Justice Department, is that how it
works?
Mr. Thorson. The regulators refer it to us and to the
Justice Department. The bank can refer it certainly. There are
a number of ways to go here. My guess is a number of those
paths were followed. So yes. And there are active cases.
Senator Kaufman. So bank regulators could make not only
civil, but also criminal referrals?
Mr. Thorson. Yes.
Senator Kaufman. If there was fraud involved? Mr. Rymer, is
this normal?
Mr. Rymer. Yes, sir, it is. It is normal.
Senator Kaufman. When is it inappropriate not to make
criminal referrals to Justice? Is there any place? I mean, if
you find fraud, it is pretty----
Mr. Rymer. Well, I think the bank employees as they found
it would have an obligation to complete a Suspicious Activity
Report and that would work its way up through to the Justice
Department.
Senator Kaufman. But if they didn't, would the regulators
do--clearly in this example, everybody--if, in fact, there was
fraud--everybody was doing well. We had a report yesterday
where it showed that the compensation for people that did the
Option ARMs and subprime, they were compensated better if, in
fact, they could turn up more mortgages in that market.
So it is in nobody's interest in the bank--you don't even
hear about it. I mean, this isn't even up here on the things
where people are talking about what the bank is doing. And the
regulations in the report that they are doing way too many
stated income loans, as far as I know, anyway, it wasn't raised
the other day and I am not seeing it anywhere else. So nobody
in the bank was worried about the risk regulators. Mr. Vanasek
and Mr. Cathcart were concerned. So how does it work, then?
Does the regulator, is this up to OTS to make the referral?
Mr. Thorson. In some cases, the regulator, if they find an
indicator of fraud, they can make a referral and will, and I
have no doubt that they do. And, in fact, obviously, people
inside the bank could also do that, not necessarily--I mean,
there are all kinds of avenues to do that, anonymously and
otherwise but, as a regulator or as a bank employee or,
frankly, almost anybody associated with this, if I had ever
found a W-2 that had been redacted, I figure we hit a gold
mine.
Senator Kaufman. Especially engaged in a business practice
which both of you admit is----
Mr. Thorson. What possible reason would you have to redact
a W-2 except for the fact that the number doesn't match what
you have reported?
Senator Kaufman. Mr. Rymer.
Mr. Rymer. Yes, sir, it is a significant problem. The U.S.
Attorney's Office in Seattle has a task force for WaMu--
actually for WaMu fraud.
Senator Kaufman. Right.
Mr. Rymer. So, I mean, they are aware of it and are working
the issue. Our office has folks contributing there. I have
special investigators working that task force as well as the
FBI and so forth.
Senator Kaufman. Right. And so when you have a situation
where not just a redacted loan, but 90 percent of all WaMu's
home equity loans are stated income, I would just say, a
target-rich environment.
I mean, it seems so systemic--90 percent--that clearly the
top management of the company was well aware of what was
happening here with stated income loans. They may not have
known about the redacting down in the field, but essentially
they were saying, OK, stated income loans. That is fine. It
doesn't matter, the size of the mortgage. The size of the
mortgage can be as big--they testified yesterday, I think,
didn't they, Mr. Chairman, that there was no limit on the size
of the mortgages that you could get under stated income.
Senator Levin. That is right.
Senator Kaufman. And so, basically, whatever mortgage we
have got, that is what we are doing. We are going to have
stated income. It is going to be the policy here.
And then what we do is we say to people, look, you want to
make a lot of money? These are the products that we are willing
to sell in order to do that, and we are going to compensate you
a heck of a lot better if you do that. And then we say, in an
environment where Wall Street says the faster you can put these
mortgage-backed securities, just get these mortgage-backed
securities, just get us the mortgages, and then we can put them
together and we can sell them and they are out of your hair, do
some repurchase agreements on some of them, and you are down
the road and we are all going to come out a lot better.
I am just finishing with that, either of your thoughts on
that.
Mr. Rymer. My general view is that there is a lot of truth
to what you said. There was the idea that these mortgages
passed through so many hands so quickly, the idea was that no
one was going to be really harmed by the fraud. Or if they were
harmed, it wasn't the originator who was going to be harmed, it
was someone down the line.
Senator Kaufman. Mr. Thorson.
Mr. Thorson. I completely agree, and also, as I mentioned
earlier, too, these types of loans really didn't help the
borrowers at all. Look at the state of foreclosures we have in
this country now and the pain and suffering that goes with
that. And whether people thought that they could figure a way
around this when it finally was time to pay, I guess maybe they
did. But the only reason that this succeeded was because of the
financial gains that were made by the people making these
loans.
Senator Kaufman. You know what most scares me about this?
It is, I think, that not just here, but in credit default
swaps, so much went on on Wall Street, we have rewarded people
who essentially said, I know what is going wrong here, but I
can't stop doing it because I am making so much money. And,
when it all goes bad, it is OK to leave it to the taxpayer, but
I will have my money and I will have my second home and I will
have my pool. I will have everything I need, and the bank goes
under. Like you said, Mr. Rymer, the bank is the one that goes
under. People lose their jobs in the banks. The shareholders
lose their equity. People lose their homes. But you know what?
I have mine.
We are doing some things in this regard, but I don't think
we have done enough to let people know you can't do that in
this country and get away with it, because if you can, they
will just keep doing it. They will come up with a different way
to kind of push the product down the line, some new way to wrap
it up in something special that no one understands, sell it,
and I am out of here and I made the price that I made.
So it is one of those things, Mr. Chairman, that I think
runs through so much of this. We have created an environment
where people know they can make a lot of money, and all you
have to do is read all the big stories, too big to fail, 13
bankers, and so on.
So anyway, I want to really thank you, not just for this
but for your service, and I wish that one of you had been the
head of OTS during this period. Thank you.
Senator Levin. I want you to take a look at Exhibit 44,\1\
if you would. We are going to hear later on from who was then
the Director of OTS, Mr. Reich. But this is an email from Mr.
Reich to Mr. Killinger. This is dated in July 2008. I want to
give you a little bit of background to this memo.
---------------------------------------------------------------------------
\1\ See Exhibit No. 44, which appears in the Appendix on page 366.
---------------------------------------------------------------------------
This is where he is telling Kelly--he calls him by his
first name--Kerry--``sorry to communicate by email. I've left a
couple messages on your office phone but I'm guessing you may
be off for a long weekend,'' and he is ``wrestling with the
issue of a MOU versus a Board Resolution,'' a Memorandum of
Understanding versus a Board Resolution as the result of a
conversation in his office and he has decided that MOU is the
right approach. And, he says, ``We almost always do a MOU for
3-rated institutions,'' and now they are 3-rated, because in
February 2008, they downgraded them from a 2 to a 3.
And then he says, ``We almost always do a MOU for 3-rated
institutions, and if someone were looking over our shoulders,
they would probably be surprised that we don't already have one
in place.'' I guess the head of OTS didn't think there was
anybody looking over his shoulder, but we ought to be shocked
that there is not a Memorandum of Understanding in place since
that was their common policy.
Now, I want to go into a little bit of the background,
because it is worse than that. We will come back to this memo.
Go back to February 2008. I talked about this in my opening
statement. OTS downgraded WaMu from a 2 to a 3. Now, once you
go from a 2 to a 3, which signifies a troubled bank, OTS policy
requires you to issue a public Memorandum of Understanding at
the same time aimed at correcting those deficiencies. OTS did
not do that. We will ask Mr. Reich about that when he is
testifying. But instead, OTS waited until the next month and
accepted a non-public Board Resolution. That is the background.
So first, instead of doing a Memorandum of Understanding,
which is public, it is a non-public Board Resolution. September
7, 2008, as we know, OTS finally, after being prodded by FDIC,
went to a 4. But now let us talk about going to the 3.
I want to go to the memorandum, Exhibit 44.\1\ I find this
to be an extraordinary document. First of all, an apology, to
Kerry, communicating by email. This is the regulator who is
head of an organization that has been presumably pointing out
defects in this bank's operations, including fraudulent
operations, for 4 years. It starts off with an apology. ``Tried
a couple messages on your office phone, didn't reach you, so I
am going to send you an email.'' ``He has been wrestling,'' he
says, ``with the issue of the MOU versus a Board Resolution.''
I don't know how much more wrestling you have got to do. But he
has been wrestling that issue.
He has decided MOU is the right approach in this situation.
And then he says, ``we almost always do that MOU for 3-rated
institutions, and if someone were looking over our shoulders,
they probably would be surprised we don't already have one in
place.'' They sure would be. And then they say a few other
things.
And then he says, ``[A]s much as I would like to be able to
say a Board Resolution is the appropriate regulatory response,
I don't really believe it is.'' I don't know why he would like
to be able to say a Board Resolution is appropriate instead of
a MOU when his own policies provided for a MOU and they have
been dawdling for all these months. But that is what he tells
Kerry.
And then he says, near the bottom, ``I do believe we need
to do a MOU. We don't consider it a disclosable event, and we
also think the investment community won't be surprised if they
learn of it and would probably only be surprised to learn one
didn't already exist.'' They sure would be. And then he is
apologizing again. ``I am sorry to communicate this decision by
email. Best regards.'' Kerry signs it, John.
I find this to be kind of a cozy relationship, to put it
mildly, that is reflected in this memorandum, in a very
deferential, apologetic email, long overdue by years, months on
the downgrading of the bank. Apologetic, deferential.
And then a few months earlier, apparently this proposed MOU
had been shared up the chain, and here we get an interesting
reaction, back in July, I guess, when they were first putting
this MOU together. This came from Mr. Dochow, who we will hear
from also later on, going up the chain to Mr. Ward. This is
Exhibit 44, by the way--I am sorry, 45. Let me point to Exhibit
45.\1\
---------------------------------------------------------------------------
\1\ See Exhibit No. 45, which appears in the Appendix on page 368.
---------------------------------------------------------------------------
Down at the bottom of page one, you will see that it is
from Mr. Ward to Mr. Dochow saying, on the WaMu MOU, ``Why did
we run it by FDIC but not me?'' That is the first question he
asked. And then Mr. Dochow answers, ``You make a good point, I
apologize, and attached is the MOU for your review. I will make
any changes you want and it has not yet gone to the company. .
. . The MOU came up yesterday in a call I had with John Reich
and Scott Polakoff, and then by John Reich with COB Steve
Frank. It went to the FDIC because I committed to Stan Ivie,''
who I guess is at the FDIC, ``to consider their comments in an
effort to minimize their letter writing and posturing.''
This is the beginning of a very strange relationship, which
I will get to in a minute, but the point of this is at the top
of that Exhibit 45, where Scott Polakoff, who is apparently
high up in the OTS, says, ``Thanks for sharing this document,''
and then notice what he says. ``It is, unfortunately, another
example of a benign supervisory document.'' It is still benign,
apparently, according to the higher-up at OTS.
Is that not, that whole MOU issue, does that not strike you
as just simply incredible, that first of all you don't have a
MOU to begin with although policy provides that it be issued
once you have a downgrading from a 2 to a 3? It is delayed.
They accept instead of a MOU a Board Resolution, which is not
public. Months and months go by. Finally, they decide, OK,
apologetically twice in an email to the people they are
supposed to be regulating, sorry we couldn't reach you. We have
tried twice. Why the hell isn't the bank getting back in 10
minutes to the regulator?
So does this strike you as being a reflection of a very
cozy relationship with much too much deference and much too
much apology, Mr. Thorson?
Mr. Thorson. Yes, sir, and the other part here, too, is the
decision as to whether to do an informal or non-public action
versus a formal or a public action. Again, he sort of
apologizes in the previous document that this could become
known. This gets right to the heart of what you were talking
about, the culture. I mean, that is really what you are talking
about. We don't want to do anything to hurt, and there is not
an acceptance of the fact that a strong regulatory control
helps them----
Senator Levin. And helps the public.
Mr. Thorson. Absolutely.
Senator Levin. And is their job.
Mr. Thorson. Right.
Senator Levin. And protects the economy.
Mr. Thorson. Correct.
Senator Levin. So far too cozy for you, as well?
Mr. Thorson. It is what?
Senator Levin. This is far too cozy?
Mr. Thorson. Absolutely, as far as I am concerned, yes.
Senator Levin. Mr. Rymer, do you have any reaction to this?
Mr. Rymer. It does indicate a level of familiarity that
makes me uncomfortable.
Senator Levin. Now let us talk about the relationship
between the Treasury and the FDIC, or the OTS, more accurately,
and the FDIC, because there was a real strain which occurred
here and I want to get to it with them, but I want to first ask
you about it.
OTS and FDIC, they addressed the risk at WaMu from somewhat
different perspectives. You have got OTS looking at the safety
and soundness of WaMu. You have got a CAMELS rating that they
use. The FDIC is assessing the risk to the Insurance Fund with
the LIDI rating, it is called. The ratings differ somewhat, and
I won't go into the detail on them, but the point I want to get
to is whether or not what you saw, you had OTS and FDIC working
together here or whether or not there was some inappropriate
blocking of access by OTS to FDIC's access to the bank data.
We have gone through some of the documents, I believe,
already, and I think you are familiar with them, are you, Mr.
Rymer?
Mr. Rymer. [Nodding head.]
Senator Levin. And can I ask both of you, in your judgment,
whether or not OTS should have allowed the FDIC to help here.
Mr. Rymer. Yes, sir. It is clear to me that they should
have. I think the FDIC, by requesting back-up examination
authority in 2005, 2006, 2007, and 2008, indicated that they
had concerns and those concerns were principally driven by its
own LIDI analysis. Not to go into too much detail, but the LIDI
analysis is looking a little bit broader, at broader indicators
than just the internal operations of the bank. It is looking at
competitive factors and macroeconomic factors in an attempt to
identify the risk that a failure would cause a loss to the DIF.
So there is no question in my mind that the FDIC's request
for back-up authority, simply given the sheer size of WaMu,
was, to me, enough reason for FDIC to ask for back-up
authority.
Senator Levin. And Mr. Thorson, are you familiar with these
documents?
Mr. Thorson. I agree with Mr. Rymer. I think, as he pointed
out in his last sentence there, the sheer size of the bank
would say that there should be a maximum of cooperation, not to
mention the fact that it is dictated by statute, as well.
Senator Levin. Are you familiar with the documents which
show that the OTS blocked FDIC access to bank data?
Mr. Thorson. I have looked at the ones that you have come
up with.
Senator Levin. All right. And they refused to allow the
FDIC to participate in bank examinations, rejected requests to
review bank loan files, and you think they should have allowed
those things?
Mr. Thorson. Well, as a matter of policy, I think they
should have allowed that. No matter what their reasoning was,
as a matter of policy, they should have, yes.
Senator Levin. All right. Well, we will get into that later
on.
Mr. Thorson. While you are doing it, if I can make one
comment, going backwards for a second----
Senator Levin. Yes, please.
Mr. Thorson. Despite the comment that said that we need to
move forward with it ASAP in July, that MOU wasn't signed until
September.
Senator Levin. Right. That is ASAP. The ``S'' is misplaced.
It probably is delayed as much as possible. That would be a
DAMAP--delay as much as possible--instead of ASAP.
Thank you both. We appreciate your work. We appreciate your
testimony. It has been a long hearing so far. It is going to
get much longer. But thank you for kicking it off.
Let me now call our second panel of witnesses: John Reich,
former Director of the Office of Thrift Supervision; Darrel
Dochow, former West Regional Director of the Office of Thrift
Supervision; and Lawrence Carter, the Examiner-in-Charge for
Washington Mutual at the Office of Thrift Supervision from 2004
to 2006, currently the National Examiner at OTS. We appreciate
you all being with us. We look forward to hearing your
testimony. I do not know if you were here at the beginning of
the first panel, but pursuant to the rules of this
Subcommittee, all witnesses who testify before our Subcommittee
are required to be sworn, so I would ask that each of you now
please stand and raise your right hand.
Do you swear that the testimony that you are about to give
will be the truth, the whole truth, and nothing but the truth,
so help you, God?
Mr. Reich. I do.
Mr. Dochow. I do.
Mr. Carter. I do.
Senator Levin. We are going to use a timing system to let
you know when 5 minutes have elapsed. A minute before that time
comes, the light will change from green to yellow, so you can
try to conclude your remarks. We appreciate your trying to keep
those, if you could, to 5 minutes, and, Mr. Reich, we are going
to have you go first and then Mr. Dochow second, and then Mr.
Carter. I know I have pronounced Mr. Carter's name correctly,
but I do not know about Mr. Reich and Mr. Dochow.
Mr. Reich. It is ``Rich.''
Senator Levin. Mr. Dochow.
Mr. Dochow. It is ``Do-ko.'' Thank you.
Senator Levin. Good. Thank you. Thank you very much. Mr.
Reich, why don't you begin?
TESTIMONY OF JOHN M. REICH,\1\ FORMER DIRECTOR, OFFICE OF
THRIFT SUPERVISION, AND FORMER VICE CHAIRMAN, FEDERAL DEPOSIT
INSURANCE CORPORATION
Mr. Reich. Good morning, Chairman Levin. I would like to
say I was delighted to be here, but that would be a bit of an
overstatement. In my retirement, I would much rather be at home
reading the Washington Post, drinking coffee, and ruminating
over the Caps loss to Montreal last night.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Reich appears in the Appendix on
page 134.
---------------------------------------------------------------------------
I did retire in February 2009, a little over a year ago,
after a 49-year career. I was in the banking business for 25
years. I was CEO of a bank in Sarasota, Florida for 12 years. I
worked on Capitol Hill. After we sold our banking organization,
I moved to Washington, DC, went to work for Senator Connie
Mack, a long-time friend and former banking colleague of mine.
I was his chief of staff for the last 3 years of his term in
the U.S. Senate.
I was appointed to the Board of Directors of the FDIC,
served on the FDIC Board for 8 years, from 2001 through the end
of February 2009. I served as the Vice Chairman of the FDIC for
the first 5 years of my 8 years on the board, was, in fact,
Acting Chairman of the FDIC for a several-week period during
2002 during which time a bank failed in Hinsdale, Illinois.
When I was asked to move by the White House to the FDIC in
2005, I had some concerns about it. The staff had been allowed
to deplete, there had been no new hiring, and there was sort of
a feeling, in my opinion, among the staff of the OTS that it
was going out of existence. It sort of has lived under the
threat of elimination ever since it was created by statute in
1989.
I would like to depart from my prepared remarks and address
a couple of statements that have been made in the press
yesterday and again this morning. My reference to Washington
Mutual as a constituent is solely attributable to the fact that
I spent 12 years here on Capitol Hill where the use of the word
``constituent'' is done hundreds of times a day every day, and
it is not in my vernacular, in reference to an institution that
we supervised, intended to reflect any sort of sinister or
inappropriate relationship with an institution that we
supervise. It was simply a habit that I picked up here that
carried over when I became a regulator. It certainly did not
imply to me that--whether it was a $300 billion institution or
a $30 million institution, I referred to it as a
``constituent.'' And it was not in any sort of a cozy
reflection.
I think it is important to point out that although
Washington Mutual has been referred to as the largest failure
in American history, in fact, the largest failure in American
history was Citi. It was not allowed to fail. It was bailed out
with billions of dollars of taxpayer money. Washington Mutual
was not deemed to be systemic and was not bailed out.
Senator Levin. For accuracy, I think we said the largest
thrift. I do not think Citi failed, but it----
Mr. Reich. It did not fail. It would have had if it not
been bailed out.
Senator Levin. I think the reference here was the largest
thrift failure.
Mr. Reich. OK. Thank you.
Senator Levin. I will correct myself again. I said it was
the largest bank failure, and that apparently is true, thrift
or otherwise.
Mr. Reich. That is true. Thank you, sir.
Three points that I would like to make. Though asset
quality was a growing and continuing concern at Washington
Mutual, this was a liquidity failure, not a capital failure. It
was brought on because of two bank runs: a $10 billion run
after the failure of IndyMac, and a $16.4 or $16.7--I heard you
say this morning--billion dollar run on deposits during the 10-
day period preceding September 25, with zero cost to the
Deposit Insurance Fund and zero cost to the taxpayer.
There have been over 200 bank failures in the United States
since January 1, 2008, many of which did, in fact, cost
millions of dollars to the Deposit Insurance Fund. This
institution was not one of those. There was no cost to the
taxpayer or to the Deposit Insurance Fund.
The second point is that a majority of Washington Mutual's
mortgages were in California and Florida, two of the States
that were particularly hit hard with the most severe price
declines in real estate.
The third point I would make that I think is very important
is that Washington Mutual suffered from a lack of diversity in
its asset portfolio because of restrictions imposed by the HOLA
statute under which it operated. They attempted asset
diversity, but the diversification that took place was all in
the area of real estate-related loans.
If you added all of the assets together of the
approximately 800 institutions that OTS supervises, it would
total probably $1 trillion, maybe a little bit more today.
Because of its concentration in real estate loans, it is a
problem that I believe Congress needs to address. In my
opinion, my personal opinion, the thrift charter is obsolete
because the HOLA statute requires that two-thirds of their
assets be invested in real estate-related loans, which is a
concentration. Many of the larger institutions are wrestling
with diversification of assets, and it is an issue that I
believe needs to be addressed in the regulatory reform.
I will stop here, Mr. Chairman, and I would be glad to take
questions.
Senator Levin. Thank you very much. Mr. Dochow.
TESTIMONY OF DARREL DOCHOW,\1\ FORMER WEST REGIONAL DIRECTOR,
OFFICE OF THRIFT SUPERVISION
Mr. Dochow. Thank you, Mr. Chairman. I will take a short
period of time here to read an oral statement, if I may.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Dochow appears in the Appendix on
page 147.
---------------------------------------------------------------------------
By way of background, I retired from the Office of Thrift
Supervision in March 2009 after a 36-plus-year career as a bank
examiner and regulator. I began my career as an assistant
national bank examiner with the Office of the Comptroller of
the Currency in 1972. I examined national banks and rose to the
position of Assistant Chief National Bank Examiner in
Washington, DC, during my 13-year OCC service. In 1985, I
became a senior regulator with the Federal Home Loan Bank of
Seattle and subsequently with the Office of Regulatory
Activities. I became an OTS employee with its creation in 1989
and served in various regional examination and supervisory
capacities, working out of the Seattle, Washington, office and
reporting to various regional line managers and ultimately to
the Regional Director. I was promoted to Regional Director,
West Region in September 2007 and thereafter reported directly
to the OTS career bank supervision executives in Washington,
DC.
Over the course of my 36-plus years of public service, I
saw some of the Nation's more notable financial and economic
crises and worked very closely with sister regulatory agencies
such as the Federal Reserve, the FDIC, the OCC, and State
regulatory authorities. I also saw agency policy changes in
response to such crises. These experiences, grounded by my
years as a bank examiner, helped define my approach to
supervision.
I have always believed that interagency cooperation is both
appropriate and beneficial. As an examiner, I found that when
fellow examiners from any of the agencies understood the same
set of facts, there was usually agreement on the bank's
condition and appropriate regulatory corrective action. In
addition, analysis is often improved by collaboration and
constructive critique. I also found that it is critical to be
factual and analytical so that conclusions are supported and
regulatory actions are appropriate. I generally considered the
seemingly unlimited FDIC staffing as a welcome aid to the OTS
West Region's limited resources. After I became Regional
Director, my predecessor and I both followed the direction
given us by OTS career executives in Washington, DC, and the
written interagency protocols governing FDIC participation in
examinations.
Bank supervision is grounded in law, regulation, and agency
policies, but can involve significant judgment and discretion.
My approach was to have open discussion of examination and
supervisory strategy, findings and proposed supervisory actions
at all levels at OTS, and with the FDIC on higher-risk
institutions. We conducted regular briefings and case
discussions including examiners, regional managers, and agency
executives, and obtained direction or concurrence on proposed
next steps and actions. Supervision was a collaborative process
between the regions and Washington.
Examination findings and ratings typically form the basis
for bank supervisory actions. I worked vigorously with the
other regions and Washington, DC, to have the most highly
talented and experienced examiners assigned to the West Region
institutions posing significant risk. I consider the OTS
examiners to be some of the very best. They are well trained,
highly experienced, extremely hard-working, independent in
thought, and were supported by me and some of the finest
specialists from the capital markets, mortgage banking,
accounting, appraisal, legal, and fair lending disciplines. I
also welcomed Washington, DC, participation in examinations and
supervision. I expected line managers that were responsible for
daily supervisory oversight to meet with examiners, bank
executives, risk managers, auditors, and directors on a regular
basis. In this regard, I also attended board meetings with the
region's largest and most troubled institutions whenever
possible. I believe in supporting examiners and their
conclusions and in taking supervisory action in accordance with
agency policy to address weaknesses.
The then OTS philosophy toward supervisory actions was that
they should be firm but fair. Generally, the prevailing OTS
practice was to calibrate the action based on the confidence of
obtaining correction and within the parameters of the OTS then
in existence enforcement policy. I have seen many instances
where a simple request from an examiner or supervisor was
effective in obtaining timely correction. To help ensure
supervisory enforcement actions were taken in accordance with
OTS' policy, the West Region has long followed a practice of
having a committee or executive review of possible enforcement
action situations. OTS D.C. participated in most Enforcement
Committee reviews and was always consulted. National tracking
systems for following enforcement actions, examination
findings, and violations were in various states of refinement,
development, or completion during this time at the OTS.
Mr. Chairman, bank supervision is a hard job, and hindsight
is a good teacher. There are things I wish I could change. I am
always deeply saddened when an institution fails because of the
impact felt by all customers, communities, employees, and other
stakeholders including taxpayers. Over my years in public
service, I worked very hard to do the very best job possible in
accordance with agency policies and procedures.
Thank you again. I will do my best to answer all your
questions.
Senator Levin. Thank you very much, Mr. Dochow. Mr. Carter.
TESTIMONY OF LAWRENCE D. CARTER,\1\ FORMER EXAMINER-IN-CHARGE
(2004-2006), AND CURRENT NATIONAL EXAMINER, OFFICE OF THRIFT
SUPERVISION
Mr. Carter. Good morning, Chairman Levin. Thank you for the
opportunity to testify on the matters concerning the
supervision of Washington Mutual, also known as WaMu,
headquartered in Seattle, Washington. I am presently a national
examiner for OTS, and I would like to tell you a little bit
about my background so that you understand how my experience
underlies my testimony today.
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\1\ The prepared statement of Mr. Carter appears in the Appendix on
page 149.
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My college education includes an associate degree from
Northern Virginia Community College, which I received magna cum
laude in 1980. I then moved to Southern California, and I
obtained a Bachelor of Science degree in economics from
University of California at Riverside in 1983. In 1987, I
graduated from California State University, Los Angeles, with a
MBA specializing in finance. While in graduate school, I worked
at Trust Company of the West, known as TCW, working with
investment account management for pension fund clients.
After I received my MBA in mid-1987, I went to work for
what was then the Federal Home Loan Bank--still is--Federal
Home Loan Bank of San Francisco, where I originally worked as a
supervisory analyst. Shortly thereafter, in 1989, I became an
examiner for the OTS when the examination functions at the
Federal Home Loan Bank Board were transferred to OTS as part of
the Financial Institutions Reform, Recovery, and Enforcement
Act (FIRREA) of 1989.
I have served in lead examination roles for many years at
many large and small savings institutions, some of which were
troubled. I also served in support roles, performing in all the
CAMELS areas of the exam: capital adequacy, asset quality,
management, earnings, liquidity, and sensitivity to market
risk. I have supervised on-site staffs of 70 or more examiners,
including the generalist, safety and soundness examiners,
compliance examiners, information technology (IT), examiners,
accountants, capital markets examiners, and Washington-based
quantitative specialists that were well versed in the emerging
Basel requirements.
Throughout my career, I have worked closely and effectively
with my counterparts from the FDIC, the Office of the
Comptroller of the Currency, the Federal Reserve, and State
regulators.
It should be noted that, with few exceptions, OTS examiners
do not work exclusively examining a single savings institution,
but are generally involved in a number of different
institutions over the course of a year. Examinations of small
banks, as you might guess, take considerably less examination
resources than large institutions like WaMu.
From 1999 through 2002, I was what you would call the loan
portfolio manager. On the annual WaMu examinations, the loan
portfolio manager (LPM) was responsible for overseeing the
asset quality or the A component of the CAMELS. In this role, I
implemented a statistical sampling process for our review of
WaMu's homogeneous loan portfolios, which included the home
loan portfolio, and I oversaw the more judgmental sampling and
loan review activities for other types of loans in multiple
geographic locations.
From 2003 through 2006, I was the dedicated examiner-in-
charge (EIC) for WaMu. And as EIC, I was responsible for exam
scoping and planning prior to our examinations or field visits.
I was responsible for overseeing the work of all examiners in
managing communication of findings during the exam process and
then preparing the examination report and leading what we call
exit meetings with both management and the board of directors
after the end of an examination.
Of course, I performed these responsibilities under the
guidance and oversight of my superiors both within the region
and within Washington, DC, as well as with the support of
numerous senior examiners and specialists.
Late in my tenure as EIC, I worked to develop our
continuous examination process, which we tailored after the
large bank supervision programs of the OCC and the Federal
Reserve.
As EIC at WaMu, I supervised an experienced team of
examiners and supervisory professionals that thoroughly
analyzed the issues and challenges concerning this very large
financial institution. I worked closely with region and
Washington office staff to resolve complex policy issues as
they arose. Our role during the examination was to identify
risks and regulatory issues, discuss those risks and issues up
through the agency's senior management, and then require
appropriate corrective actions by WaMu management to address
those risks and issues in a manner that promoted the safe and
sound operation of the institution.
Two years after I ended my term as EIC at WaMu, the
institution failed. I should note that I have no special
personal insight into the final days of WaMu, but I would be
pleased to share with the Subcommittee my observations and
experience gained from my 23 years of regulating savings
institutions, and answer any of your questions.
Senator Levin. Thank you very much, Mr. Carter.
Mr. Reich, let me start with you. In your opening
statement,\1\ at the top of page 9 you wrote that stated
income, low-document, and no-document loans were anathema to
you. You said it was anathema because of your experience as a
former banker. You were concerned about those types of loans
for some time. You then came to OTS. Your examiner on the
ground said that stated income loans was a flawed product. Your
staff in Washington, DC, said that NINA loans--that is where
there is no income and no asset figures given--were imprudent.
You had the authority as Director of OTS to do something about
it, but you did not. So what stopped you?
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Reich appears in the Appendix on
page 134.
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Mr. Reich. Most of what you said is absolutely correct. I
do not recall, though, hearing from my examiner on the ground
saying it was a flawed product.
Senator Levin. Well, you believed it was a flawed product
yourself.
Mr. Reich. I did, and I questioned it at the outset, and--
--
Senator Levin. You were the Director, weren't you?
Mr. Reich. I was the Director.
Senator Levin. So why not change it?
Mr. Reich. From the outset, the argument against making any
sort of immediate change was that this was a product that had
been in existence on the West Coast of the United States for
more than 20 years, dating back to the 1980s, and that the
institutions which offered this product had minimal to no loss
experience with it. It was also a common product that was
used----
Senator Levin. Are you referring to stated income loans or
Option ARMs when you just said that?
Mr. Reich. Both stated income and option instruments.
Senator Levin. All right. It was your experience that these
were flawed products.
Mr. Reich. I would not necessarily call it a flawed
product, but it was a product that I was uncomfortable with,
and I was influenced by the fact that the product had been in
existence for more than 20 years with positive experience in
West Coast institutions.
Senator Levin. It was anathema to you.
Mr. Reich. It was. It was foreign to me.
Senator Levin. No, it was anathema, not foreign.
Mr. Reich. I grew up in an era where the fundamental
principles of credit administration were character, collateral,
capacity, and conditions.
Senator Levin. You used the word ``anathema'' in your
statement.
Mr. Reich. I did.
Senator Levin. You have this procedure here, you have this
approach which is anathema to you, one of a number of things
which were anathema to you, but they are still in existence.
Did you, as head of the agency, not just say we are going to
change this?
Mr. Reich. I could have said that.
Senator Levin. Why didn't you say it?
Mr. Reich. I chose not to because of the experience of
institutions over the preceding 20 to 25 years.
Senator Levin. And you regret it?
Mr. Reich. In hindsight, I regret it.
Senator Levin. Not in hindsight. In foresight you believed
it was wrong. Coming in you believed it was----
Mr. Reich. We are at a point of hindsight today, and I
regret it.
Senator Levin. What kind of efforts did you make to change
these practices? Did you issue a temporary new guidance and let
people comment on it?
Mr. Reich. No, I did not. As I said, I was influenced by
the fact that there were 20 years of experience, of positive
experience with these instruments.
Senator Levin. So Washington Mutual then is originating
hundreds of billions of dollars in these adjustable-rate
mortgages. OTS allows them to engage in a set of high-risk
lending practices in connection with the loans. You have low
teaser loans, as low as 1 percent for 1 month, to entice
borrowers. They were qualifying borrowers with lower loan
payments than they might have to pay if the loan were recast.
You are allowing borrowers to make minimum payments, which is
in the vast majority of the cases resulting in negatively
amortizing loans, and on and on.
Then your people in the field make these kind of findings,
and these are Exhibits 1c, 1d, and 1e.\1\ Were you here when I
read these findings in the field?
---------------------------------------------------------------------------
\1\ See Exhibit Nos. 1c, 1d, and 1e, which appear in the Appendix
on pages 199, 200, and 202.
---------------------------------------------------------------------------
Mr. Reich. I was not.
Senator Levin. All right. Well, let me read them to you. I
am going to again read the somewhat longer context that these
are from, Exhibits 1d and 1e.
In Exhibit 1d,\2\ ``2004 Underwriting of these SFR loans
remains less than satisfactory.''
---------------------------------------------------------------------------
\2\ See Exhibit No. 1d, which appears in the Appendix on page 200.
---------------------------------------------------------------------------
``The level of SFR underwriting exceptions in our samples
has been an ongoing examination issue''--that means OTS was
unhappy with them--``for several years and one that management
has found difficult to address. . . .''
Next, still 2004, this is what your folks found:
``[Residential Quality Assurance]'s review of 2003 originations
disclosed critical error rates as high as 57 percent of certain
loan samples. . . .''
In 2005, ``SFR [Single Family Residential] Loan
Underwriting . . . has been an area of concern for several
exams.'' That means several years.
``[Securitizations] prior to 2003 have horrible
performance.''
Continuing reading down under 2005, ``. . . concerns
regarding the number of underwriting exceptions and with issues
that evidence lack of compliance with bank policy.''
Next, still 2005, ``[W]e 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. Our concerns are increased when the risk
profile of the portfolio is considered''--and it was risky--
``including concentrations in Option ARM loans to higher-risk
borrowers, in low and limited documentation loans, and loans
with subprime or higher-risk characteristics.''
In 2006, the next page, ``[U]nderwriting errors continue to
require management's attention.''
``Overall, we concluded that the number and severity of
underwriting errors noted remain at higher than acceptable
levels.''
In 2007, ``Underwriting policies, procedures, and practices
were in need of improvement, particularly with respect to
stated income lending.''
Your people are finding all this stuff. ``Based on our
review of 75 subprime loans originated by [Long Beach], we
concluded that subprime underwriting practices remain less than
satisfactory.'' How is that for an understatement? ``Given that
this is a repeat concern . . . we informed management that
underwriting must be promptly corrected''--``promptly
corrected''--``or heightened supervisory action would be
taken.'' No, it would not. Year after year after year, it was
not taken. Why should they believe it was going to be taken
now?
In 2008, ``High [Single Family Residential] losses due in
part to downturn in real estate market but exacerbated by:
geographic concentrations, risk layering, liberal underwriting
policy, poor underwriting.'' That is 2008, July.
Then in Exhibit 1e,\1\ 2006, ``Within [Enterprise Risk
Management], fraud risk management at the enterprise level is
in the early stage of development.'' Heck, they are just
beginning to manage the fraud risk in 2006.
---------------------------------------------------------------------------
\1\ See Exhibit No. 1e, which appears in the Appendix on page 202.
---------------------------------------------------------------------------
In 2007, ``Risk management practices in the . . . Home
Loans Group during most of the review period were inadequate. .
. . We believe that there were sufficient negative credit
trends that should have elicited more aggressive action by
management''--how about more aggressive management by your . .
. agency?
``In particular, as previously noted, the risk
misrepresentation''--here you go. Now you are talking fraud.
``. . . the risk misrepresentation in stated income loans has
been generally reported for some time.'' For some time it has
been going on.
On and on, year after year. So what do you do about it?
What does OTS do about it? Not one single formal enforcement
action against WaMu from 2004 until 2008.
Mr. Reich. That is not correct, Mr. Chairman.
Senator Levin. Until the end of 2008, it is correct.
Mr. Reich. There was a formal enforcement action for BSA
and flood insurance violations that led to--which was a formal
action and included----
Senator Levin. That is an overcharge for flood insurance.
That is not what we are talking about.
Mr. Reich. Civil money penalties.
Senator Levin. That is not what we are talking about.
Mr. Reich. But it also included BSA and anti-money-
laundering violations.
Senator Levin. That is a money-laundering violation. We are
talking about what they were doing in terms of the underwriting
practices, the credit practices here, the mortgages they were
issuing. No board resolutions required, no Memorandums of
Understanding required, no fines. So the bank--I forgot what
the number was. It came out. I think Senator Coburn used a
number as to how many warnings, how many findings, how many
deficiencies, year after year after year.
Mr. Reich. I think he cited a number in excess of 500
items.
Senator Levin. Yes. Now, is that apparently normal for OTS?
Mr. Reich. Is what normal?
Senator Levin. What I just described. You go year after
year after year of these kind of findings, and you do not have
any formal action taken. All you do is say we have told them
they ought to do better, we have told them they ought to do
better, they say they will do better. And they do not.
Mr. Reich. My response to that, Mr. Chairman is that----
Senator Levin. You are the cop on the beat or supposed to
be. Not a ticket, not a fine for this? How many years would it
have taken if they did not go under before you would have
acted? Is this acceptable to you?
Mr. Reich. Washington Mutual was a 2-rated institution
until early 2008.
Senator Levin. Well, it took you long enough----
Mr. Reich. Typically, formal actions are not utilized in
institutions that are 1 and 2----
Senator Levin. Well, that is in your hands. That is your
decision not to give them a formal warning.
Mr. Reich. I think that is the fairly common practice in--
--
Senator Levin. It may be common, but that is OTS'
determination not to take any kind of formal action at all, and
the 2 is your decision.
Mr. Reich. That is true, but----
Senator Levin. And you were reluctant to increase it to a 3
even though the FDIC was pushing you to do it, and when you did
finally--finally--decide in early 2008 to push it from a 2 to a
3, you did not even then do anything publicly. You then
violated your own policy, issuing a Memorandum of Understanding
instead of--you had a board action, which is private, instead
of a Memorandum of Understanding, which is public. Even after
all these years of all these violations, you finally decide in
early 2008 you are going to push them from a 2 to a 3, you then
do not make that public, you do not do what policy indicated
you traditionally do, which is to have a Memorandum of
Understanding, which is a public document. You delay that for
months. Then you apologize in an email, ``I am so sorry,'' you
say, you are so sorry that you have to write him with an email.
You have tried him twice on the phone.
Now, I got to tell you, it is not only feeble enforcement,
it is pitiful enforcement. You want to defend it? Go ahead.
Mr. Reich. I would simply point out that the FDIC had a
resident examiner on premise at Washington Mutual throughout
the entire period of time that you are talking about, and that
there was no ratings disagreement of Washington Mutual being a
2-rated institution until 2008.
Senator Levin. And then there was a disagreement----
Mr. Reich. And then there was.
Senator Levin. You disagreed with them. So for another 6
months after they went pushing you to a 3, but this--did they
make these kind of findings year after year after year, the
FDIC?
That was your agency. Don't try to say the FDIC was sitting
there. Your agency had primary responsibility, not FDIC. As a
matter of fact, you even pushed them away, your people, because
they did not have primary responsibility. You pushed them away.
You did not want them to have a seat at the table. You would
not even give them a desk, by the way. But your people made
these findings, not FDIC. You are the primary regulator, and
you did not want FDIC to be meddling around in your backyard.
Now, let us go back to your agency. Year after year you
make these findings. Is that in your judgment adequate
regulation?
Mr. Reich. Well, those are all items that are taken from
examination reports, and they are sort of taken out of context.
Senator Levin. No, they are not. I read the context. I gave
you the context on these.
Mr. Reich. I believe the 2006 examination report states in
the cover letter that risk management practices and internal
control environment continue to improve in 2005.
Senator Levin. Well, I read you 2006.
Mr. Reich. Right.
Senator Levin. OK. So it said it had not. They remain.
Mr. Reich. The 2007 general comments for the year 2006 and
through the first quarter of 2007 indicated that there were
continuing credit challenges, that operating results improved,
that there had been a cease-and-desist order with BSA, AML, an
increase----
Senator Levin. That was the money-laundering issue.
Mr. Reich. That is correct.
Senator Levin. Yes. I would not cite that in defense of
your feeble enforcement, that there is a money-laundering
order. But, at any rate, let us talk about what they were doing
there with mortgages.
Mr. Reich. It also said that asset quality was satisfactory
and trends were negative.
Senator Levin. Are you using that as a defense?
Mr. Reich. I am not using it as a defense. I am simply
pointing out that the examination results in sum indicated that
the institution still deserved for the years up until 2008 the
2 rating that it was given by the OTS, and that was agreed to
by the FDIC.
Senator Levin. And then the FDIC in February 2008, they
finally persuade you, and they made an effort, by the way, for
some time to persuade you to go to a 3, but nonetheless,
finally in February 2008 you have a 3 rating. What happened?
Why, then, is there not the usual traditional Memorandum of
Understanding, so called, made public? Why is it then?
Mr. Reich. I don't know, to tell you the truth. I do not
know why it took so long to implement the MOU.
Senator Levin. Why don't you know? This is a huge issue.
You knew you were coming here. Why don't you know that? I mean,
you used that as an excuse for no formal enforcement action,
that they were a 2 instead of a 3. Then you come in front of us
and you say, well, you don't know why it took so long when you
finally decided to move them to a 3 to have a Memorandum of
Understanding which is public for failure for another, what, 7
months, from February, and you don't know why?
Mr. Reich. Well, I knew that there was----
Senator Levin. You should know why.
Mr. Reich [continuing]. A great deal of back and forth
between----
Senator Levin. Not with FDIC. They were pushing you hard to
go to a 3. So who is the back and forth with?
Mr. Reich. I think the back and forth is between the OTS,
the FDIC, and perhaps regional management on the West Coast. I
am not certain.
Senator Levin. It wasn't with FDIC. They were pushing you
hard. Are you at all embarrassed by this?
Mr. Reich. I am.
Senator Levin. You ought to be.
Mr. Reich. I am, by nature, Mr. Chairman, a humble person.
I am a casual person and an informal person, and it is not at
all unusual for me to address the people who run the
institutions that I supervised, was responsible for
supervising, by their first name, if I know them, particularly
if I am 10 years older than they are.
Senator Levin. The apologetic nature of that email
doesn't----
Mr. Reich. I am not disturbed. I make no apologies----
Senator Levin. It doesn't come through to you at all?
Mr. Reich. I make no apology for that email whatsoever.
Senator Levin. Do you make any apology for the 6-month
delay in making public their rating?
Mr. Reich. No, I don't know if apology is the right word,
but I regret that there was a 6-month delay.
Senator Levin. And you don't know why?
Mr. Reich. I don't recall now. It has been 2 years, and I
can't remember yesterday, let alone 2 years. But I regret that
it took so long.
Senator Levin. This was not some ordinary institution, by
the way. As you know, it is the largest institution that has
ever been taken over by FDIC, bank or thrift. So this is not
something which is sort of asking you to kind of look back at
some institution which was some small institution you can't
remember. This was the biggest bank failure in history.
Mr. Reich. That is true.
Senator Levin. So when you tell us you can't remember why
it is that at a critical time you can not remember why it is--
--
Mr. Reich. I was not personally involved in the negotiation
of the components of the MOU and I do not know, I do not
recall, don't think I ever knew exactly the reasons for the
length of time that it took.
Senator Levin. Well, Mr. Dochow, maybe you can tell us. Why
did it take so long?
Mr. Dochow. Mr. Chairman, my recollection is that the
interim downgrade to a 3 from a 2 was done on an interim basis.
This was before the examination results were completed. This
was before the examination findings had been written. This was
a proactive move, quite frankly, to move this institution from
a 2 to a 3 based on what we were seeing. And as a result----
Senator Levin. The FDIC wanted to do it a lot earlier than
you did, right?
Mr. Dochow. I don't have that recollection.
Senator Levin. You don't?
Mr. Dochow. My recollection is that any differences we had
were in late 2008, mid-2008, over a rating between a 3 or a 4,
not to a 3. I think there was general concurrence, based on my
recollection. And that was an interim move. That was a
proactive move to do it before the examination had concluded,
and a Board Resolution was required. Now, you can argue that
the Board Resolution may have been stronger, but remember, this
examination was ongoing. The examiners are still developing
facts and we were working towards an enforcement action.
Senator Levin. Well, then how do you--I will have to go
back to Mr. Reich, his own memo here in July. This is July.
``I've been wrestling with the issue of a MOU versus a Board
Resolution as a result of our conversation in my office. I have
decided that a MOU is the right approach for OTS to do in this
situation. We almost always do a 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.'' You
betcha. July 3. It wasn't until, when, September, that the MOU
was finally made public. So there is another--July, August,
September--another couple of months.
But, Mr. Reich, this is your memo, this is your email to
Kerry. You would like to be able to say a Board Resolution is
the appropriate--it is so apologetic, and you don't even see
that. And then he says, ``[T]he investment community . . .
would probably only be surprised to learn that one didn't
already exist.''
Now, you can say whatever you want, Mr. Dochow, about this
was something in progress, this was interim. There was a
decision that was made in February, was that not true? Wasn't
there a decision made in February to move them from a 2 to a 3?
Mr. Dochow. Yes.
Senator Levin. OK.
Mr. Dochow. Mr. Chairman, my recollection may not be
precise here. It has been quite some time, and I have had some
limitations on access to documents. But I believe the OTS
policy at that point in time did not require the initiation of
a MOU. But instead, at that point in time, the OTS policy was
consideration of a Board Resolution or a MOU, and that the
policy requiring a MOU came in place after that time period.
Senator Levin. Well, I am just reading the memo from Mr.
Reich here to Mr. Killinger. ``Kerry, we almost always do a MOU
for 3-rated institutions, and if someone were looking over our
shoulders,'' which I sure as hell wish there were, ``they would
probably be surprised we don't already have one in place.'' I
mean, that is your email, so pretty good evidence
contemporaneously.
Senator Kaufman.
Senator Kaufman. Thank you. I would like to go through some
of this. Mr. Reich, what is a stated income loan?
Mr. Reich. It is a loan where the borrower states his
income. But there is actually a little bit more documentation
behind stated income, low documentation, and no documentation
loans than is obvious. Those are catch-all terms. But it is my
understanding that there is a little more documentation than
the popular conception.
Senator Kaufman. We had a panel the other day and I asked
each of them and they said stated income loans are loans where
the only income is the stated income----
Mr. Reich. I think that in many cases, there is background
checking of reasonableness for the amount of income reported,
depending upon the person's occupation.
Senator Kaufman. Is that your testimony, is that there was
background checking on stated income loans beyond----
Mr. Reich. That is what I have been told.
Senator Kaufman. Yes. And that is----
Mr. Reich. Now, I am not saying that was the case in every
stated income loan----
Senator Kaufman. Right.
Mr. Reich [continuing]. But that there were some procedures
which existed----
Senator Kaufman. Right.
Mr. Reich [continuing]. By institutions that made stated
income types of loans that relied upon other types of reporting
agencies to sort of verify the reasonableness of income for
certain types of occupations.
Senator Kaufman. Right. Mr. Dochow, has that been your
experience with stated income loans?
Mr. Dochow. Actually, I think Mr. Reich is very accurate
here. Stated income loans tend to refer to programs for stated
income.
Senator Kaufman. Right.
Mr. Dochow. They were originally designed for self-employed
high-income individuals.
Senator Kaufman. Right.
Mr. Dochow. They migrated over the years and they were
offered inappropriately to some customers.
Senator Kaufman. OK.
Mr. Dochow. But when an institution makes a stated income
loan in their program, they should be getting, and the
expectation is they are checking FICO scores----
Senator Kaufman. Right.
Mr. Dochow [continuing]. They are checking appraisals and--
--
Senator Kaufman. Right.
Mr. Dochow [continuing]. They are doing a reasonableness
test on that stated income.
Senator Kaufman. Right.
Mr. Dochow. So they have outside data sources for doing
that.
Senator Kaufman. Right.
Mr. Dochow. And that is what the examination process
referred to. So there are additional checks. It is not a
customer walking in and saying, ``I make $100,000. Give me the
loan.'' That is just not the way it is done.
Senator Kaufman. You are not saying that is the way it is
done. You are saying that is the way it is not supposed to be
done?
Mr. Dochow. That is not supposed to be done that way.
Senator Kaufman. Exactly. And why did they even start a
stated income? Why would you even have stated income loans? I
mean, if I were to borrow money, I fill out this whole
incredible form about where is my bank account, how much is in
it, and how much I make, and have to provide documentation of
what I make. It is the one thing that I think everybody in
America knows, when you go into a loan, you have got to verify
to the person that is making the loan what your income is.
Mr. Dochow. And I do the same thing, Senator----
Senator Kaufman. Right.
Mr. Dochow [continuing]. And I think that is the
appropriate way--but I think we also need to keep in mind, the
way it has been explained to me is that stated income
originally was for high-income individuals who had income that
was hard to document through a W-2.
Senator Kaufman. Right.
Mr. Dochow. Now, what happened was, over the years, it
became commoditized----
Senator Kaufman. Exactly.
Mr. Dochow [continuing]. And the GSEs started accepting the
programs.
Senator Kaufman. Yes.
Mr. Dochow. And even their automated underwriting, Desktop
Underwriter or Loan Prospector, started accepting more liberal
terms.
Senator Kaufman. Exactly.
Mr. Dochow. And so it became the situation where the
documentation kept in the file, quite frankly, sometimes was
purged.
Senator Kaufman. Yes.
Mr. Dochow. As you heard earlier today.
Senator Kaufman. Yes.
Mr. Dochow. Now, it was purged not because it wasn't
considered.
Senator Kaufman. Right.
Mr. Dochow. It was purged because the stated income loan
had to operate under a given program.
Senator Kaufman. Right.
Mr. Dochow. In order to qualify for the program, you
couldn't have that information in the file. So I think there--
--
Senator Kaufman. How would you have a program, you said you
can't have the W-2 form in there?
Mr. Dochow. Because that is my understanding, the way it
has been explained to me is that is the way the GSEs and the
secondary market accepted those programs.
Senator Kaufman. No, I can understand why they accepted the
program. They will accept anything. They were trying to get as
many mortgages as they could and get mortgage-backed securities
and make it all work. I am just saying, why would the OTS
accept that?
Mr. Dochow. I can tell you that it was standard practice
that those loans were made, and that to the extent they were
sold into the secondary market without recourse, or even with
recourse--we focused on the recourse, quite frankly.
Senator Kaufman. Sure. You didn't focus on the riskiness of
the loans?
Mr. Dochow. We focused on the riskiness to the bank in
terms of what it may have to repurchase.
Senator Kaufman. In other words, if some bank just said,
look, we are not going to use any of this program, we are just
taking money in, you wouldn't look at that as something to
consider in your oversight regulating an institution?
Mr. Dochow. No. I maybe have misunderstood the question.
Senator Kaufman. Sure.
Mr. Dochow. We obviously are concerned with an
institution's ability to prove the ability of the customer to
repay the loan, and that is why the agencies on an inter-agency
basis issued the Non-Traditional Mortgage Guidance and the
Subprime Guidance, to make sure that you documented the
customer's ability to repay.
Senator Kaufman. Right. Mr. Reich, I assume you agree with
what Mr. Dochow was saying?
Mr. Reich. I do.
Senator Kaufman. So it started out 20 years ago as a
program for high-wealth people. I was going to go on, but I
have to stop on that. It seems to me a high-wealth person is
the easiest person to show you what they have got. And
obviously, they are going to be the ones with the biggest
mortgages. It made more sense the other day. They were saying
it started with people who are self-employed. What would you
say a high-income person would be?
Mr. Dochow. Well, Senator, what I meant, when I said high-
income, I was including self-employed----
Senator Kaufman. No, I meant, what is a high-income person?
Mr. Dochow. It would vary upon the type of loan they were
getting----
Senator Kaufman. No, I mean, what would you consider? If
you were putting together a program and you started and you
said, look, we are starting a program and we are going to have
high-income people----
Mr. Dochow. High six-figure incomes.
Senator Kaufman. High six-figure. I cannot believe that
anyone with a high six-figure income comes in for a loan and
doesn't give you documentation on what they are making, at
least a portion of what they are making. To have no stated
income, that is hard to believe.
So it started out. It was one of those things you used in
special cases. I think, Mr. Reich, that is what you said. It is
a special case. We are going to use it with high-income people.
The people the other day said we are going to start out using
it with folks who are self-employed. So that is a good program,
and it is working for 20 years, as Mr. Reich says.
What happens when you find out that 90 percent of all
WaMu's home equity loans are stated income, and you find out
that 73 percent of all Option ARMs are stated income, and 50
percent of your subprime loans are stated income? I mean,
wouldn't you stop at that point and say, what is going on here?
Mr. Reich.
Mr. Reich. I didn't know those percentages until I heard
you say them today.
Senator Kaufman. Let me just make sure I get this in
context. WaMu was one of the big thrifts that you were
supervising?
Mr. Reich. That is correct.
Senator Kaufman. In fact, they were the biggest, right?
Mr. Reich. That is correct.
Senator Kaufman. And they had, I think at one point, of the
thrifts you were supervising, 25 percent of all the assets
under supervision were WaMu assets?
Mr. Reich. Approximately.
Senator Kaufman. Do you think it is hard for me to believe
that you didn't know that 90 percent of all the home equity
loans they were doing were stated income?
Mr. Reich. I don't know if it is hard for you to believe or
not, but I did not personally keep track of the composition of
each segment of their portfolio. I was focused on asset quality
overall and not within each component of the portfolio.
Senator Kaufman. Mr. Dochow.
Mr. Dochow. The percentages are alarming.
Senator Kaufman. Yes.
Mr. Dochow. But I also think it is fair to keep in
perspective different products.
Senator Kaufman. I am trying to keep this in perspective. I
really am.
Mr. Dochow. Let us take the home equity loans.
Senator Kaufman. Sure.
Mr. Dochow. If you and I went into a bank and wanted a home
equity line of credit, those become automated approval
processes----
Senator Kaufman. Right.
Mr. Dochow [continuing]. Much like a credit card.
Senator Kaufman. Sure.
Mr. Dochow. You fill out your paperwork, you put down what
your income is----
Senator Kaufman. Right.
Mr. Dochow [continuing]. And the bank pulls your FICO
scores, your credit reports, the loan gets approved or
disapproved. Those programs lend themselves more to that type
of underwriting.
Senator Kaufman. Right.
Mr. Dochow. They are smaller in dollars. They are large in
volumes. And the credit score, their credit reports, their
loan-to-value ratios were historically the most predictive of
ability to pay and those loans' performance.
Senator Kaufman. So why not just ask people what their
income was and have some verification for it? That is the part
I am having trouble with. I got all the rest of it.
I mean, we could poll everybody in this room. I don't think
anyone has ever gone in, outside of maybe if they were with
WaMu or some of the other banks in California which did
practice this, Mr. Reich, or this business as WaMu--I don't
think anybody in this room has ever gone into a loan and they
said, what is your income, and they said, OK, that is enough. I
am going to check your FICO score and everything else, but you
don't have to document where your income is coming from. You
don't have to give me a W-2 form. You don't have to do anything
else. I have credit cards, I have never seen that as an
experience for me.
And again, I realize it started in this industry, and I
think maybe it started for a good reason. And as Mr. Reich
said, I think everyone would say this is an anathema. A stated
loan is anathema. I think that is what most people would say. I
think the two regulators who were here earlier kind of went,
wow. When the folks from the two risk managers that testified
the other day were concerned about this and reported their
concern to management.
So I am trying to figure out--because every time something
like this has come down over history, the standard answer you
hear--well, everybody did it. Everybody did it. And when you
hear that, that is when I get very scared because what are we
going to do here in the Senate so that we deal with a concept
that everybody did it is--we are a Nation of laws, not a Nation
of everybody did it.
Mr. Reich and Mr. Dochow, would you like to comment on my
concern?
Mr. Reich. I think stated income loans have since been
ruled unsatisfactory--I am not entirely certain of that, but I
believe that the regulators have since eliminated stated income
loans as a category of loans in the future.
Senator Kaufman. So that is what really concerns me. Do you
get the point I am trying to make? Here is a policy that
everyone agrees was a very bad policy. Here is a policy that
was so widespread that 90 percent of the home equity loans fall
in this policy, a policy that you said was anathema, a policy
that even Mr. Dochow, with all due respect, other concerns,
most people say was bad. I am not talking about people in this
room, I am talking about regulators, people in WaMu. Every time
I have read it, everything I read about stated income, from
experts, folks like you, they say, this is not a good program.
This is not a good idea.
And you allow a situation to develop where 90 percent of
the home equity loans, 73 percent of the Option ARMs--I keep
saying these numbers over again because I hope they are going
to change--50 percent of the subprime loans are stated income
loans. And once it comes to light, everyone says we have to
stop this.
Mr. Dochow, with all due respect to your explanation of how
this is a loan and could make some sense, everybody said, Whoa,
this has got to stop.
And so, Mr. Reich, my point is, when you are sitting up
here, you are trying to figure out, how do we stop this--what
is the next stated income loan? Do you see what I am saying?
What is the next program where people will say, well, everybody
did credit default swaps. Everybody did XYZ. Everybody took
$500 out of the till every Thursday before they went home. Do
you see my concern here?
Mr. Reich. I understand your frustration.
Senator Kaufman. Thank you. Mr. Dochow.
Mr. Dochow. I think you make an excellent point, Senator.
Let me add a little, if you will, flesh to some of your
comments----
Senator Kaufman. Sure.
Mr. Dochow [continuing]. Because I think they are
absolutely on point. We saw when credit cards first came out,
as an industry, that the modeling worked great for a few years,
then failed miserably.
Senator Kaufman. Yes.
Mr. Dochow. We saw it with Basel II, the capital analysis
that it said these mortgages needed very little capital. There
is very little risk. Everybody was overcapitalized.
And so what we find is that the financial system, to the
extent it is free market, it develops products for the short-
term.
Senator Kaufman. Yes.
Mr. Dochow. And that is very difficult because you have
that balancing act between having a free market, capitalistic
system and a safe and sound system. And to have someone just
simply rule, this product is good, this product is bad, has
some consequences. So it is a very difficult dilemma and----
Senator Kaufman. Yes, and frankly, I am concerned, because
I don't want to see over-regulation, and I know you don't,
either. But when you have situations like this, like you say,
it was a systemic problem, and it was a systemic problem right
to the top, we are going to just self-regulate the markets, we
don't need any regulation, it was pretty widespread.
Let me ask you, though, at some point, Mr. Thorson said
earlier that this is like the fact that these numbers, which I
will not read again, there were so many of these types of
loans, and as the Chairman said, even have specific cases where
people went in and redacted the W-2, at some point, doesn't
this begin to look like fraud on somebody's part?
Mr. Dochow. I will comment, Senator, if I may.
Senator Kaufman. Sure.
Mr. Dochow. Actually, I think it raises a different issue--
--
Senator Kaufman. OK.
Mr. Dochow [continuing]. In addition to the potential
fraud. It raises the issue of income and incentives. And what I
mean by that is stated income programs generally gave the
lending institutions a higher margin.
Senator Kaufman. Right.
Mr. Dochow. And even though the customer provided the
income, even though the bank may have considered the income
and----
Senator Kaufman. Right.
Mr. Dochow [continuing]. Looked at those W-2s, when they
were redacted from the file, the bank was then entitled to the
higher income.
Senator Kaufman. Right.
Mr. Dochow. Now, the customer may have come in and applied
for the stated income program and requested it and the bank had
income information, but the bank--I think the issue it raised
in my mind when I heard that earlier was--what is the incentive
here?
Senator Kaufman. Right.
Mr. Dochow. Is the customer being given a higher-costing
product than they should have been given?
Senator Kaufman. Yes. And here is my concern. I was at a
hearing yesterday on Afghanistan and the national police and
the problem that we spent $8 billion and we have nothing to
show for it, and there is a way to deal with this at such a
high level that we get away from what actually happened. Oh,
yes, it was because of Basel. It was because of the national
leadership in this country saying we should have a free market
and we didn't need any regulation.
And we have now learned that is not a problem, that was a
real problem. Alan Greenspan, as one of the parents of this,
said this is a problem. It causes me dismay that we failed. We
found out that the stated income loan doesn't work. But this is
at a very cold-blooded level.
In the end, it took some people down in the trenches--and
we know that the Wall Street people were coming and encouraged
people to give mortgages. We can get these mortgage-backed
securities and we know we can move them down the line and they
lead, like the Chairman said, toxic waste flowing down the
river away from us.
And in that kind of environment, everybody--and we have a
compensation program, as you said, which is just saying to
people, you got a lot more compensation the more risky the
events got. So this is all happening.
But in the end, somebody has to say, I am going to break
the law. I am going to commit fraud. I am going to do
something. When you have 90 percent stated income loans--by the
way, it is from the top of the firm right on down. Everybody
has got to know what is going on. These are not dumb people.
And that is kind of what my concern is. OK, I understand
it. It was a bad environment. They weren't getting good
guidance from their national leadership. I understand that they
were doing techniques that had been used, as Mr. Reich says,
for 20 years and were OK. I know my compensation is way up.
Everybody's compensation is up, the more of these things we do.
And I know Wall Street was singing their siren song about
mortgage-backed securities and we can all make a lot of money.
As Mr. Thorson said, this is a target-rich environment. It
took some people in the building to basically say, I am going
to take the money. I am going to put in stated loans. I mean,
there are cases where everybody involved, every loan, they go
to someplace and just tell me what you want, fill out the
forms, we are off and running, right? I mean, this is an
environment.
As a regulator, I mean, if you were regulating this now and
you knew about this thing, isn't this time to send some notices
to the Justice Department about referrals?
Mr. Reich. If we see evidences of fraud, we should refer it
to the Justice Department.
Senator Kaufman. All right. Mr. Dochow.
Mr. Dochow. In fact, Senator, one of the things I have been
known to do is to require institutions themselves to make the
criminal referrals, also.
Senator Kaufman. Right. That would be the best. But the
problem is, when you have it, like you said, systemically,
where people are--Mr. Reich, you didn't know about this 90
percent, 73, and 50 percent, and hindsight is 20/20, but not
taking hindsight, just saying today, if you knew when you were
there that 90 percent--these numbers, wouldn't you at least
look into the fact that there might be fraud being created?
Mr. Reich. I might have, had I known those numbers at that
point in time.
Senator Kaufman. Yes. Mr. Dochow.
Mr. Dochow. The answer is yes.
Senator Kaufman. Mr. Carter, you have been sitting here
very patiently through the whole thing. What do you think?
Mr. Carter. We knew there was a greater propensity for
fraud in stated income loans. From an examination standpoint,
we would look at the fraud risk management practices of the
institution from the top down.
Senator Kaufman. And if you saw this going on, you were
aware of these numbers, you would have at least asked them to
make a referral to the Justice Department? If not, you would
have referred it yourself?
Mr. Carter. Any time we saw any evidence of anything
criminal, we would require the institution to file a Suspicious
Activity Report.
Senator Kaufman. And is it fair to say that since, at least
Mr. Reich and Mr. Dochow--by the way, were you aware of these
numbers, 90 percent, 73 percent, and 50 percent?
Mr. Carter. I don't recall those numbers offhand.
Senator Kaufman. So we are saying no one was aware of the
numbers. But what we are saying is if you did know the numbers,
you would at least in the first instance begin to look into--I
read, Mr. Carter, you would have looked into it? I mean, the
target-rich environment is not a bad phrase to use when you
have 90 percent of your loans being stated income, is that fair
to say?
Mr. Carter. We elevated our review of fraud risk management
practices as the market began to heat up----
Senator Kaufman. Yes, but I mean, back in the beginning,
and this is what scares me. We start using things like fraud,
examination, whatever you just said, and it all sounds so nice
and cold-blooded, but when you look down at this thing, as you
say, and you look at this and you say, there is somebody
committing fraud down here, and it isn't just some clerk down
at the bottom doing this. They are doing something that Mr.
Reich has qualified as an anathema, that everyone considers as
poor banking policy, and they are doing it within 90 percent of
their prime loans and 53 percent of their--somebody down there
is doing something.
And so it doesn't matter whether you are making money or
not, to go back to the Chairman's point. This institution is
making money or isn't making money. You still look at this
thing and say, what is going on here? And if you knew that, I
think all three of you agree, you would look into it, and I
suggest that if you looked into it based on what others have
said, you would have found that this just wasn't happening.
This was not a coincidence. That is the only point I want to
make. Am I making a fair statement, Mr. Reich?
Mr. Reich. In my opinion, our examiners on the ground were
testing asset quality throughout all of their portfolios and
they did that consistently, year after year after year.
Senator Kaufman. Right.
Mr. Reich. And the institution continued to be 2-rated,
which is----
Senator Kaufman. But, I mean, because you didn't have it
and you didn't know--you now know that all these stated loan
things were out there. Don't you have to, now that you know,
say that at least you would begin to look into the possibility
that it might be fraud?
Mr. Reich. I would agree with that, Senator Kaufman, but I
think, also, we need to remember what the economic environment,
the competitive environment and----
Senator Kaufman. Sure. I have got it.
Mr. Reich [continuing]. The emphasis on the American dream,
getting people in their homes----
Senator Kaufman. Right.
Mr. Reich [continuing]. And finding financing vehicles that
would enable them to do that.
Senator Kaufman. OK. Thank you. The only point I want to
make is we went through that in Basel II, where all these
things are going on, but in the end, when it comes--that is
what scares me, Mr. Reich. I am getting OK, and then you scare
the hell out of me again because you basically say, well, you
have got to understand the environment. So it is the
environment. Everybody was doing it. You have got to understand
that.
And my basic thing is, if that is what we are, then Senator
Levin and I are on a fool's errand to try to straighten this
out. If every time something gets to be popular and every time
people are making a lot of money--I mean, if people are making
a lot of money, my normal response would be, I ought to look at
that. That is not reassuring to me.
Mr. Reich. Senator, I think lessons have been learned from
what we have been through.
Senator Kaufman. Thank you. Mr. Dochow.
Mr. Dochow. One observation I would offer is I have always
believed that companies such as banks who are insured by the
FDIC and the taxpayer is ultimately on the hook ought to have a
special standard, a special creed of some type, and that their
performance, in part, ought to be measured by that standard to
the customer, to the public interest.
I can tell you, in my career, I have been dismayed at
comments from CEOs and even small community banks who say their
only responsibility was to shareholders.
Senator Kaufman. Right.
Mr. Dochow. I think that gets to the linchpin.
Senator Kaufman. I think that is basically--I am sorry to
have gone so far over, Mr. Chairman.
Senator Levin. No, not at all. I am glad you are doing what
you are doing--it is exactly on target. It is not, though, just
what you have discussed. It is also the cultural environment
inside the regulatory agency. I want to read you a couple more
emails about that cultural environment.
If you take a look at Exhibit 39\1\, right in the middle
there, it says--this is to you, Mr. Dochow. ``We are going to
have the same battle on the complaint memo, although I still
stand by the findings. Since we weren't able to do a separate
evaluation of the process, they will fight it. It doesn't
matter that we are right, what matters is how it is framed. And
all we can do''--listen to this--``is point to the pile of
complaints and say there is a problem.''
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\1\ See Exhibit No. 39, which appears in the Appendix on page 357.
---------------------------------------------------------------------------
That is not all you can do. You can do a lot more than that
if you have the will to do it.
Take a look at Exhibit 34.\2\ This one is really pretty
dramatic stuff. Exhibit 34, this is a time when OTS was looking
at an underwriting recommendation, and they were going to be a
little bit tougher in their recommendation, and they were
talked out of it by the bank. Take a look at page 2. ``OTS
confirmed today that they will re-issue this memo without the
`Criticism.' It will be a `Recommendation.' '' So it starts off
as a criticism, but then OTS is talked into making it less than
a criticism. It is just going to be a recommendation.
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\2\ See Exhibit No. 34, which appears in the Appendix on page 335.
---------------------------------------------------------------------------
And then if you look at the first page of Exhibit 34, you
will see a memo, ``Good news''--this is inside of the bank.
``Good news--John''--and that is Robinson at WaMu--``was able
to get the OTS to see the light''--you guys were really seeing
the light a lot--``and revise the Underwriting rating to a
Recommendation. Our response is already complete.''
And then at the top of this memo from the head of Home
Loans, ``I'll bet you're a happy guy!!! Well done.''
Well, they were too happy too often with OTS backing off
from taking strong action.
And then take a look, if you would, at--and, by the way,
while Senator Kaufman is here, I think that stated income loans
are still not prohibited at all. We just heard that from the
last panel, so I think, Mr. Reich, when you said that you
thought----
Mr. Reich. I thought it had been dealt with in the past
year.
Senator Levin. No, it is not at all dealt with. It is still
a very open issue, and it is the reason why Congress has a
responsibility to put down some bright lines here. We cannot
rely on the regulators. That is obvious from today's hearing,
it seems to me. We should be able to rely a lot more on the
regulators, but we cannot. We have to do some tough stuff----
Senator Kaufman. All the same, Mr. Chairman, good fences
make good neighbors, and I think good regulators work best when
they have bright-line rules on what is OK and what is not OK.
Senator Levin. They can point to them when they come to
telling the folks they are supposed to regulate, Hey, this is
the law, we are going to enforce it.
There is plenty of discretion to do that, which is not used
too often, as we are seeing. But, nonetheless, it will, I
think, help pretty clearly if we have some bright lines.
Then we have to take a look at Exhibit 19.\1\ OTS examiners
knew that Washington Mutual and Long Beach were notorious for
selling bad loans. This gets to the point that Senator Kaufman
was talking about. Just let them go.
---------------------------------------------------------------------------
\1\ See Exhibit No. 19, which appears in the Appendix on page 277
---------------------------------------------------------------------------
Now, Exhibit 19, in 2005 you had an OTS examiner sending an
email to colleagues with this description of the Long Beach
mortgage-backed securities: ``[Securitizations] prior to 2003
have horrible performance. LBMC [Long Beach] finished in the
top 12 worst annualized NCLs [net credit losses] in 1997 and
1999 thru 2003. . . . At 2/05, LBMC [Long Beach] was #1 with a
12% delinquency rate.'' Its delinquency rate was No. 1, and you
folks knew about this.
Now, OTS apparently does not think too much about the
impact of the thrifts that you are supposed to regulate selling
billions of dollars in poor-quality, high-risk, toxic loans in
the financial markets. Apparently, that is not--you do not view
that inside your jurisdiction. But it could be very directly
inside your responsibility because if those loans come back,
that does have an impact on the institutions that you are
supposed to regulate. Would you agree with that, Mr. Dochow?
Mr. Dochow. Yes.
Senator Levin. OTS, on Exhibit 17,\2\ in May 2004 issued a
findings memo on excessive errors in the underwriting process,
concluded that some of the reasons were sales culture focused
heavily on market share via loan production and extremely high
lending volumes. OTS recommended to WaMu that it should
compensate loan processors based on the quality of the loans
that they made. And on page 5, WaMu laid out a set of
corrective actions that it planned to take. But as is happening
regularly, as we have seen, WaMu did not carry out the plan
that it designed. And so next year, Exhibit 27,\3\ OTS asked
WaMu to address ``continuing high levels of errors in loan
origination process.'' That is OTS' words. OTS had to revisit
the problem of paying loan staff for quantity over quality.
Again, it asked WaMu to reward loan processors based on the
quality of the loans that they made.
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\2\ See Exhibit No. 17, which appears in the Appendix on page 269.
\3\ See Exhibit No. 27, which appears in the Appendix on page 311.
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So how about Mr. Carter? Do you know whether OTS was more
successful the second time around in pressuring WaMu to reward
its loan processors for loan quality instead of quantity? Do
you know?
Mr. Carter. I do not recall specifically what progress they
made, but they made steady progress throughout the
examinations.
Senator Levin. They made steady progress on what?
Mr. Carter. In addressing many of our issues.
Senator Levin. Well, what was the issue? We have just gone
through about 20 of them. What was the issue that you think
they made the greatest progress on?
Mr. Carter. The corrective action plans that they would
give us normally would involve changing management, changing
systems, and bringing in new processes.
Senator Levin. But the output, the outcome.
Mr. Carter. The overall outcome of improving single family
underwriting was something they struggled with from exam to
exam.
Senator Levin. And ``struggled with'' being a bureaucratic
euphemism for they did not do much.
Mr. Carter. I do not think I would go as far as to say they
did not do much.
Senator Levin. Well, how far would you go? You say they
struggled with it. In other words, they did not accomplish very
much.
Mr. Carter. They were not fully effective in addressing all
the underwriting issues.
Senator Levin. How about saying, instead of ``not fully
effective,'' use more direct language like ``they were
ineffective?'' I got that not fully effective throughout your
ratings here. They were not fully effective. How about saying
``ineffective?''
Mr. Carter. Ultimately, in reducing the exception rates
down to levels that we thought would be satisfactory, they were
ineffective.
Senator Levin. They were ineffective. OK.
Mr. Carter, take a look at Exhibit 7,\1\ more a cultural
problem. Long Beach, you say in Exhibit 7, ``was working at a
deliberate, reasonable pace.'' That is on page 1. And then in
Exhibit 7, I believe this is where you said the natural
evolution, if I can find those words, would be sufficient.
Well, we will come back to that. I do not have the right number
exhibit in front of me.
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\1\ See Exhibit No. 7, which appears in the Appendix on page 228.
---------------------------------------------------------------------------
Exhibit 7 is right. Take a look in the middle of that.
``Long Beach--natural evolution internally will address a
number of issues.'' Well, it did not. So you wrote on Exhibit
32,\2\ Mr. Carter, in reference to WaMu's request to move Long
Beach Mortgage under the bank, ``[W]e are not comfortable with
current underwriting practices, and you don't want them to
grow''--your words--``significantly without having the
practices cleaned up first.''
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\2\ See Exhibit No. 32, which appears in the Appendix on page 328.
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Six months later, now Exhibit 36,\3\ in response to
findings that Long Beach Mortgage had not improved their
practices. OTS wrote it could not ``simply say [to them that]
`you made a commitment and haven't kept it.' '' Why couldn't
you tell Long Beach, simply, ``You made a commitment and
haven't kept it?'' Why do you say that you cannot do that in
Exhibit 36? Why can't you tell Long Beach, ``Hey, you guys made
a commitment. You haven't kept it?''
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\3\ See Exhibit No. 1i, which appears in the Appendix on page 210.
---------------------------------------------------------------------------
Mr. Carter. Where are you on that page?
Senator Levin. Exhibit 36.
Mr. Carter. Can you point me there?
Senator Levin. It is about eight lines from the top. ``Our
findings are similar in some ways, but I don't think we can
just simply say, `You made a commitment and haven't kept it.' I
think 90 days to get a completely acceptable exception rate may
also be unrealistic. . . .'' Now, mind you, this is a promise
they made 6 months before.
Why can't you simply say to the people you regulated, ``You
made a commitment and haven't kept it?''
Mr. Carter. Some of the difficulty--we were very focused on
taking and looking at samples of loans. Then we were focused on
exception rates and how many of the loans had errors in them.
How we defined ``exception'' rate was not always black and
white.
Senator Levin. Well, you said they haven't kept the
promise. Why don't you just tell them they haven't kept it?
Mr. Carter. I think that we did tell them.
Senator Levin. No, you said you cannot just simply tell
them, ``You made a commitment and haven't kept it.'' Why can't
you say those words? Like ``unacceptable,'' why can't you use
the word ``unacceptable'' in your documents? We were finally
able to get you to say that here today, but your documents--
that is not the way you talk. Why can't you tell someone you
regulate, ``Folks, you made a commitment 6 months ago, and it
was conditioned''--``our determination that you could become
part of WaMu was dependent on you making that commitment. You
haven't kept it?'' Why can't you look people in the eye and
say, ``You made a commitment. You haven't kept it?''
Mr. Carter. I think that overall when you look at single
family underwriting, we told them that.
Senator Levin. You said here you cannot tell----
Mr. Carter. This is not single family underwriting overall.
This is looking at a specific action plan where they had made
promises in the past----
Senator Levin. They had not kept them.
Mr. Carter [continuing]. And we had to judge how much
progress they made on that action plan. They didn't do nothing.
I think that is a double negative, but they had made progress
on the action plan. We had to make a judgment call. Did they
make sufficient progress that we would say it would be
adequate? Did they make so insufficient of progress that we
would say they were totally inadequate?
Senator Levin. It does not have to be ``totally.'' Just
``inadequate.''
Mr. Carter. And I think that what I said here is that we
could not conclude that their progress was wholly inadequate,
because they did make some progress.
Senator Levin. I am not saying ``wholly inadequate.'' Can
you use the words, ``Folks, your progress is inadequate?'' Are
you able to tell them that?
Mr. Carter. For their progress on this specific action
plan, I did not conclude we could tell them that.
Senator Levin. That it was inadequate?
Mr. Carter. That is right.
Senator Levin. You could tell them it was not wholly
adequate.
Mr. Carter. Yes.
Senator Levin. But not inadequate.
Mr. Carter. I do not think I could say it was wholly
inadequate.
Senator Levin. I did not use the word ``wholly.'' You could
tell them it was not wholly adequate, but you could not tell
them it was inadequate. That is what you are telling us.
Mr. Carter. Yes.
Senator Levin. That is the kind of bureaucratic speech
which I think sends the message to people you regulate that,
hey, folks, you are making progress, instead of telling them it
is inadequate, speaking clearly and directly to people that you
have a responsibility to regulate. And I think it goes--
frankly, it is one of the issues that I have seen throughout
these documents, is that kind of not clear statements to people
you regulate. And I will not go over a lot of them because
obviously it is running late, but there are a lot of them
exactly like that.
Now the issues with FDIC and the turf battle that you folks
had. Exhibit 49 \1\, Mr. Dochow, is an email from Mr. Finn to
you. ``The message was crystal clear today. Absolutely no FDIC
participation on any OTS 1 and 2 rated exams.''
---------------------------------------------------------------------------
\1\ See Exhibit No. 49, which appears in the Appendix on page 389.
---------------------------------------------------------------------------
Now, you could have allowed them, could you not, to
participate? It is not a prohibition. It is your discretion as
to whether or not they could participate on an OTS 1 and 2
rated exam. Is that correct that it is not against regulations?
Mr. Dochow. I am not sure I am the right one to be
answering that. My understanding is that----
Senator Levin. Well, who is the right one here? Mr. Reich,
are you the right one?
Mr. Reich. I will be glad to answer the question.
Senator Levin. Is it against your regulations that they
participate, or is it just discretionary?
Mr. Reich. We have an agreement between the agencies as to
when it is appropriate for back-up examinations, and that
agreement applies mainly to 3, 4, and 5 rates institutions and
not 1 and 2 rated institutions.
Senator Levin. Now, there was a 2002 interagency agreement,
was there not, with FDIC?
Mr. Reich. That is correct.
Senator Levin. And there was a protocol.
Mr. Reich. That is right.
Senator Levin. And it permits OTS discretion, does it not,
in allowing FDIC----
Mr. Reich. It does.
Senator Levin. You had the discretion to allow them to do
it?
Mr. Reich. Well, may I expand?
Senator Levin. Oh, sure. Crystal clear, no participation on
any OTS 1 and 2 rates exams. This is 2006.
Mr. Reich. There are reasons for the policy as it exists,
and one of the reasons is that, first of all, the primary
regulator is the primary Federal regulator, and when another
regulator enters the premises, when the FDIC enters the
premises, confusion develops about who is the primary
regulator, who really is calling the shots, who do we report
to, which agency.
Second, there is the statutory authority that Congress has
given the primary Federal regulator. There is the desire to
avoid confusion with the institution. And, thirdly, when the
FDIC enters an institution, if it is known--sometimes they
enter as examiners of the primary Federal regulator or are not
identified as being FDIC examiners; but if it is known that
they are, alarm bells can go off both within the bank and
within the community where the bank is located.
Senator Levin. And you have discretion to allow them to
enter?
Mr. Reich. We do.
Senator Levin. And you did not exercise it. There instead
was a series of emails here showing some real turf battles
going on.
Mr. Reich. This was at the very outset of my entrance at
OTS, and I was--I mean, I have no recollection of----
Senator Levin. Well, maybe Mr. Dochow does. On July 25, if
you will look at Exhibit 45,\1\ this is your feeling about
FDIC, and you wanted to share this MOU we have talked about
with them and why it went to FDIC: ``[B]ecause I committed to
[them] to consider their comments in an effort to minimize
their letter writing and posturing.'' You viewed FDIC as
someone that was doing posturing. Is that accurate?
---------------------------------------------------------------------------
\1\ See Exhibit No. 45, which appears in the Appendix on page 368.
---------------------------------------------------------------------------
Mr. Dochow. I have always believed in sharing full
information with the FDIC. I have always been guided by agency
policy and the interagency protocol. The issue with the MOU was
to make sure we had the full FDIC comments. This is July 2008.
Senator Levin. I know.
Mr. Dochow. This is a time period where the agencies were
struggling to determine if the 3 rating or the 4 rating was the
appropriate rating. And historically, the FDIC had written a
number of memos back in the--I understand in the early 2000s
doing one-sided documentation of issues. And it created----
Senator Levin. One-sided documentation?
Mr. Dochow. One-sided documentation of issues. And so I had
worked very hard to develop a strong relationship with Stan
Ivie, who was the Regional Director at the FDIC.
Senator Levin. Could you explain what is one-sided
documentation?
Mr. Dochow. Ignoring the primary regulator's views and
simply stating speculation or conjecture or their analysis.
Senator Levin. And so you wrote in 2008 to Sheila Bair at
FDIC Exhibit 66?\2\
---------------------------------------------------------------------------
\2\ See Exhibit No. 66, which appears in the Appendix on page 435.
---------------------------------------------------------------------------
Mr. Dochow. Exhibit 66?
Senator Levin. ``Dear Sheila, You really know how to stir
up a colleague's vacation.''
``I do not under any circumstances want to discuss this on
Friday's conference call. . . . I want to have a one on one
meeting with Ben Bernanke prior to any discussion. . . . I may
or may not choose to have a similar meeting with Secretary
Paulson. I should not have to remind you the FDIC has no role
until the PFR [the primary regulator] (i.e., the OTS), rules on
solvency and the PFR utilizes PCA.''
So no role for FDIC. Now, this is a bank. If this bank goes
under, their Insurance Fund is wiped out. They have about one-
third of the money in the Insurance Fund that they would have
to lay out if this bank goes under. But you are telling her,
the head of FDIC, ``I should not have to remind you that FDIC
has no role''--which is not accurate. They have a back-up role
surely to protect their Insurance Fund.
Then Scott Polakoff writes to you that he has ``read the
attached letter from the FDIC regarding supervision of WaMu and
am once again disappointed that the FDIC has confused its role
as insurer with the role of the Primary Federal Regulator,''
that its letter is ``inappropriate and disingenuous.'' \1\
---------------------------------------------------------------------------
\1\ See Exhibit No. 59, which appears in the Appendix on page 419.
---------------------------------------------------------------------------
And now going to July 2008, you have your letter saying
that they are ``posturing.'' That is why you sent the MOU to
them.
So you think they are exceeding their jurisdiction, and you
think they are posturing. Is that fair? That is what your
emails show. At that time you thought they were exceeding their
jurisdiction, they had no role----
Mr. Dochow. That is not my email, Mr. Chairman.
Senator Levin. Which one?
Mr. Dochow. Exhibit 66. Those aren't my emails.
Senator Levin. Well, Exhibit 45, let us go to the posturing
one. You thought they were posturing.
Mr. Dochow. No. What I thought was by us being cooperative
and fully sharing the memorandum of understanding, if we could
get the reviews, it would avoid posturing.
Senator Levin. Yes, but that means you were afraid they
would be posturing. You had a fear that they were going to be
posturing.
Mr. Dochow. I do not express it that way.
Senator Levin. ``It went to the FDIC because I committed to
[them] to consider their comments in an effort to minimize
their letter writing and posturing.'' You had a fear of their
posturing.
Mr. Dochow. I had a concern that they would be posturing.
Senator Levin. You had a concern, not a fear.
Mr. Dochow. Not a fear.
Senator Levin. But a concern.
Mr. Dochow. Yes.
Senator Levin. And what was your concern?
Mr. Dochow. My concern was that they would start
documenting the files with a series of information that we
would then have to respond to and that would drag out the
process. Therefore, we would not be effective in getting the
supervision enforcement in place in a timely manner.
Senator Levin. And, Mr. Reich, you are the one who wrote
that memo to Sheila Bair in August reminding her the FDIC has
no role until OTS rules on solvency. Is that accurate, they
have no role? Don't they have a back-up role?
Mr. Reich. They do have a back-up role.
Senator Levin. So why say no role? Kind of over the top,
isn't it?
Mr. Reich. Well, it was in the context of what was going on
during this period of time. I did not mean to imply that they
have----
Senator Levin. You are not implying----
Mr. Reich [continuing]. No role whatsoever.
Senator Levin. You are not implying. You are stating it
explicitly.
Mr. Reich. Obviously, they have a back-up role, and they
have an on-site examiner at WaMu.
Senator Levin. Well, you are reminding her----
Mr. Reich. So they do have a role.
Senator Levin. Well, not at that time. You wrote her in
August. You must have been upset. You reminded her that the
FDIC has no role. Those are your words, not mine.
Mr. Reich. These were tense times.
Senator Levin. OK. I am sure they were. So what was the
tension between your agency and FDIC here? Your folks would not
even give them a chair in the office, a desk.
Mr. Reich. I do not think that is accurate.
Senator Levin. All right. We will hear from them later.
What was the tension?
Mr. Reich. Well, Rome was burning. The economy was going to
Hell in a hand basket.
Senator Levin. Yes, but what was the tension between the
two of you? You treated them, instead of being collaborators to
try to address a common problem, you treat them as though
somehow or other they are to be shoved away. What caused this?
Mr. Reich. I think basically and fundamentally it was who
was the primary Federal regulator.
Senator Levin. It was turf, in a word.
Mr. Reich. I think OTS had the responsibility as the
primary Federal regulator.
Senator Levin. Turf.
Mr. Reich. We had the statutory responsibility.
Senator Levin. Instead of going at this as partners----
Mr. Reich. I have more than most--an understanding of the
role of the FDIC and their need to participate. I have been
there.
Senator Levin. Let us take a look at another one of your
emails, Exhibit 68.\1\
---------------------------------------------------------------------------
\1\ See Exhibit No. 68, which appears in the Appendix on page 439.
---------------------------------------------------------------------------
Mr. Reich. I assume we are talking about audacity.
Senator Levin. Yes, we are talking about audacity. Chairman
Bair writes OTS that she informed WaMu of a ratings
disagreement. You expressed, ``I cannot believe the continuing
audacity of this woman.'' What is audacious about FDIC telling
WaMu about a potential downgrade, just telling WaMu? Why is
that so audacious that you cannot believe the audacity of this
woman?
Mr. Reich. Again, it relates to the fact that OTS was the
primary Federal regulator----
Senator Levin. I understand.
Mr. Reich [continuing]. And I thought that OTS ought to be
the agency that relayed the downgrade in rating to the new CEO
who just took over.
Senator Levin. Turf.
Mr. Reich. Characterize it as how you may. I have the
highest regard for Sheila Bair, but these were tense times, and
people's blood pressure increases under situations like this,
and sometimes we say things that we wish would not appear in
print.
Senator Levin. What really strikes me throughout here is
that we have a situation where we have two regulators; both
clearly have a stake. You are the primary regulator, but it is
clear that FDIC has a significant interest. If this bank goes
under again, their Insurance Fund is wiped out.
So instead of supporting each other, instead of supporting
with open arms, saying, ``Hey, let's proceed together on this,
let's do this together,'' instead of kind of ``I've got your
back, you've got my back, let's go after a common goal,'' it is
back biting that I read in these emails.
Mr. Reich. Chairman Levin, if I may, I volunteered----
Senator Levin. Well, no, let me finish.
Mr. Reich. OK.
Senator Levin. Instead of kind of collaborating with the
FDIC, we have seen how OTS collaborated with the people they
are supposed to regulate, just collaborating all the way,
working with them instead of taking action when it was due
against them, act against them directly. So you see all that
collaboration between you and the people you are supposed to
regulate. But when it comes to collaborating with another
agency to go after a problem which threatens this economy, we
see this kind of email traffic. And I have got to tell you, I
think the American taxpayers and the American people expect a
lot more from their regulators than what we have seen in this
situation.
Mr. Reich. Well, first of all, I think taking and
publicizing an email that is taken totally out of context is--
--
Senator Levin. That is the whole email. I read the whole
email.
Mr. Reich. It is a very short email message----
Senator Levin. Well, how can it be out of context?
Mr. Reich. But it does not in any way describe the context
of the environment that took place.
Senator Levin. Well, I read the whole email.\1\
---------------------------------------------------------------------------
\1\ See Exhibit No. 66, which appears in the Appendix on page 435.
---------------------------------------------------------------------------
Mr. Reich. I want to say that----
Senator Levin. ``You really know how to stir up a
colleague's vacation. I do not under any circumstances want to
discuss this on Friday's conference call, in which I may or may
not be able to participate depending on cell phone service
availability on the cruise ship location,'' where you are at.
``Instead, I want to have a one-on-one meeting with Ben
Bernanke prior to any such discussion. . . . Also, I may or may
not choose to have a similar meeting with Secretary Paulson.''
``I should not have to remind you the FDIC has no role
until the [primary regulator] ( . . . OTS) rules on solvency .
. . ''
Now, I will tell you, that is the context. I am not taking
anything out of context. I read the whole thing twice.
Mr. Reich. Well, it is not all of the context. I
volunteered to have the OTS make a presentation in-depth to the
Board of Directors of the FDIC during this period of time. I
don't remember now the date that it took place, but there was
such a briefing, and it was led by Darrel Dochow, and he did an
absolutely outstanding job presenting an in-depth picture of
the situation at WaMu. It was at the same board meeting that a
presentation took place by another agency on another
institution which was far less informative and far less in-
depth.
Senator Levin. That is the context?
Mr. Reich. That is part of the context.
Senator Levin. Well, from what I can see--and we have
looked at plenty of contexts. We have 500 pages of context.
About the only time OTS showed backbone was against another
agency's moving, in your view, into your turf. Boy, that really
got your dander up. That got your blood pressure up. I do not
see your blood pressure getting up against a bank which is
engaged in the kind of dangerous practices that the bank
engaged in, dangerous to their solvency, dangerous to their
investors, dangerous to their depositors, dangerous to this
economy. I never saw that blood pressure come up until you are
in some kind of a turf issue with FDIC. That is the way I think
any fair reading of these documents lead one to.
Does anybody want to add anything before you are excused?
[No response.]
Senator Levin. Thank you. Thank you for being here today.
We will go to our next panel.
We will take a 10-minute break.
[Recess.]
Senator Levin. The Subcommittee will come back to order.
I will now call our third panel of witnesses, John Corston,
Acting Deputy Director of the Large Institutions and Analysis
Branch at the Federal Deposit Insurance Corporation, and George
Doerr, the Deputy Regional Director of the Division of
Supervision and Consumer Protection at the FDIC in San
Francisco. We thank you both for being with us. We know it has
been a long morning and early afternoon.
Pursuant to Rule 6, all witnesses who testify before this
Subcommittee must be sworn in at this time. We would ask you
both to stand and raise your right hand.
Do you solemnly swear that the testimony you are about to
give will be the truth, the whole truth, and nothing but the
truth, so help you, God?
Mr. Corston. I do.
Mr. Doerr. I do.
Senator Levin. Were you here when I described the timing
system?
Mr. Corston. Yes.
Mr. Doerr. Yes, we were.
Senator Levin. So, Mr. Corston, we will have you go first,
and then Mr. Doerr.
TESTIMONY OF JOHN CORSTON,\1\ ACTING DEPUTY DIRECTOR, DIVISION
OF SUPERVISION AND CONSUMER PROTECTION, COMPLEX FINANCIAL
INSTITUTION BRANCH, FEDERAL DEPOSIT INSURANCE CORPORATION
Mr. Corston. Thank you, Chairman Levin. I appreciate the
opportunity to testify on my role with the FDIC regarding
Washington Mutual Bank. On behalf of the Corporation, we have
submitted to the Subcommittee a written statement that responds
to specific issues that were requested by the Subcommittee. In
addition, allow me to briefly introduce myself and my roles and
responsibilities at the FDIC.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Corston appears in the Appendix
on page 153.
---------------------------------------------------------------------------
I am John Corston, Acting Deputy Director for the FDIC's
Division of Supervision and Consumer Protection's Complex
Financial Institution Branch in Washington, DC. I have had a
leading role in this branch since 2005, after working in three
different regions in various capacities related to bank
supervision. I started as a field examiner with the FDIC in
1987.
An element of my duties as Acting Deputy Director of
Complex Financial Institutions is to oversee the Large Insured
Depository Institution Program (LIDI). Broadly, the LIDI
program provides forward-looking assessment of insured
depository institutions over $10 billion, provides highly
experienced technical experts to provide on-site support for
the regions, operates continuous presence at the eight largest
insured institutions, and assists in developing and
recommending strategy to the Division Director and the Chairman
regarding specific institutions.
With regard to Washington Mutual, I worked with technical
experts on my staff and coordinated with the region to evaluate
CAMELS and LIDI ratings and supervisory strategy, including
enforcement actions. While the region is primarily responsible
for these areas, input from the Complex Financial Institutions
Branch played a significant role in the decisionmaking process.
I also worked with my Washington-based counterpart at the
Office of Thrift Supervision on LIDIs, including Washington
Mutual, to resolve issues regarding FDIC's actions or
conclusions that were not resolved at the regional level.
One of the roles of the FDIC's Complex Financial
Institution Branch is to identify risks that impact large
institutions, including high-risk lending strategies such as
those that took place at Washington Mutual. To do this, we have
technical experts on-site at institutions we have identified
through the LIDI review process that are considered to possess
higher levels of risk. For instance, we placed staff on-site at
Countrywide, IndyMac, and Washington Mutual to identify high-
risk activities and measure their impact on the financial
condition.
My branch's responsibility is to examine financial
institutions and gain an awareness of the speed in which the
institution could deteriorate, determine its sensitivity to
market events, and analyze its exposure to loss so appropriate
and timely responses can be developed.
I thank you for the opportunity to testify today and I am
pleased to answer any of your questions.
Senator Levin. Thank you very much. Mr. Doerr.
TESTIMONY OF J. GEORGE DOERR,\1\ DEPUTY REGIONAL DIRECTOR, SAN
FRANCISCO REGION, FEDERAL DEPOSIT INSURANCE CORPORATION
Mr. Doerr. Chairman Levin, I will be even more brief. I
appreciate the opportunity to testify on my role with the FDIC
in the supervision of Washington Mutual Bank (WaMu).
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Doerr appears in the Appendix on
page 155.
---------------------------------------------------------------------------
I am George Doerr, Deputy Regional Director for the FDIC in
the San Francisco Regional Office, a position which I have held
since June 2007. I have been with the FDIC almost 40 years.
From September 2002 until June 2007, I was Assistant Regional
Director for the FDIC San Francisco Regional Office. The San
Francisco Region covers 11 States--Washington, Oregon,
California, Arizona, Nevada, Utah, Idaho, Wyoming, Montana,
Alaska, and Hawaii, in addition to the Territories of Guam and
American Samoa and also Micronesia. As Assistant Regional
Director in those years, among my responsibilities was our
Regional Large Bank Program, which included WaMu.
The three matters the Subcommittee asked me to be prepared
to address with respect to WaMu are, one, Non-Traditional
Mortgage Guidance; two, WaMu's condition as assessed through
the CAMELS ratings; and three, FDIC's Large Insured Depository
Institutions Program and ratings, also referred to as the LIDI
program. On behalf of the Corporation, we have provided
discussion of these three matters in the written statement
submitted to the Subcommittee.
Thank you again for the opportunity to testify, and I am
pleased to respond to any of your questions.
Senator Levin. Thank you both. Mr. Doerr, first, take a
look at Exhibit 51a, if you would.\1\
---------------------------------------------------------------------------
\1\ See Exhibit No. 51a, which appears in the Appendix on page 392.
---------------------------------------------------------------------------
Mr. Doerr. OK.
Senator Levin. It is a memo entitled, ``Potential Impact of
Possible Housing Bubble on Washington Mutual.'' In this memo,
the FDIC wrote an analysis of WaMu's single-family residential
loan portfolio, focusing on Option ARMs, hybrid loans, low
documentation loans, which means low number of document loans,
payment shock, and geographic concentrations. Now, if single-
family residential lending was traditionally safe, what were
the risks that FDIC saw with these aspects of WaMu's lending
that made it less safe than historical times?
Mr. Doerr. Well, we were becoming concerned with what would
happen were there to be a dramatic downturn in the mortgage
industry and with housing in general, or what effect that sort
of downturn would have on the mortgage industry.
Senator Levin. Loans were risky, were they? They had
multiple risk factors layered on top of each other. Borrowers
in low documentation loans were subject to higher default risk.
Is that not true? Payment shock increased default risk.
Geographic concentrations were vulnerable to high housing rate
increases. Were they all true?
Mr. Doerr. That is correct.
Senator Levin. All right. The IG report, and that is
Exhibit 82,\2\ page nine, found that Option ARMs were 47
percent of the loans in WaMu's portfolio. So now in light of
the elevated risks in that memo, low documentation, payment
shock, geographic concentrations, did FDIC or OTS discourage
these products? If not, why not?
---------------------------------------------------------------------------
\2\ See Exhibit No. 82, which appears in the Appendix on page 484.
---------------------------------------------------------------------------
Mr. Doerr. Well, we did not specifically discourage those
products. I, for one, can see a problem with certain of those
products. You have been talking during the hearings with stated
income loans, and I certainly see some holes in those. But as
an agency, FDIC did not take the position to prevent
institutions from making those loans.
What we did is we provided Non-Traditional Mortgage
Guidance in October 2006. We set out in the guidance certain
safe and sound principles under which institutions should
approach these non-traditional mortgages. For example, one
should qualify borrowers at the fully indexed rate, not at the
teaser rate. Also, that when evaluating a borrower's capacity
to handle increased amounts accruing in a negative amortization
loan, you have to evaluate the borrower's ability to pay the
loan through to maturity. Avoidance of over-reliance on
collateral or the ability to refinance was another big mistake
made by a number of firms.
And when it comes to risk layering, which you mentioned,
what we did was encourage quality controls and risk mitigation
for risk layering items such as stated income loans, no
documentation loans, high loan-to-value, high debt-to-income,
and those sort of items. So that was the interagency statement
that was issued.
Senator Levin. Right. Now, that interagency position is not
binding, is that correct?
Mr. Doerr. It is not a law. It is not a rule or regulation.
Senator Levin. Is it binding by regulation?
Mr. Doerr. It is not.
Senator Levin. Should it be?
Mr. Doerr. Well, we might consider that.
Senator Levin. What would it take? I mean, given, I think,
what we understand the risks are here, I am just wondering
whether or not it shouldn't be more than just guidance.
Mr. Doerr. As FDIC, we expected our institutions to be in
compliance with that guidance and be in compliance with it
right away.
Senator Levin. Without it being stated as being mandatory.
You view that as an expectation----
Mr. Doerr. Yes.
Senator Levin. And has that expectation been lived up to,
do you know?
Mr. Doerr. Been lived up to in----
Senator Levin. Has the guidance been followed?
Mr. Doerr. It has in some institutions and it has not in
others.
Senator Levin. Have you, or will you remind all
institutions about your expectation?
Mr. Doerr. That is our expectation.
Senator Levin. But will you remind all the institutions?
Mr. Doerr. Well, that----
Senator Levin. How would they know it is your expectation
unless you send them frequent reminders of it?
Mr. Doerr. I think it would be a good idea that perhaps we
might. That is a policy item for our Washington office, but I
would agree with you, that would be a good idea.
Senator Levin. All right. Mr. Corston, you can jump in
here, too, if you would.
Mr. Corston. Absolutely. We certainly have concerns over
any loan product that, again, has less information incorporated
into an underwriting process that is layering on more risk. In
this case, we came out with our guidance to provide examiners
some guidance and the industry some guidance when the risk
became very apparent to our agency and others.
Senator Levin. On Exhibit 51b,\1\ if you will take a look
at that exhibit, this is a 2005 memo entitled, ``Insured
Institutions' Exposure to a Housing Slowdown.'' Mr. Corston,
what were the FDIC's concerns about the structure of the loans
that were popular at that time? What were the risk of those
loans in bank portfolios?
---------------------------------------------------------------------------
\1\ See Exhibit No. 51b, which appears in the Appendix on page 398.
---------------------------------------------------------------------------
Mr. Corston. The concern we had with these loans was the
attributes were such that when you have optionality in
payments, it becomes far more difficult to determine
performance, whether you are the bank or whether you are an
examiner. Many of them became an apparent collateral dependent,
and when you are only depending on one source of repayment,
again, the risk goes up. We became very concerned about the
housing market in general and the volume of loans that we had
that appeared to be dependent on the values of the underlying
real estate as opposed to the underlying capacity of a borrower
to repay themselves.
Senator Levin. On page four of that memo, you wrote about
Washington Mutual, among others, and you wrote there what they
held in Option ARMs and that 70 percent of Option ARM customers
only make the minimum payment each month. Do you see that on
page four?
Mr. Corston. Yes, I do.
Senator Levin. This is a memo, by the way, from you to
Michael Zamorski, right? Do I have that right?
Mr. Corston. That should be the Division Director.
Senator Levin. He is the Regional Director?
Mr. Corston. He would be the Division Director.
Senator Levin. OK.
Mr. Corston. That is correct.
Senator Levin. OK. What consequences can you expect when
most customers only make minimum payment in terms of the
borrower's reaction to a payment shock? What consequences can
you expect to negative amortization, to the safety and the
soundness of institutions that hold these kind of assets?
Mr. Corston. It suggests the inability to repay the loan
out of their payment capacity, which moves the reliance to the
underlying collateral. And I think we have seen the results.
Senator Levin. Now, several OTS officials told our
Subcommittee that single-family residential lending, compared
to other types of lending, was historically very safe, so that
is how they judged WaMu's lending. Is that a fair comparison,
given that WaMu's lending practices departed radically from
historically safe products and practices? Either one of you.
Mr. Doerr, why don't you start?
Mr. Doerr. No. There is definitely a problem there. What we
would expect is strong underwriting to take place, to take into
account the ability of a borrower to handle a payment shock. If
you are going to give them a teaser rate to attract them into
the institution, that is fine, but you have to qualify them to
be able to pay the loan as it resets.
Senator Levin. Mr. Corston.
Mr. Corston. In the case of Washington Mutual, certainly
the standard 30-year fixed-rate amortizing mortgage is
generally not a problem. Any product that you have that has
amortization built in and a steady interest rate that does not
vary with the capacity of the borrower to pay, generally, from
an underwriting standpoint, is not a problem. That is not what
70 percent of these products were.
Senator Levin. Now, as WaMu's condition continued to worsen
in the summer of 2008, the FDIC conducted a capital analysis,
recommended to OTS that a 4 rating was warranted. Take a look
at Exhibit 63.\1\ Do you see that?
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\1\ See Exhibit No. 63, which appears in the Appendix on page 431.
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Mr. Corston. Yes.
Senator Levin. This is from Sheila Bair to John Reich, and
I should have asked Mr. Reich about this. ``Sheila, in my view,
rating WaMu a 4''--this is now August 2008--``rating WaMu a 4
would be a big error in judging the facts in this situation. It
would appear to be a rating resulting from fear and not a
rating based on the condition of the institution. WaMu has both
the capital and the liquidity to justify a 3 rating.''
And then the email back from Ms. Bair to Mr. Reich, ``We
will follow the appropriate procedures if the staff cannot
agree. You asked me to hear out WaMu. I hope that you would
also hear out our examination staff if it comes to that.''
Then later, the next month, in September, after a lot of
back-and-forth, OTS followed FDIC's lead and agreed to a 4
rating. Why was OTS resistant to the FDIC's tougher stance?
Mr. Doerr. Well, we found that very puzzling. We made a
recommendation in May to the OTS concerning capital. We
presented to them a stress capital analysis. We sent it to them
a day ahead and then we held a conference call with Mr. Dochow.
And when I say ``we,'' that is the Regional Director, Stan
Ivie, and me. We held a conference call with him to discuss
that. His reaction was this was not a Generally Accepted
Accounting Principles (GAAP), and he rejected the argument. It
is not a GAAP analysis. It is a stress analysis. It says that
the institution is going to need capital, more capital, to be
able to manage itself through a stress scenario as embedded
losses begin to become real losses. It is under the principle
that reserves are there to handle expected losses and capital
is there to handle unexpected losses. So it is a different item
entirely.
We wanted to get capital addressed in some form of action.
OTS was going to do a MOU, we became aware, and we contacted
Mr. Dochow and wanted into the process so that we could get
capital addressed in that MOU.
As far as the rating goes, we had our dedicated examiner
tell the WaMu Board on July 15, that in FDIC's view, this could
be a 4. We had not made a final decision at that point----
Senator Levin. You had not made a final decision.
Mr. Doerr. We had not made a final decision----
Senator Levin. It could be or should be?
Mr. Doerr. Could be. But by the end of the month, we had
made that decision, and----
Senator Levin. What month are we talking about?
Mr. Doerr. July 2008.
Senator Levin. OK.
Mr. Doerr. On July 31, we briefed Chairman Sheila Bair, and
the result of which was we told her this is a composite 4 and
why. Mr. Corston was on that. And she went over to tell
Director Reich that very day the same thing. It is composite 4.
Senator Levin. Mr. Corston, anything you want to add to
that?
Mr. Corston. The only thing I will add is the capital
analysis showed a capital deficit and that was our concern. And
any institution that was showing a deficit in capital to the
magnitude that we were estimating, and it was approximately $5
billion, we felt in no way we could justify a composite 3
rating.
[Pause.]
Senator Levin. Mr. Doerr, you have been in management roles
in the FDIC's West Division since 1989, and as I understand it,
your division was responsible for WaMu. Through 2005, if I am
correct, the FDIC's working relationship with the OTS was a
positive, cooperative relationship. Is that correct?
Mr. Doerr. That is correct.
Senator Levin. Now, if you look at Exhibit 51c,\1\ this is
your examiner, Mr. Funaro. He wrote the following to you.
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\1\ See Exhibit No. 51c, which appears in the Appendix on page 404.
---------------------------------------------------------------------------
Mr. Doerr. I am sorry. I have to find the page.
Senator Levin. Yes. That is OK.
Mr. Doerr. OK. I have got it here.
Senator Levin. OK. If you look near the bottom there, it
says, ``Darrel Dochow contacted me today and we arranged a
meeting for September 14 at 9:00 a.m. . . . I was assuming we
would coordinate for the fall visit . . . and he would update
me on WaMu, since I haven't had access to the WaMu examiner's
library since the end of the [second quarter].'' Why did he not
have access to the WaMu examiner's library since then?
Mr. Doerr. Chairman Levin, he was supposed to. Initially,
this tied into the fact that Washington Mutual management was
moving to a new tower, so there was different space to be
provided for the examiners, and we fully understood that. That
was in July. But OTS was to make provisions to provide Mr.
Funaro with space in the building. This dragged on and on. They
promised that they would take care of it. There were calls.
There were meetings. I was involved in one call where Mr.
Dochow in August promised that he would take care of this,
absolutely no problem.
So every time this came up, we were promised it would be
corrected. It dragged on. It dragged on. This is in September
and it is still not taken care of. In fact, we got another
email come October and it was still an outstanding issue.
Senator Levin. What was the reason?
Mr. Doerr. I can't explain what the reason was. I
personally think they didn't want us there. I mean, we were
denied physical access and the access to this examiner library.
That is a library of electronic materials that WaMu puts
together for the regulators, for both the OTS and the FDIC. He
had temporarily lost that as part of the move, but you
shouldn't have to go 4 months without having to have that. We
have a dedicated examiner arrangement for the large banks with
all of the other regulators and part of it is sharing
information. So he should have had access to that.
Senator Levin. And it was essential that Mr. Funaro have
access to that library in order to get information about the
Washington Mutual?
Mr. Doerr. Absolutely.
Senator Levin. Now, was an explanation given to either of
you about that at any time, as to why that was?
Mr. Doerr. Why that delay happened?
Senator Levin. Yes.
Mr. Doerr. I never received an explanation, no.
Senator Levin. Did you get involved in that also, Mr.
Corston, I believe?
Mr. Corston. As far as an explanation?
Senator Levin. Were you involved in this issue?
Mr. Corston. Oh, in this?
Senator Levin. The access issue for FDIC?
Mr. Corston. I was definitely involved in the access issue
at certain stages. This is probably not the stage where I got
involved, but I was very involved in the later stages.
Senator Levin. OK. Now, if you will look down at--well, did
you have anything to add, then, to that, as to what the reason
was for that denial of access to the FDIC?
Mr. Corston. No reason was given.
Senator Levin. All right. Now, if you look at the bottom of
Exhibit 51c,\1\ at the message from you, Mr. Doerr, to Mr.
Carter, here is what it says there. It says, ``John, we
received a letter from RD Mike Finn regarding our routine
request to join their next on-site exam target this fall. As
you know, Mr. Finn says no, totally contrary to what Vanessa
and I discussed with Deputy Dochow on August 17.''
---------------------------------------------------------------------------
\1\ See Exhibit No. 51c, which appears in the Appendix on page 404.
---------------------------------------------------------------------------
So here is another situation that came up where there is
refusal on the part of OTS to do something jointly with the
FDIC. Again, the date of this Exhibit 51c is September 2006.
Can you tell us what FDIC was seeking to do and why, and what
do you know as to why OTS was not permitting you to do it?
Mr. Doerr. We were seeking to join their examination.
Senator Levin. Why?
Mr. Doerr. We followed our normal protocols under the
interagency agreement, and on August 14, we sent the OTS a
letter and we asked to join under that interagency agreement,
and we were surprised. We got a letter back from them dated
September 1 and it said that OTS' position was that FDIC needed
to establish a basis upon which we could join an examination.
They knew of no disagreements between the agencies, and without
a disagreement, we had no basis to be there and we were not
invited to be on the examination.
Senator Levin. Was it important in order for you to have a
basis that you have access?
Mr. Doerr. Yes.
Senator Levin. I mean, it is a chicken-and-egg issue, I
presume.
Mr. Doerr. It is circular. We need access to determine the
condition of the institution and they are saying we have no
disagreements. The institution is sound, and so you have no
basis.
Mr. Corston. Chairman Levin, if I could add some
background, we had dedicated examiners in six of the largest
institutions at the time. Washington Mutual was one of them.
Our examiners on-site, the dedicated examiners, worked
regularly with the primary Federal regulator and participated
in examinations, and the reason was so we had a good idea of
the risk in those institutions. The only way this agency can
get that information is to acquire it through direct on-site
access to the information. This was a unique situation where we
were receiving push-back from the primary Federal regulator.
Senator Levin. Did OTS continue to have this posture
towards FDIC requests to look through files, Mr. Corston?
Mr. Corston. Yes, they did.
Senator Levin. And do you have any examples of that?
Mr. Corston. Mr. Doerr probably would have the best
examples----
Senator Levin. All right. Mr. Doerr.
Mr. Doerr. Yes, we did. We actually got resolution to this
2006 matter, both to join the examination and the access for
Dedicated Examiner Funaro in November. It took several months,
but we got it.
We again followed our protocols to join the examination for
2007, only to find out in February from Mr. Funaro that OTS
refused to allow us to look at loan files.
Senator Levin. Now, FDIC requested to look at files after
the Non-Traditional Mortgage Guidance, correct?
Mr. Doerr. That is correct.
Senator Levin. And OTS had opposed that guidance and they
took this position, even to the extent that they opposed having
the FDIC tag along with the OTS' own review, and I think you
have just described that, is that correct?
Mr. Doerr. That is correct.
Senator Levin. All right.
Mr. Doerr. We told them that our examiners will sit side by
side with your examiners. No duplication of effort here. We
will work some files, you work some files, but we want to work
some files.
Senator Levin. And did you believe that OTS had a
substantive reason for the positions that it took in terms of
FDIC access, or was it, in your view, just a regulatory turf
battle?
Mr. Doerr. I knew of no substantive position that could be
taken to tell us not to look at loan files.
Mr. Corston. I also received no substantive----
Senator Levin. From your perspectives, it was a turf
battle. Protecting turf.
Mr. Corston. Yes.
Mr. Doerr. That is a good description of it.
Senator Levin. Now, there is a binder in front of you there
which remains a sealed exhibit because apparently there is--
bank examination reports are apparently confidential, so that
file is sealed. Can you take a look at Tab Q207, the FDIC LIDI
report? I think, Mr. Corston, this is going to be for you.
Mr. Corston. OK.
Senator Levin. Can you explain what this LIDI off-site
rating and scale is?
Mr. Corston. Essentially, we have a scale that goes from A
to E, and what we try to do with that scale is take the risk
level of the institutions. This rating does not tie necessarily
to CAMELS, but it does predict CAMELS when you get to the C, D,
and E levels.
A C stable would indicate an institution that would more
than likely still be CAMELS 2 rated, but probably have higher
levels of risk. It could also include 3-rated institutions. The
reason Washington Mutual would be included as a C stable is
that it had higher levels of risk.
Senator Levin. So that in this exhibit, which is based on
the second quarter of 2007, is it accurate to say that FDIC
assigned WaMu a C rating?
Mr. Corston. That is correct.
Senator Levin. Which is kind of, is it fair to say, heading
towards a 3? Is that a fair summary? Is that some sort of
weaknesses or concentrations which----
Mr. Corston. A C negative would clearly indicate that it
would be heading towards a 3. As a C stable, it would certainly
have the risk characteristics of an institution that could be
heading to a 3 if it was under some level of stress. You can
see the areas where it was most vulnerable, most notably in the
area of credit risk, which was increasing in nature. That is
probably the first red flag in this report.
Senator Levin. And what is the date of this?
Mr. Doerr. This was actually done in October. There is
something wrong with the date. It says 1899, but it was
actually--it was done in October of----
Senator Levin. That is a computer error, apparently. We saw
that, too. But the information was based on the second quarter?
Mr. Corston. That is correct.
Senator Levin. All right. And so is it accurate to say that
FDIC had a more negative outlook for WaMu at that time than a
simple 2 CAMELS rating?
Mr. Corston. Correct.
Senator Levin. So what were you looking at that would not
be inside that OTS 2 rating? Were there some additional things
you were looking at?
Mr. Corston. Essentially, we would be looking at the level
of risk and the direction of risk. So when we are looking at
this report, it has moderate to high credit risk that is
increasing in nature. And I think if you go through the
reports, you will see that the mitigants for higher levels of
credit risk, such as risk practices and things like that, were
not apparent in this institution. That was a concern. And this
is one of the reasons that access to clearer information for
the FDIC in that situation was more critical.
Senator Levin. Just to make sure I understand that, that is
why--what you just said is the access to their information----
Mr. Corston. To their information.
Senator Levin [continuing]. Was more critical.
Mr. Corston. More critical.
Senator Levin. Because of the situation there. Now, if you
look at the credit issue or rating at the top right-hand corner
of that document, they are A-1 or A. Is that correct?
Mr. Corston. Correct.
Senator Levin. Now, look forward a few more tabs to the Q2,
second quarter, 2008 LIDI. OK?
Mr. Corston. Yes.
Senator Levin. Now, the credit ratings, instead of being A-
1 or A, now have gone down to B, AA2, BBB plus, and BBB. Is
that correct?
Mr. Corston. Correct.
Senator Levin. And this is the information in the second
quarter of 2008.
Mr. Corston. Correct.
Senator Levin. Now, as of 2008, then, the credit ratings
continued to go down all the way to non-investment grade in
September.
Mr. Corston. Yes.
Senator Levin. But how important were those rating agency
downgrades between those two documents? Was that significant?
Mr. Corston. And it is significant in that the funding
mechanisms that this institution had had some triggers that
could be triggered by the outside credit rating agencies. So
when we looked at Washington Mutual, we had to consider these
outside credit rating agencies because it could impact the
thrift's access to liquidity.
Senator Levin. So is it fair to say that those credit
rating agencies' ratings were of great significance to you. You
put great stock and significance in them.
Mr. Corston. Absolutely.
Senator Levin. Now, what is the relationship between asset
quality and liquidity?
Mr. Corston. It has everything to do with liquidity. If you
have strong asset quality, you will not have liquidity issues
because your assets--you can borrow either against them or you
can sell them. If you have weak asset quality, you are going to
have liquidity issues at some point.
Senator Levin. Now, there are some that have said that
WaMu's liquidity problems were unexpected and were the result
simply of market forces. Isn't it the case, however, looking at
these documents, that since liquidity is based in significant
measure on asset quality, WaMu's liquidity problems arose, at
least in significant part, because of bad quality of their
mortgage loans, which were the bulk of their assets?
Mr. Corston. Correct.
Senator Levin. Do you have a conclusion as to why
Washington Mutual failed?
Mr. Corston. Asset quality. Weak asset quality. It brought
on the liquidity problems.
Senator Levin. And that lack of sufficient capital was
something that reflected embedded losses in their asset
portfolio?
Mr. Corston. As has been discussed earlier, with the
optionality in their payment structure in their assets, they
are extremely hard to value. That makes it very difficult for
us as an insurer to deal with, but it also makes it very
difficult for investors to value the company and put capital
in. So the type of business they were involved in made it very
difficult for them to go out, and raise capital, one, and then,
two, when the liquidity became squeezed, the assets, again,
with the asset quality deterioration, they could not fund
themselves.
Senator Levin. OK. Take a look finally--and I think this
will be my last question--at Exhibit 1b. This is a chart that
we have used to show some of the high-risk lending practices
that were going on not just in Washington Mutual but a lot of
other lenders across the country, and bank regulators allowed
these unsafe, unsound mortgage practices to go on.
Now, Exhibit 1b\1\ is in your book. You will not be able to
read that unless you have phenomenal eyes, which probably you
do given your occupation. At least you used to.
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\1\ See Exhibit No. 1b, which appears in the Appendix on page 198.
---------------------------------------------------------------------------
Mr. Doerr. I can read the chart. Is that where it is?
Senator Levin. All right. Well, it is also in your book of
exhibits, Exhibit 1b. These are some of the practices that we
have talked about. One is low-document loans, teaser rate
loans, stated income loans, interest-only rate loans,
negatively amortizing loans. Those five that I just rattled
off, what is the status of those practices today? Are they
permitted? Are they frowned upon?
Mr. Corston. They certainly are frowned upon. To the degree
they are not permitted, I do not know. As far as nontraditional
loans, to the extent that they are being done at this point,
there is not nearly as much market acceptance. A lot of these
loan types had characteristics targeted towards a
securitization market that does not exist anymore.
Senator Levin. Right. But that could come back again.
Mr. Corston. Yes, it could.
Senator Levin. What in the rules, guidance, regulations is
there today relative to those five elements?
Mr. Doerr. There is nothing to prevent them in the rules
today.
Senator Levin. Are they discouraged in any guidance?
Mr. Doerr. Well, unless there is strong risk mitigation--I
mean, there is a right way and a wrong way to make some of
those loans. A negative amortization loan, if the borrower has
the financial capacity and you can verify that to pay that loan
through to maturity. If all you are doing is finding a way to
get them a loan and not worrying about what comes later, that
is wrong.
So it is a question of not strictly discouraging all
negative arm loans, but there has to be a right way to handle
them.
Senator Levin. How about stated income loans?
Mr. Doerr. Stated income loans, I guess----
Senator Levin. Does that depend, too? Is that the answer--
--
Mr. Doerr. Well, if you went back to what Mr. Dochow
mentioned of high-net-worth borrowers and it is limited to
that, I can see some circumstances where a person has $100,000
worth of securities that they own free and clear, you might not
worry about what their income is. But other than a situation
like that, stated income is probably not right.
Mr. Corston. I would say, Chairman Levin, under no
circumstances would these be considered acceptable to the level
that Washington Mutual was putting these loans on the books. I
mean, if these are one-off situations--I do not know I could
speak to that necessarily, but, no, this is not an acceptable
structure for an institution to do in any type of volume. We
have seen the type of risk and the results.
Senator Levin. So since there is no regulation on the books
for these kinds of risky practices, how are we going to get
them on the books? How are the regulators going to put into the
books that you can--obviously, there may be circumstances where
you can have a stated income loan under the kind of
circumstance you talked about. But as a general practice, no.
How do we get these kind of important practices and policies in
place? They are not there now. Should we legislate? I am
tempted, frankly--and I may do it--to just ban negatively
amortizing loans. But you point out if you have a guy who has
plenty of assets and securities, you might want to, for some
reason I cannot imagine, have a negatively amortizing loan. But
how are we going to do it? Should we legislate it?
Mr. Corston. Well, policy is not my area of expertise, but
I will say this: As an examiner in an institution, a tool such
as a regulation is fairly easy to support. Guidance becomes--
you can support it, but it is not as strong. Because it goes
more to best practices, again, it becomes more something you
need to influence.
So it is something that, certainly from a rules standpoint,
obviously needs to be looked at. From an examiner's standpoint,
it is a challenge.
Senator Levin. You had an acceptable structure at WaMu, as
you said.
Mr. Corston. Yes.
Senator Levin. So why wasn't it changed? What were the
reasons it was not changed from what you have heard? Is it that
there was not clear guidance, that there was not good common
sense used? What were the reasons?
Mr. Corston. At the time when examiners were in these
institutions, we knew--and one of the first memos that you
brought up, we saw the issues. But it became very hard to
influence institutions to change these practices. They
certainly were competing against each other, and there were
institutions outside the insured environment that were
influencing the underwriting also. And it became difficult from
an examiner's point of view as a one-off to influence, say,
Washington Mutual when there were other non-insured
institutions with which they competed. It made it a challenge.
And I would say when we were dealing with these institutions at
the time, that is what we were facing.
Senator Levin. After a while--I do not have the exact--I
guess it was October 2006, there is a joint interagency
guidance for nontraditional mortgages that is agreed upon. I do
not know why it was guidance instead of enforceable
regulations. We have talked a little bit about that. There was
not a clear effective date, but I understand FDIC, Office of
the Comptroller of the Currency (OCC), and the Federal Reserve
treated the guidance as effective immediately. Is that correct?
Mr. Doerr. That is correct.
Senator Levin. OTS did not. It gave thrifts a year to
implement. I do not think that guidance dealt with NINA loans.
Did it? Do you remember?
Mr. Doerr. Well, that is probably what you would call
layered risk. It would probably be in there, one of the
elements of layered risk.
Senator Levin. How about no-document loans?
Mr. Doerr. Same. That is a layered risk.
Senator Levin. I guess one of the issues, obviously the big
issue we will be looking at in the next two hearings is the
dumping of high-risk loans into the financial system as a
whole. We have been looking at the upstream. In one bank, a big
bank, these mortgages ended up being a lot of toxic mortgages
were created and put into the commercial stream. Next week we
will be looking at credit rating agencies, how were those
mortgages rated when they were securitized and the failures,
the flaws, the shortcomings in that process, and then the week
after we will be looking at the investment banks and the
securitizing and the selling of those securities and what were
the failures and inadequacies in that process that led to such
horrific outcomes for our economy.
But what role, if any, should the regulators have, what
guidance should there be relative to a financial institution
dumping these kind of toxic mortgages into a financial system?
They can come back and bite the institution themselves,
obviously, if they turn out to be flawed and there is a claim
back on the institution. So that is one area why I would hope
regulators would see that something needs to be done in that
area. But, in general, I think you know exactly what I am
driving at. What, if any, guidance should be given to
institutions by regulators relative to that issue as to putting
into the stream of commerce the mortgages which are bad
mortgages? Let us just call them that. Mr. Corston.
Mr. Corston. I do not deal directly, obviously, with
policy, but I will say this. There are efforts to have
institutions have what they call ``skin in the game,'' but I
think the most important thing is that loans that are
underwritten should be underwritten the same as if you are
going to portfolio on your balance sheet as opposed to pushing
them off your balance sheet.
Senator Levin. And how do you put that in guidance? How do
you write that in guidance? Should that be a standard? And
should that be checked in the institution? Should your
regulators or some regulator, depending on who it is, go to an
institution and say, look this is now the guiding principle,
act as though you are keeping this in your own portfolio, and
if there is not a specific amount of skin kept in the game,
whatever that percentage might be----
Mr. Corston. Right.
Senator Levin [continuing]. How would a regulator check
that out to see whether that kind of guidance is being
followed? Act as though you are going to own this instead of
just dumping it in a stream.
Mr. Corston. Through the same exam process we do now. They
are underwriting the loan so we can see the underwriting
standards and we can sample them.
Senator Levin. The same standards that you are now using to
check----
Mr. Corston. The same process.
Senator Levin. The same process could be effective in
adding that one element of guidance.
Do you want to add to that, Mr. Doerr?
Mr. Doerr. That is correct. It is consistent underwriting
on both sides of the equation--for the portfolio loans, for the
securitized loans.
Senator Levin. Thank you both. Did you want to add
anything?
[No response.]
Senator Levin. OK. Thank you. I appreciate your coming.
OK. We are going to have a fourth panel.
[Pause.]
Senator Levin. Our final panel this afternoon: Sheila Bair,
Chairman of the Federal Deposit Insurance Corporation; and John
Bowman, Acting Director of the Office of Thrift Supervision. We
are grateful not just for your being with us today, but for
your voluntary, or involuntary, patience. I think you both know
what our rules are, so under Rule VI, our witnesses, all of
them, are sworn in.
So we would ask you to please stand and raise your right
hand.
Do you solemnly swear that the testimony you are about to
give to this Subcommittee will be the truth, the whole truth,
and nothing but the truth, so help you, God?
Ms. Bair. I do.
Mr. Bowman. I do.
Senator Levin. Ms. Bair, why don't we ask you to go first.
TESTIMONY OF THE HON. SHEILA C. BAIR,\1\ CHAIRMAN, FEDERAL
DEPOSIT INSURANCE CORPORATION
Ms. Bair. Chairman Levin, I appreciate the opportunity to
testify regarding the role of regulators in their supervision
of Washington Mutual Bank (WaMu). The FDIC shares the
Subcommittee's concerns about issues associated with the
primary regulation of large and complex insured depository
institutions that pose significant risk to the Deposit
Insurance Fund and the FDIC's role as back-up supervisor.
---------------------------------------------------------------------------
\1\ The prepared statement of Ms. Bair appears in the Appendix on
page 156.
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To assist the FDIC in carrying out its deposit insurance
responsibilities, Congress has given the FDIC ``back-up''
authority to examine insured banking organizations, like WaMu,
that have a different agency as their primary Federal
regulator. We have often used this authority in a collaborative
process to convince the primary regulator to require corrective
measures. However, when the collaborative process fails, our
ability to independently access information is governed by a
2002 Interagency Agreement in which the FDIC agreed to conduct
a special examination only when an institution ``represents a
heightened risk'' to the Deposit Insurance Fund. As we learned
in the case of WaMu, this is a self-defeating requirement as we
must first gain entry before we can establish that the
requisite triggering conditions exist.
For example, in 2005, WaMu management made the decision to
change its business strategy from conventional single-family
loans to nontraditional and subprime loan products. OTS
management determined that FDIC should not actively participate
in OTS examinations at WaMu, citing the 2002 Interagency
Agreement. In subsequent years, the FDIC faced repeated
resistance to its efforts to fully participate in examinations
of WaMu. Even as late as 2008, as problems at WaMu were
becoming more apparent, OTS management sought to limit the
number of FDIC examiners involved in the examination and did
not permit the FDIC to review loan files.
In the spring of 2008, WaMu raised additional capital, but
the amount raised proved to be insufficient. Virtually all
other high-risk mortgage lenders had closed, gone bankrupt, or
had chosen to be acquired by other institutions. WaMu's board
rejected an acquisition offer from a large commercial bank in
favor of a capital infusion that allowed WaMu to retain its
independence and management to stay in place, but limited
future options for raising capital. In both July and September
2008, WaMu suffered substantial deposit runs, and liquidity was
dissipating quickly. By September 24, cash on hand had declined
to $4.4 billion, a dangerously low amount for a $300 billion
institution that had seen average daily deposit withdrawals
exceeding $2 billion in the previous week. The next day the OTS
closed WaMu.
It has been an extraordinarily challenging time for the
Nation's banking industry, and we have all learned lessons at
many levels. I am very proud of the FDIC's role as an early
advocate for banning unaffordable abusive lending practices,
for fighting against large bank capital reductions, and, most
importantly, for maintaining confidence in the Nation's banking
system by resolving failed institutions in an orderly way and
ensuring that insured depositors have seamless access to their
money. However, we too are learning important lessons from the
crisis, and a central one is that we need to be more proactive
in using our back-up authority, particularly for the larger
institutions where our exposure is the greatest.
We have welcomed the findings and recommendations of the
Inspectors General of the FDIC and the Treasury from their WaMu
review and have already begun a number of their suggested
initiatives. In addition, the FDIC strongly supports pending
legislative reform efforts to address the orderly resolution of
large financial organizations. The ability to resolve these
institutions in the same way that smaller banks are treated, as
we did with WaMu, is essential to ending the too-big-to-fail
doctrine.
The FDIC also strongly supports the need for an independent
consumer financial protection regulator. Products and practices
that strip personal wealth undermine the foundation of the
economy. Finally, we support legislation to require that
issuers of mortgage securitizations retain some ``skin in the
game'' to provide added discipline for underwriting quality. In
fact, the FDIC Board will consider in May a proposal to require
insured banks to retain a portion of the credit risk of any
securitizations that they sponsor.
The FDIC would always like to see troubled institutions
return to health and safe and sound practices. However, as was
the case with WaMu, when an institution is no longer viable,
closing and resolution represent the best course. Further delay
by the government would have significantly raised the cost to
the FDIC, imposed losses on uninsured depositors, and creditors
to even greater losses. The resolution went smoothly. The FDIC
was able to preserve all of WaMu's deposits, both insured and
uninsured. The resolution left branches open, preserved many
jobs, and allowed for a seamless transition for WaMu's
customers the day after the bank was closed. In other words,
most of WaMu was saved.
As with all FDIC resolutions, the institution was not
bailed out but, rather, competitively bid to the private
sector. We were able to sell it at zero cost to the Deposit
Insurance Fund. In contrast, had the FDIC been forced to
liquidate WaMu, the FDIC estimates that it would have suffered
approximately $41 billion in losses.
Thank you for the opportunity to testify, and I am pleased
to answer your questions.
Senator Levin. Thank you very much, Ms. Bair. Mr. Bowman.
TESTIMONY OF JOHN E. BOWMAN,\1\ ACTING DIRECTOR, OFFICE OF
THRIFT SUPERVISION
Mr. Bowman. Good afternoon, Chairman Levin. My name is John
Bowman. I am a career Federal employee who became Acting
Director of the Office of Thrift Supervision a little over 1
year ago during the height of the financial crisis after about
5 years as the agency's chief counsel. It is not a role that I
sought, but I am honored to serve.
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\1\ The prepared statement of Mr. Bowman appears in the Appendix on
page 181.
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My written testimony summarizes OTS' supervision of
Washington Mutual, and the reasons why WaMu failed. It is
important to note that this failure came at no cost to the
Deposit Insurance Fund and at no cost to the American taxpayer
unlike recent failures of other financial institutions and the
near collapse of some of the Nation's largest banks which were
deemed ``too big to fail'' and, therefore, provided government
assistance.
The demise of WaMu came early in the procession of more
than 200 banks and thrifts that have closed during this crisis.
Lifelines, such as the Treasury's TARP program and the FDIC's
increase in deposit insurance coverage, came too late for WaMu.
During the real estate boom before the crisis, WaMu and
other financial firms made a critical error by widely
underwriting home mortgages based more on the value of the
collateral represented by the homes than on the borrower's
documented ability to repay. As home prices continued to rise,
these practices supported a widely praised initiative to
increase homeownership in America. Yet, as we now know,
homeownership reached unsustainable levels and became too much
of a good thing.
Like all of the players in the home mortgage market, bank
managers at WaMu and elsewhere mistakenly believed that they
were effectively averting risks by moving loans off their books
and securitizing them. Similarly, homeowners perceived little
risk in their adjustable-rate mortgages because they thought
they could sell their homes at a profit before rate resets
kicked in. Investors believed mortgage-backed securities
carried little risk because credit rating agencies rated them
highly. Those beliefs proved misplaced when the real estate
market collapsed, the secondary market froze, and the risks
turned out to be all too real. The fallout hit financial
institutions large and small, with State and Federal charters,
overseen by every banking industry regulator.
Since WaMu's failure, the OTS has taken lessons to heart
from our own internal review of failed thrifts and from the
Treasury Inspector General's Material Loss Reviews, and we have
made strides to address the resulting recommendations. We have
instituted controls to better track problems identified in
their examination reports and to take timely, effective action
when necessary. We have established a Large Bank Unit to keep
close watch over our largest regulated institutions,
strengthened oversight of our OTS regions, enhanced supervisory
consistency among regions, tightened scrutiny of problem banks,
and set deadlines for taking enforcement actions after safety
and soundness downgrades. In short, we have made meaningful
changes.
Although some thrifts helped to overinflate the housing
bubble, traditional thrifts whose managers stuck to their
conservative business practices of lending to people they knew
and keeping loans on their books weathered this economic storm
and continue to provide badly needed credit in their
communities. Because consumer and community lending remains
important for American families, I continue to believe in the
thrift charter and the need for thrifts to have a separate
regulator. With the changes we have instituted, I believe we
have made the OTS significantly stronger for the future.
Thank you again, Mr. Chairman. I am happy to answer your
questions.
Senator Levin. Thank you very much, Mr. Bowman.
Throughout the last few years of WaMu's operation, the FDIC
as the back-up regulator made repeated requests to participate
in OTS exams and was continually rebuffed. We heard in the
second panel how the FDIC sought to participate in OTS exams of
Washington Mutual, was limited in terms of staff, forbidden to
do file review. For periods of time, OTS blocked FDIC access to
exam material.
Mr. Bowman, are you familiar with that, and was that the
right course of action?
Mr. Bowman. I can't say that I am familiar with it, Mr.
Chairman, given my responsibilities prior to becoming the
Acting Director, but I have read enough about it and I have
been watching these proceedings to have a sense of what is
alleged to have gone on.
Senator Levin. What is your reaction?
Mr. Bowman. My reaction is twofold, actually. One is the
two people who were probably the two most senior people within
our organization were both prior employees of the FDIC. John
Reich, who spoke earlier, was the Vice Chairman of the FDIC for
5 years. Scott Polakoff, who was the Senior Deputy Director,
had served at the FDIC, I think probably in excess of 25 years,
including that as a Regional Director out in Chicago. My sense
was they knew what the issues were. Their perspective, I
presume, would be as close to the FDIC's as anyone's within
OTS. So I followed their lead.
Senator Levin. I mean, why should it take the FDIC 4 months
to get a desk or access to the examiner's library with WaMu
documents? Does that make any sense to you? Does it ring right?
Mr. Bowman. Yes, that is sort of a specific allegation,
sir, that I really don't have any response to.
Senator Levin. All right. And did you follow the email
traffic back and forth here?
Mr. Bowman. No.
[Pause.]
Senator Levin. The FDIC was going to discuss with WaMu the
recommendation that it was going to make to downgrade its
standing from a 2 to a 3. OTS got wind of it and said, ``I
cannot''--this is from Mr. Reich to Mr. Polakoff, rating
disagreement--``I cannot believe the continuing audacity of
this woman,'' the audacity being that they were going to sit
down and discuss their recommendation to downgrade WaMu. Why is
that so audacious?
Mr. Bowman. Are you reading from a particular email, sir?
Senator Levin. I am, Exhibit 68.\1\
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\1\ See Exhibit No. 68, which appears in the Appendix on page 439.
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Mr. Bowman. All right.
[Pause.]
Mr. Bowman. So the question again?
Senator Levin. What is audacious about the FDIC seeking
access to--not in this case access--sitting down with a bank
which has had the kind of problems that the bank had and to
tell that bank that they were going to recommend a downgrading
in their rating? Why is that so audacious?
Mr. Bowman. Well, I think you probably have to ask John
Reich that, sir. I don't mean to----
Senator Levin. I did.
Mr. Bowman [continuing]. Make light of it, but I am not
sure exactly what else might have been going on with the
Director at that time, what his perception was, what his
perspective was, and why he would have put it into an email
like this.
Senator Levin. And in terms of access to files and sitting
next to OTS when you do your examination, is there anything
particularly problematic about that?
Mr. Bowman. I don't think so----
Senator Levin. Did that happen?
Mr. Bowman. That FDIC should sit next to an OTS examiner?
Senator Levin. No, that they should be rejected when they
try.
Mr. Bowman. Well, I mean, the difficulty I am having with
the characterization of rejected is that I am looking at the
FDIC IG's report, which was issued as part of this, and that
seems to indicate that, in fact, in the end, and I am quoting
now from page 45 of the report, the information obtained from
invoking back-up examination authority did not prompt FDIC to
challenge OTS' composite rating of WaMu until mid-2008. So that
to me indicates that the FDIC got its information. They did
not----
Senator Levin. It took 4 months----
Mr. Bowman. Maybe not in a timely fashion----
Senator Levin. Yes. Mr. Bowman, it took 4 months to get a
desk. Now, look, there is a problem. There is a turf----
Mr. Bowman. A desk?
Senator Levin. Yes, a desk.
Mr. Bowman. OK.
Senator Levin. In FDIC's offices----
Mr. Bowman. WaMu's offices.
Senator Levin. No, in OTS' offices. In WaMu's offices.
Mr. Bowman. Right.
Senator Levin. Let me get it straight. In WaMu's offices
where OTS had space, it took 4 months for the FDIC to get a
desk. Now, there is a problem there. There was a turf war going
on here, it is obvious. They couldn't get to the examiners'
library that had WaMu documents. We had testimony here today.
Did you hear that testimony?
Mr. Bowman. I heard some of it, yes, sir.
Senator Levin. Should that be the case? Should that happen?
Mr. Bowman. It depends upon the circumstances.
Senator Levin. All right. Do you know anything about these
circumstances?
Mr. Bowman. These particular circumstances? I know there
was a dispute going on in terms of how the 2002 agreement
should be implemented. Yes, sir, I know that.
Senator Levin. All right. And you know that Mr. Dochow in
July 2008 sends a message about that Memorandum of
Understanding that was finally issued relative to this bank.
The first thing he wanted to know was how come that went to the
FDIC before it came to me. The answer that he gets back, that
Mr. Dochow sends to Mr. Ward, is the following.\1\ He
apologized, sends the MOU, and he says, ``The MOU came up
yesterday in a call I had with John Reich and Scott Polakoff. .
. . It went to the FDIC because I committed to [the FDIC] to
consider their comments in an effort to minimize their letter
writing and posturing.'' FDIC's posturing.
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\1\ See Exhibit No. 45, which appears in the Appendix on page 368.
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This is the email traffic between your people. Does that
bother you that is the case, that there is this feeling that
exists here that there is a rejection of access to files, to
doing an examination with the FDIC sitting next to it, that a
Memorandum of Understanding which is shared with the FDIC, that
the FDIC is viewed as being a posturer and that is why it was
sent, to try to avoid that posturing? Is that kind of something
that folks in your agency feel about the FDIC, and does it
trouble you if they feel that way, and how do you cure it?
Mr. Bowman. I am not sure what other people within the
agency think about the FDIC. I know what I think about the
FDIC.
Senator Levin. No, but your people--this is the expression.
Mr. Bowman. Right. I have two responses.
Senator Levin. Does that trouble you, is my point.
Mr. Bowman. I have two responses. To the extent that an
employee of the OTS, and I say that as the Acting Director,
uses that kind of language in an email correspondence is
inappropriate.
To the extent that it reflects other issues that may have
prompted that language, there has to be a way to work those
issues out.
Senator Levin. Now, with the FDIC, when they were not given
the access to the files, they weren't given space and they
asked for reasons, they are not even given reasons. When I
asked, what was the reason given by OTS, they said, ``We
weren't given any reasons.''
Then you have an Interagency Memorandum which has now been
entered into. As I understand this, the agencies negotiated
this memorandum. There is a standard in there for FDIC access
and FDIC involvement. Is this Interagency Memorandum--and I ask
this of you, Ms. Bair--is this memorandum sufficient now, or is
it being renegotiated? What is the status of this memorandum?
Ms. Bair. No, it is not sufficient and it is being
renegotiated.
Senator Levin. And why is that?
Ms. Bair. Because, I think as our IG reported, it is
circular in that it requires us to show risk before we can get
access, and frequently we need the access to prove the risk. So
we really need much broader authority to be able to go in when
we feel it is necessary to protect the Deposit Insurance Fund
or gauge our risk exposure.
Senator Levin. And Mr. Bowman, what is your reaction to
that renegotiation?
Mr. Bowman. I have a couple of thoughts. One is going back
to your earlier question about the access to information. I go
to the report of the FDIC IG that was issued today. In that
document, it states categorically that the FDIC had sufficient
information to arrive at and concur with the CAMELS rating that
the OTS had entered into. That is a significant amount of
information in terms of who got to sit at which desk or who got
to sit in which chair----
Senator Levin. No. It is not which desk.
Mr. Bowman. Whether they got a desk or not, or whether they
had to stand in the hall----
Senator Levin. No, whether they had access----
Mr. Bowman. I don't have any information about that.
Senator Levin. Mr. Bowman, the question here is access.
Mr. Bowman. It appears, sir, that they got the access
because they came up with a CAMELS rating----
Senator Levin. It took them 4 months----
Mr. Bowman [continuing]. That concurs with the OTS.
Senator Levin. Mr. Bowman, it took them 4 months to get a
desk with your folks. They were denied access for 4 months at a
critical moment of a bank that was in deep trouble. I hope you
are not going to justify that. I hope you will look into what
happened and why it happened----
Mr. Bowman. I will certainly look into it, sir. I can't
justify it because I don't have any knowledge of it other than
what is being presented here today.
Senator Levin. All right. Well, I think your folks did have
knowledge of it long before today and I think you should have
looked into it long before today so----
Mr. Bowman. I think at least two of those folks that spoke
today, sir, no longer work at the agency.
Senator Levin. Yes, but your legislative folks have access
to this material.
Mr. Bowman. OK. I also should point out, sir, the first I
saw the information I am being asked about in terms of this
book here was when it was placed on the desk in front of me. We
asked access to it so I could perhaps be a little bit more
helpful yesterday and was refused permission to see it----
Senator Levin. These are your documents.
Mr. Bowman. But there were probably how many different
documents turned over?
Senator Levin. According to my staff, these documents were
shown to you in your interview. We had an interview with you,
did we not?
Mr. Bowman. The number of documents that were shown to me
in my interview numbered 10. I see a significant number of tabs
beyond 10.
Senator Levin. And how many did we ask your staff about, or
your former staff about today, more than 10?
Mr. Bowman. I don't know.
Senator Levin. Well, let us take a look at something which
comes from your documents which I have asked them about. These
were OTS documents. These are excerpts from documents. I don't
know if I want to read these again. I don't think you were here
earlier----
Mr. Bowman. I can save you the trouble.
Senator Levin. You can? OK. Well, do you want to look at
Exhibit 1d in your book.\1\ This is the pattern. ``Underwriting
of single-family residential (SFR) loans,'' 2004, ``remains
less than satisfactory.'' Level of SFR underwriting exceptions
in our samples has been an ongoing examination issue, ``in
other words, a problem,'' for several years and one that
management has found difficult to address. ``[Residential
quality assurance]'s review of the 2003 originations disclosed
critical error rates as high as 57 percent of certain loan
samples. . . .'' SFR loan underwriting, this has been an area
of concern for several exams. Securitizations prior to 2003
have horrible performance.
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\1\ See Exhibit No. 1d, which appears in the Appendix on page 200.
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Year after year after year, these are the findings, and yet
no formal action taken by OTS against this bank. That was a
problem. I don't know whether--I guess you didn't hear me ask
questions about it before, but this is not effective
regulation. It is feeble regulation, year after year after
year.
The Inspector General's report is highly critical. I don't
know if you have read that report or not. Did you?
Mr. Bowman. I actually read the report prior to providing
the management response and accepted it. We, in fact, have
already adopted the one recommendation that was made in that
report in terms of further changes by the Office of Thrift
Supervision, which was the implementation of a system to track
management responses. This had been put in place in October
2007.
Senator Levin. So you have read that critical report?
Mr. Bowman. I have read it and the FDIC's, as well.
Senator Levin. Mr. Bowman, are you willing to work with the
FDIC to come up with an Interagency Memorandum which will make
it possible for the FDIC to promptly access information about
insured institutions whenever it finds the need for
information?
Mr. Bowman. Sir, up until whenever it finds the
information, I was prepared to say, yes, I would be prepared to
work with them along with the Federal Reserve Board, the OCC,
which are the four Federal regulators. I should point out, sir,
that my only hesitation in saying that whenever they would like
to get the information is that we do have a statutory structure
which assigns certain responsibilities to different agencies.
The FDIC's authority as it relates to the Federal Reserve, the
Office of the Comptroller of the Currency, and the Office of
Thrift Supervision is that of a back-up regulator.
One of the complaints, and I think one of the reasonable
complaints by Congress coming out of this crisis is that there
was no one to provide or assign responsibility to. There was no
one in charge. To the extent that we mix up or try to shave
over who the primary Federal regulator is, I think we get
ourselves into trouble again with that same kind of charge. If
we are responsible for it, if we made a mistake, we should be
held accountable for it. We can work with the FDIC, and I am
committed to making sure that we work something out so that we
don't have a situation like we apparently had with FDIC and OTS
as it relates to WaMu.
Senator Levin. Is there any reason, since they are a back-
up regulator that has got major skin in the game, as one would
say, given the fact that they insure these firms, these banks,
is there any reason why you cannot work together cooperatively
without mixing up your roles in terms of accountability?
Mr. Bowman. As you also know, as the Acting Director of the
OTS, I am also a Director on the Board of Directors of the
FDIC. So the answer to your question is there is no reason why
we can't work together.
Senator Levin. Is there any reason why we cannot assign
principal responsibility to you if we wanted to, or to any
other regulator if we wanted to, without having that kind of
cooperative relationship with the FDIC? In other words, you can
assign responsibility to someone and still have them act in
cooperation with somebody else, right?
Mr. Bowman. Absolutely.
Senator Levin. All right. So that fact was repeated in
these emails. OTS has principal responsibility. FDIC doesn't.
We went through these emails earlier today. OTS wanted to
remind the FDIC that OTS was the principal regulator, as though
FDIC didn't know it. And that is what is so darn troubling
here, is in critical times in terms of this bank and its
depositors, its impact on the economy, its investors, and so
forth, we didn't see that. We didn't see a cooperative
relationship, and I can still not understand what the
reluctance was. I don't understand why FDIC was apparently
rejected when it sought access to materials and access to joint
examinations.
[Pause.]
Senator Levin. Let me ask both of you about some of the
risky practices that we have talked about at these hearings,
the stated income loans, the negative amortizing loans, teaser
rates. Should these practices be banned, either by a regulator
or by Congress? I think, Ms. Bair, you talked about one of
them, I believe.
Ms. Bair. Yes. We have----
Senator Levin. Go into all of them, the 3 or 4 that we have
talked about.
Ms. Bair. We have. We are opposed on a policy level. We are
opposed to stated income. We are opposed to teaser rate
underwriting. You need to underwrite at the fully indexed rate.
We think you should document income. You should document the
customer's ability to repay, not just the initial introductory
rate, but if it is an adjustable product, when it resets, as
well.
One of the things that complicates the ability to set
strong underwriting standards across the board is that we can
only reach insured depository institutions and a lot of this--
actually, the majority of this--was done by non-banking
institutions that would not be subject to prudential standards
or consumer standards of bank regulators.
The Federal Reserve under HOEPA does have the authority to
apply consumer lending standards across the board. In 2008, we
filed a strong comment letter urging the Federal Reserve to ban
stated income, to require ability to repay, to require
underwriting at the fully indexed rate for all higher-risk
mortgages, not just subprime or higher-rate mortgages, but also
Option ARMs, interest-only loans, any non-traditional mortgage
product. The Federal Reserve did finalize rules, but they only
apply to the high-rate loans. They don't apply to the negative
amortization loans.
They are out for comment again on this issue. We filed
another comment letter suggesting that these type of standards
should apply to at least non-traditional mortgages. I think,
frankly, given the deterioration in the prime market, they
should consider applying them across the board to all
mortgages.
The authority is there now and we have strongly encouraged
the Federal Reserve to use that and we would be happy to make
our comment letters available to the Subcommittee.
Senator Levin. And you have the authority, as well?
Ms. Bair. The banking regulators have the authority for
insured depository institutions under safety and soundness
rules, yes.
Senator Levin. But you have the authority to act on all of
those items that you enumerated?
Ms. Bair. We do for insured depository institutions.
Senator Levin. Stated income, teaser rates, document----
Ms. Bair. That is right, for insured depository
institutions, the primary regulators do.
Senator Levin. And you do. And you have made
recommendations to your board, have you?
Ms. Bair. We have. We joined the Interagency Guidance,
which was a negotiated document. It did not completely ban
stated income, as our examiners indicated, but it did make
clear that we think that should be the exception, not the rule.
I personally would be willing to go further and just eliminate
stated income. I think if you provide flexibility in terms of
the types of documentation that could be provided, whether it
is deposit slips or W-2s or tax returns, fine. Any third-party
good verification of income can be allowed. But some
verification should be made.
I, frankly, don't personally think there is any reason for
a stated income loan and we would be happy to see rulemaking
applied across the board for all insured depository
institutions. But again, you are only getting part of the
market if you don't apply that to the non-banks as well, and
you do get into this regulatory arbitrage problem. The more
standards you put on banks, you have the non-banks doing looser
underwriting and drawing market share from the banks.
Senator Levin. Well, that is exactly the kind of testimony
which I think is going to be very helpful to us as we proceed
with the legislative response.
Mr. Bowman, what would be your answer to my question?
Mr. Bowman. I actually would agree with everything that
Chairman Bair said. Unfortunately, the OTS does not have
separate regulatory responsibility or regulation writing
responsibility. That goes to the Federal Reserve as HOEPA. And
in terms of guidance versus regulation, regulation is the way
to go in that regard.
The only difficulty and the only caution I might have,
taking Chairman Bair's point, one is it has to be applied
across the board, both to regulated depository institutions as
well as what is euphemistically referred to as the shadow
banking agencies or the shadow banking industry.
I think we also have to be careful in terms of, right now,
we are getting lots of indications that there is a credit
crunch going on in our country. Consumers, small businesses,
individuals don't have the kind of access to credit that they
believe they need. Some of that may be an overreaction to the
response to what happened in 2003 through 2007, but the more
prescriptive we become in terms of the kinds of products that
are made available to consumers, I think it could have an
impact upon availability of credit.
Senator Levin. Subject to that risk, it is important,
though, that we be clear and prescriptive? Subject to that risk
that you have just outlined----
Mr. Bowman. Yes.
Senator Levin [continuing]. You support what Ms. Bair said?
Mr. Bowman. Yes.
Senator Levin. OK. And did you comment on the negative
amortizing loans, Chairman Bair?
Ms. Bair. Yes. Well, we think, again, that any loan that
has adjustable features must be underwritten at the fully
indexed rate so that the issuer of the loan should determine
not just whether the borrower can make the payment at the
initial introductory rate, but when it resets.
These Option ARMs are terrible products. As was the case
with WaMu and most of the institutions that made these loans,
the vast majority of borrowers continued making the minimum
payment only, so building up not only negative amortization,
but also facing an interest rate increase when the loans reset.
Our experience with failed banks is that Option ARMs almost
always go bad when they hit the reset period. They were not
underwritten at the fully indexed rate and shouldn't be
allowed. Again, we have encouraged the Federal Reserve to
expand their rules so that they apply to all non-traditional
mortgages, not just what we call subprime, which are the high-
rate mortgages.
Senator Levin. That is very helpful.
Mr. Bowman, do you want to react to that?
Mr. Bowman. Nothing to add to that. I agree with that.
Senator Levin. OK. You have indicated that you have already
sent some public comments----
Ms. Bair. Yes.
Senator Levin [continuing]. On this that you would share
with this Subcommittee. We appreciate that.
Any comments further on this subject, Mr. Bowman, we would
appreciate from you, as well.
I think on that positive note, we will end. Rather than
trying to summarize a long hearing, I don't think I will. It is
obvious that we had a situation where a bank was riddled with
unsafe and unsound lending practices. The regulators saw them,
understood them, but did not act to stop them, and that was
part of the problem that we have had, a big part of it. Other
parts will be taken up next week when we look at the credit
rating agencies, what their failures were that contributed to
this economic disaster. And then the week after, we will be
looking at the investment banks and what their major
contribution was to this economic disaster.
But today's hearing will now be adjourned with thanks.
Ms. Bair. Thank you.
Mr. Bowman. Thank you, Mr. Chairman.
[Whereupon, at 2:55 p.m., the Subcommittee was adjourned.]
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