Sunday, September 4, 2011


review WaMu loan files, insisting that the FDIC instead rely on the findings and conclusions of
OTS examiners who conducted the loan file reviews.
In September 2006, when OTS first refused to give the FDIC direct access to WaMu loan
files, an FDIC senior official commented: “The OTS must really be afraid of what we might
come across, but bottom line is we need access to the information.”786
782 11/10/2006 letter from OTS senior official Michael Finn to FDIC Regional Director John Carter, OTSWMS06-
008 0001827, Hearing Exhibit 4/16-52b.
The FDIC explained to
the Subcommittee that it needed direct access to the loan files to assess the higher risk loans
WaMu was issuing, both to evaluate what insurance fees should be imposed on Washington
Mutual and to assess the extent of any threat to the Deposit Insurance Fund.
783 Id.
784 See, e.g., 1/22/2007 letter from Michael Finn to John Carter, Hearing Exhibit 4/16-52d.
785 See, e.g., April 16, 2010 Subcommittee Hearing at 73-74.
786 9/7/2006 email from FDIC senior official John Carter to George Doerr, FDIC-EM_00252239, Hearing Exhibit
In February 2007, OTS refused an FDIC request to review WaMu loan files to evaluate
the bank’s compliance with recently issued federal guidance on how to handle nontraditional
mortgages, such as subprime, stated income, and negatively amortizing loans. Even though
Washington Mutual was issuing exactly those types of loans under its High Risk Lending
Strategy, OTS indicated that it did not plan to evaluate WaMu’s compliance with the guidance
and did not want the FDIC to perform that evaluation either. In a February email, the FDIC
Dedicated Examiner at WaMu informed the FDIC Assistant Regional Director: “OTS is
restricting FDIC on the current examination in the SFR [single family residential loan] review
segment. OTS will not allow us to review SFR loan files.”787 The Assistant Regional Director
relayed the development to the Regional Director: “John, here we go again. … OTS wants to
draw a distinction between loan file review as an examination activity (that they object to) vs.
risk assessment (which they do not object to). I don’t fathom the distinction.”788
Two months later, in April 2007, the FDIC continued to press for permission to review
WaMu loan files. The FDIC Assistant Regional Deputy wrote in an email to a colleague:
“[OTS Regional Director] 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 WAMU’s compliance with
nontraditional mortgage guidance. ... Mr. Finn and his examiner, Ben Franklin, stated that
OTS did not intend to look at files for purposes of testing nontraditional mortgage
guidance until after the bank made a few changes they had agreed to. I asked if we could
then join the file review whenever ots did look at this, and he said, ‘No.’”789
At the Subcommittee hearing, when asked about these incidents, the FDIC Chairman
Sheila Bair testified:
“[I]n 2005 … OTS management determined that FDIC should not actively participate in
OTS examinations at WaMu, citing the 2002 interagency agreement. In subsequent
years, 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.”790
Both the Treasury and the FDIC Inspectors General were critical of OTS’ actions. In response to
a question about “[w]hether or not OTS should have allowed the FDIC to help” with the
examinations of WaMu, FDIC IG Rymer responded:
“[I]t is clear to me that they [OTS] should have. … [T]hey [the FDIC] had concerns and
those concerns were principally driven by its own LIDI analysis. … [T]here is no
question in my mind that the FDIC’s request for back-up authority, simply given the
787 2/6/2007 email from Stephen Funaro to George Doerr, Hearing Exhibit 4/16-55.
788 2/6/2007 email from George Doerr to John Carter and others, Hearing Exhibit 4/16-55.
789 4/30/2007 email from George Doerr to David Collins, FDIC_WAMU 000014457, Hearing Exhibit 4/16-57.
790 April 16, 2010 Subcommittee Hearing at 80-81 (testimony of Sheila Bair).
sheer size of WaMu, was, to me, enough reason for FDIC to ask for back-up
Treasury IG Thorson agreed:
“I agree with Mr. Rymer. … [T]he 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.
… [A]s a matter of policy, I think they [OTS] should have allowed that. No matter what
their reasoning was, as a matter of policy, they should have, yes.”792
OTS Turf War. At the Subcommittee hearing, John Reich, the OTS Director, was asked
about the friction between the two agencies. In response to a question about the August 2008
email in which he wrote that the FDIC had “no role” at WaMu until OTS “rules on solvency,”793
Mr. Reich: I think basically and fundamentally it was who was the primary Federal
Mr. Reich stressed that the key point he was trying to convey was that OTS was WaMu’s
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.”794
The evidence shows that OTS senior officials not only resisted, but resented the FDIC
participation in the oversight of Washington Mutual Bank and deliberately took actions that
limited the FDIC oversight, even in the face of a deteriorating $300 billion institution whose
failure could have exhausted the entire Deposit Insurance Fund. After contrasting OTS’ hardedged
treatment of the FDIC with the collaborative approach it took towards WaMu, Senator
Levin observed:
“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
791 April 16, 2010 Subcommittee Hearing at 34.
792 Id. at 35.
793 See 8/6/2008 email from OTS Director John Reich to FDIC Chairman Sheila Bair, “Re: W,” FDICEM_
00110089, Hearing Exhibit 4/16-66 (“I should not have to remind you the FDIC has no role until the PFR
[Primary Federal Regulator] (i.e. the OTS) rules on solvency.”).
794 April 16, 2010 Subcommittee Hearing at 64.
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
Because OTS has been abolished, its turf war with the FDIC is over. But witnesses from
the FDIC told the Subcommittee that the remaining banking regulators also sometimes resist its
participation in bank oversight. In particular, a senior FDIC official told the Subcommittee that,
although the FDIC has the statutory authority to take an enforcement action against a bank, the
FDIC has never used that authority because the other regulators would view it as “an act of war.”
The WaMu case history demonstrates how important it is for our federal regulators to view each
other as partners rather than adversaries in the effort to ensure the safety and soundness of U.S.
financial institutions.
D. Regulatory Failures
In a market economy, the purpose of regulation within the financial markets is to provide
a level playing field that works for everyone involved, from the financial institutions, to the
investors, to the consumers and businesses that rely on well functioning financial systems. When
financial regulators fail to enforce the rules in an effective and even handed manner, they not
only tilt the playing field in favor of some and not others, but also risk creating systemic
problems that can damage the markets and even the entire economy.
At the April 16, 2010 hearing of the Subcommittee, Senator Coburn had the following
exchange with Inspectors General Thorson and Rymer, which explains in part why OTS failed as
a regulator to address WaMu’s harmful lending policies:
Senator Coburn: 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. ... 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 ... basically assigning a ‘satisfactory’ rating when
conditions are not is contradictory 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. ...
795 Id. at 66.
Senator Coburn: [To Mr. Thorson] 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.
In trying to understand why OTS failed to make use of its enforcement tools to compel
WaMu to operate in a safe and sound manner, the Subcommittee investigation has identified
factors that have resonance not only in the recent financial crisis, but are critical for regulators
and policymakers to address in order to avoid future financial disasters as well.
(1) OTS’ Failed Oversight of WaMu
During the five-year period of the Subcommittee’s inquiry, from 2004 to 2008, OTS
identified over 500 serious operational deficiencies at WaMu and Long Beach. At WaMu, the
problems included weak lending standards, high loan exception and error rates, noncompliance
with bank loan policy, weak risk management, poor appraisal practices, and poor quality loans.
At Long Beach, OTS identified many of the same problems and added on top of those, weak
management, poor quality mortgage backed securities, and inadequate repurchase reserves. The
problems are described in examination report after examination report, and OTS raised many of
the same concerns, in writing and in person, with WaMu’s Board of Directors.
But for all those years, OTS did little beyond describing the problems and asking bank
executives to make improvements. When the reforms failed to materialize, the problems
continued, and the risk increased, OTS stood on the sidelines. Subcommittee interviews found
that, until 2008, OTS regulators never even held internal discussions about taking an
enforcement action against the bank. In 2008, in the face of mounting losses, OTS took two
informal, nonpublic enforcement actions, which contained few mandatory measures or deadlines
and were together insufficient to save the bank.
In trying to understand the agency’s years of inaction, the Subcommittee’s investigation
concluded that the lack of enforcement reflected an OTS culture of deference to bank
management, demoralized examiners whose oversight efforts were unsupported by their
supervisors, and a narrow regulatory focus that allowed short term profits to excuse high risk
activities and disregarded systemic risk. Inflated CAMELS ratings may have further reduced the
pressure to act, while conflicts of interest may have also tempered OTS’ willingness to take
tough enforcement action against WaMu.
(a) Deference to Management
Part of the reason that OTS declined to take enforcement action against Washington
Mutual was a posture of deference to the management of the institutions it regulated. Ronald
Cathcart, WaMu’s chief enterprise risk officer from 2006-2008, described OTS as essentially
believing in “self-regulation”:
“I … have actually operated in banks under three regulators, in Canada under the Office
of the Supervisor of Financial Institutions, at Bank One under the OCC, and then at
Washington Mutual under the OTS[.] … [T]he 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 that I had …
seen with the other two regulators. … I would say that the OTS did believe in selfregulation.”
A former OTS regulator who later took a job with WaMu, was quoted in a press report as saying
that OTS provided “by far the softest” oversight of any federal bank regulator.797
Evidence of OTS’ unusually deferential approach can be found in its internal documents,
starting at the top. In a May 2007 email, for example, cancelling lunch with a colleague so he
could instead have lunch with WaMu’s CEO, Kerry Killinger, OTS Director, John Reich,
described the bank as “my largest constituent.”798 At the Subcommittee hearing, Mr. Reich
defended using the term, testifying that referring to others as constituents was a “habit” he had
picked up while working on Capitol Hill.799 One Senator pointed out that OTS’ true constituents
were not the banks it regulated, but “the American people it was supposed to protect from unsafe
and unsound banking practices.”800
On another occasion in July 2008, Mr. Reich sent an email to Mr. Killinger informing
him that OTS had decided to issue a Memorandum of Understanding (MOU) to address issues of
concern at the bank. In the email, the OTS Director apologized twice for his method of
communication, but also sounded a note of regret for his decision to take a tougher approach:
I’m sorry to communicate by email – I’ve left a couple of messages on your office phone,
but I’m guessing you may be off for a long weekend.
I’ve been wrestling with the issue of an MOU versus a Board Resolution as a result of
our conversation in my office last week. And I’ve decided that an MOU is the right
approach for OTS to do in this situation ….
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. …
So as 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 do believe we need to do an MOU. We
796 April 13, 2010 Subcommittee Hearing, at 39-40 (Testimony of Ronald J. Cathcart, former WaMu Chief
Enterprise Risk Officer, 2006-2008).
797 “Lax Regulators Helped Doom Washington Mutual,” Associated Press (4/16/2010).
798 5/2/2007 email from OTS Director John Reich to Shelley Hymes, “Re: Lunch Friday,” Reich_John-
00025837_001, Hearing Exhibit 4/16-78.
799 April 16, 2010 Subcommittee Hearing at 36.
800 Id. at 5 (opening statement of Senator Levin).
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.
Again, I’m sorry to communicate this decision by email, but I’m scheduled to be out of
the office next week myself and wanted you to have this information.
Best regard, Kerry,
The email does not convey a message from an arms-length regulator concerned about a
failing bank. To the contrary, the email conveys a sense of familiarity and discloses that the
head of OTS knew his agency had already been providing preferential treatment to the bank by
failing to impose an MOU after its downgrade to a 3 rating five months earlier, in February
2008. Mr. Reich stated that others “looking over our shoulders … would probably be surprised”
an MOU was not already in place at WaMu.
When asked about this email at the Subcommittee hearing, the Treasury and the FDIC
Inspectors General both expressed discomfort with its language and tone:
Mr. Thorson: 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.
… [T]here is not an acceptance of the fact that a strong regulatory control helps them.
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.802
Equally telling is the fact that, even after sending the email, OTS delayed imposing the MOU on
WaMu for another two months, waiting until September 2008, just three weeks before the bank’s
Like the head of the agency, OTS examiners also took a deferential approach to WaMu.
In a January 2006 email discussing WaMu’s desire to purchase Long Beach, for example, the
OTS Examiner-in-Charge indicated that, rather than insist the bank clean up Long Beach
801 7/3/2008 email from OTS Director John Reich to WaMu CEO Kerry Killinger, OTSWMS08-014 0000912-13,
Hearing Exhibit 4/16-44.
802 April 16, 2010 Subcommittee Hearing at 34.
803 See also id. at 46 (When asked why OTS took so long to complete the MOU, former OTS Director John Reich
testified: “I don’t know, to tell you the truth. I do not know why it took so long to implement the MOU. … I regret
[the] … delay.”).
problems before the purchase, OTS would have to rely on its “relationship” with WaMu to get
the job done:
“The letter [from WaMu] seems okay. They obviously want to leave it a little squishy, of
course, on the growth plans, but at least they make a firm commitment to clean up the
underwriting issues. 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 [Long Beach] to grow significantly without having the practices cleaned up
On another occasion in June 2006, the same OTS Examiner-in-Charge sent a lengthy
email to his Regional Director discussing plans for the annual WaMu Report on Examination
(ROE). His email expressed concern about losing credibility with the bank if OTS pressed too
hard on certain reforms, twice noted the bank’s size and complexity, and stressed that the bank
was making progress in fixing identified problems:
“[W]e still have some strong feelings on some items that I’d like to ‘push back’ … some
on. Generally we feel that we are quite balanced and do not have any gloves on in our
approach to our findings and conclusions at WAMU. We have some concern that if we
press forward with some things … we may run the risk of losing some credibility in
terms of understanding the size and complexity of their business and looking as though
we do not have a balanced perspective. My own fear is that we may not have done
enough to communicate to you [the Regional Director] why we feel that the few negative
things we have brought up through findings memos and meetings, while important to
keep in front of management, are not so serious they wipe out all the right things the
institution is doing in all those areas we reviewed and did not have any issues, nor should
they negate the ongoing good progress in making improvements in a manner that seems
reasonable given the size, complexity, and status of the institution.”805
The Examiner-in-Charge then listed three areas of concern, problems at Long Beach
which he seemed to downplay, the need to limit the number of corrective actions listed in the
ROE, and the need to review how OTS cited the bank for compliance violations. In the Long
Beach discussion, he wrote that improvements “will take time because of size and complexity
…. We don’t feel demanding more than providing us with an acceptable action plan with
realistic timelines is appropriate or necessary at this time.” On the corrective actions, he wrote
that the list had to be limited or “more important findings will get lost. … We feel strongly that
we should not cite all findings and corrective actions within the body of the ROE … [which] is
already not getting read I believe.” He also expressed concern that OTS was “starting to ‘overmeeting’
the institution” and suggested that “the exit meeting” with the bank to discuss the ROE
findings had “become almost unnecessary.”
804 1/27/2006 email from Lawrence Carter to Darrel Dochow, OTSWMS06-008 0001082, Hearing Exhibit 4/16-32.
805 6/15/2006 email from Lawrence Carter to Darrel Dochow, Dochow_Darrel-00022908_001, Hearing Exhibit
After urging patience on WaMu reforms, suggesting a limit on the corrective actions
listed in the ROE, and recommending fewer meetings with WaMu management, the curious final
line in the email is: “My management class this week has made me feel empowered! Can you
tell? Please don’t fire me!”
Additional evidence of OTS deference is its reliance on WaMu to track its own
compliance with OTS findings calling for corrective action. At all other thrifts, OTS tracked the
extent to which the thrift implemented OTS findings, using its own systems. But at WaMu, OTS
did not keep its own records, but relied on WaMu’s Enterprise Risk Issue Control System
(ERICS). The Treasury and the FDIC Inspectors General criticized this arrangement, noting that
they were unable to use WaMu’s system to determine the status of multiple OTS findings.806 In
addition, they noted that, in 2006, ERICS discontinued its practice of identifying “repeat
findings,” making it difficult to identify and track those findings.807
Finally, the actual language used by OTS in its reports and memoranda that described
deficiencies demonstrated a passive approach to dealing with management. Common phrases
noted that the bank’s practices were “less than satisfactory,” error rates were at “higher than
acceptable levels,” and “management’s actions did not improve underwriting to a satisfactory
level.” OTS reports rarely used more assertive language that, for example, called the bank’s
efforts unsatisfactory, inadequate, or ineffective. An exchange at the Subcommittee hearing
between Senator Levin and the OTS Examiner-in-Charge at WaMu from 2004 to 2006,
Lawrence Carter, captured the issue:
Their report explicitly
recommends against OTS’ relying on a bank’s systems in the future to track compliance.
“Mr. Carter: 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: … Can you use the words, ‘Folks, your progress was 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.
806 See, e.g., IG Report at 30.
807 See Thorson prepared statement, April 16, 2010 Subcommittee Hearing at 12.
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.”808
At times, WaMu took advantage of its special relationship with OTS and lobbied for
leniency. In one instance from May 2006, a WaMu official from the Regulatory Relations
division sent an email to his colleagues stating that he was able to convince the agency to reduce
an audit “criticism” to the less serious category of a “recommendation”: “OTS confirmed today
that they will re-issue this memo without the ‘Criticism.’ It will be a ‘Recommendation.’”809 His
colleague forwarded the email to bank executives noting: “Good news - John was able to get the
OTS to see the light and revise the Underwriting rating to a Recommendation.”810
A more serious incident involved WaMu’s 2005 discovery, after almost a year-long
investigation by an internal Home Loans Risk Mitigation Team, of substantial loan fraud taking
place at two high volume loan offices in California, known as Downey and Montebello. The
WaMu investigators found that 83% of the loans reviewed from the Downey office and 58% of
the loans reviewed from the Montebello office contained fraudulent information, either with
respect to the borrower or the appraised value of the property. The investigators wrote up their
findings and presented them to WaMu’s Chief Risk Officer and the President of Home Loans.811
Two years later, in 2007, after a mortgage insurer refused to insure any more loans issued
by the lead loan officer in the Montebello office, OTS directed WaMu to investigate the matter.
WaMu’s internal auditors launched an investigation, confirmed the loan fraud problem at the
Montebello office, and also uncovered the 2005 investigation whose fraud findings had been
ignored. WaMu took until April 2008 to produce a report documenting its findings.
No one, however, informed OTS, and WaMu took no action to stop the fraudulent loans.
808 April 16, 2010 Subcommittee Hearing at 60-61.
also initially resisted providing the report to OTS, claiming it was protected by attorney-client
809 5/30/2006 email from John Robinson, WaMu VP of Regulatory Relations, to colleagues, JPM_WM02619435.
Hearing Exhibit 4/16-34.
810 5/30/2006 email from Wayne Pollack, WaMu SVP, to David Schneider, et al., JPM_WM02619434, Hearing
Exhibit 4/16-34.
811 See 11/17/2005 WaMu internal memorandum, “re So. CA Emerging Markets Targeting Loan Review Results,”
JPM_WM01083051, Hearing Exhibit 4/13-22a; 11/16/2005 WaMu internal PowerPoint presentation, “Retail Fraud
Risk Overview,” JPM_WM02481934-49, Hearing Exhibit 4/13-22b; 11/19/2005 email from Cheryl Feltgen to
colleagues, “Re: Retail Fraud Risk Overview,” JPM_WM03535694-95, Hearing Exhibit 4/13-23a; 8/29/2005 email
from Jill Simons to Timothy Bates, “Risk Mit Loan review data ‘Confidential,’” JPM_WM04026076-77, Hearing
Exhibit 4/13-23b.
812 4/4/2008 WaMu internal memorandum, from June Thoreson-Rogers, Corporate Fraud Investigations, and
Michele Snyer, Deputy General Auditor, to Stewart Landefeld, Acting Chief Legal Officer, and others, Hearing
Exhibit 4/13-24.
OTS’ deference to WaMu management appeared to be the result of a deliberate posture
of reliance on the bank to take the steps needed to ensure that its personnel were engaged in safe
and sound practices. The reasoning appeared to be that if OTS examiners simply identified the
problems at the bank, OTS could then rely on WaMu’s own self interest, competence, and
discipline to ensure the problems were corrected, with no need for tough enforcement action. It
was a regulatory approach with disastrous results. While OTS may have hoped that it could
accomplish its regulatory responsibilities by simply identifying problems without the threat of
enforcement action, that approach proved ineffective.
The OTS Examiner-in-Charge at the time told the Subcommittee that he insisted on
seeing the report. After finally receiving it and reading about the substantial loan fraud occurring
at the two loan offices since 2005, he told the Subcommittee that it was “the last straw” that
ended his confidence that he could rely on WaMu to combat fraudulent practices within its own
(b) Demoralized Examiners
For five years, OTS examiners identified serious problems with WaMu’s lending
practices and risk management, but OTS senior officials failed to support their efforts by using
the agency’s enforcement tools to compel the bank to correct the identified problems. WaMu’s
chief risk officer from 2004 to 2005, James Vanasek, remarked at the Subcommittee hearing on
how OTS examiners seemed to receive little support from more senior officials in terms of
“[T]he OTS Examiner-in-Charge during the period time in which I was involved … did
an excellent job of finding and raising the issues. Likewise, I found good performance
from … the FDIC Examiner-in-Charge. … What I cannot explain is why the superiors
in the agencies didn’t take a tougher tone with the banks given the degree of … negative
findings. My experience with the OTS, versus with the OCC, was completely different.
So there seemed to be a tolerance there or a political influence on senior management of
those agencies that prevent them from taking a more active stance. By a more active
stance, I mean putting the banks under letters of agreement and forcing change.”814
Internal OTS documents and emails indicate that the result was a cadre of OTS examiners who
were skeptical of their ability to effect meaningful change at WaMu, who were too often
rebuffed by their own management when they tried to reduce risk or strengthen bank controls,
and whose leaders worked to weaken rather than strengthen the standards used by examiners to
hold banks accountable.
813 Subcommittee interview of OTS Examiner-in-Charge Benjamin Franklin (2/17/2010).
814 April 13, 2010 Subcommittee Hearing at 39 (testimony of James G. Vanasek, former WaMu Chief Risk Officer,
Low Expectations. The documents show that OTS examiners had low expectations that
WaMu would actually implement recommended changes at the bank. Ultimately, OTS
examiners adapted to the situation, they gave up trying to make the bank act more quickly, and
WaMu was able to delay needed changes for long periods of time if it wished.
In 2003, for example, one OTS examiner wrote to the Examiner-in-Charge:
“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 …. If any target is missed, as happens at WaMu,
then we may not be in a position to determine the effectiveness of the corrective
In 2005, another OTS examiner wrote: “They agree to take all action required to correct the
problem. The Target Completion Dates are not real timely but fine for WaMu.”816
Other examiners were more critical. In 2007, for example, one OTS examiner wrote:
“Regulatory Relations [the WaMu office established to work with regulators] is a joke.
The purpose of this group seems to be how can we give the regulators the bare minimum
without them raising a fuss.”817
The examiner also wrote:
“WaMu’s compliance management program has suffered from a lack of steady,
consistent leadership. Dick Stevenson, who took over as Chief Compliance Officer on
March 2, 2007, is the bank’s ninth compliance leader since 2000. … The OTS is very
concerned that this lack of consistent, stable leadership leaves the program vulnerable.
This amount of turnover is very unusual for an institution of this size and is a cause for
concern. The Board of Directors should commission an evaluation of why smart,
successful, effective managers can’t succeed in this position. If you would like my
opinion, just ask. (HINT: It has to do with top management not buying into the
importance of compliance and turf warfare and Kerry [Killinger] not liking bad
In an interview, OTS examiner Benjamin Franklin, who worked at the agency for 24
years, told the Subcommittee that the thrifts he oversaw generally did not “collaborate” with the
agency but would “fight” OTS reviews and resist OTS recommendations. He said that at WaMu,
815 6/27/2003 email from Dennis Fitzgerald, OTS Examiner, to Lawrence Carter, OTSWEM04-0000006748,
Hearing Exhibit 4/16-15.
816 6/8/2005 email from Verlin Campbell, OTS Examiner, to Zalka Ancely, OTS Examiner, OTSWME05-003
0000634, Hearing Exhibit 4/16-29.
817 5/31/2007 Draft Compliance Memo from Susie Clark, OTS Compliance Specialist, Franklin_Benjamin-
00020408_002, Hearing Exhibit 4/16-9.
818 Id. at Franklin_Benjamin-00020408_001.
“for the most part” OTS examiners were “butting heads” with bank personnel and it was difficult
to effect change.819
Weak Standards. The documents show that the OTS examiners were also frustrated by
the agency’s weak standards, which made it difficult to cite WaMu for violations or require the
bank to strengthen its operations.
In 2007, for example, an examiner critical of WaMu’s compliance procedures wanted to
downgrade the bank’s compliance rating from 2 to 3, but told the OTS Examiner-in-Charge that,
due to the lack of standards on compliance matters, she didn’t believe she could win a battle with
the bank:
“I’m not up for the fight or the blood pressure problems. … It doesn’t matter that we are
right, what matters is how it is framed. … They [Washington Mutual] aren’t interested
in our ‘opinions’ of the [compliance] program. They want black and white, violations or
not. … [O]ur training always emphasizes ‘Best Practices’ but when it comes down to it,
we don’t have the resources to show the risk.”820
At another point, when discussing standards for calculating acceptable loan error rates, an
OTS examiner wrote:
“We will need additional discussion of acceptable error rates and how we view their
[WaMu’s] standard. … [A] 2.5 percent error rate would mean that approximate[ly]
$600.0 million could be originated and be within acceptable guidelines. A 20.0 percent
medium error rate means that $4.8 billion of loans with these types of errors could be
originated without a criticism. The latter seem[s] especially high when you consider that
their medium criteria includes loans that we don’t think should be made.”821
The OTS Examiner-in-Charge responded with a lengthy email criticizing outdated, unclear OTS
standards on the acceptable loan error rate for a portfolio of subprime loans:
“Unfortunately, our sampling standards are 10 years old and we have no standards of
acceptance really. It depends on our own comfort levels, which differ. … Moreover, our
guidance requires that an exception be SIGNIFICANT, which ... we have over time
interpreted as loans that should not have been made. … 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. I have always used these standards as rough benchmarks and
not absolutes myself, upping my expectations for higher risk portfolios. … It would be
819 Subcommittee interview of Benjamin Franklin (2/17/2010).
820 6/3/2007 email from OTS examiner Mary Clark to Examiner-in-Charge Benjamin Franklin, “Compliance
Rating,” OTSWMS07-013 0002576, Hearing Exhibit 4/16-39.
821 11/21/2005 email exchange between OTS examiner Benjamin Franklin and Examiner-in-Charge Lawrence
Carter and others, OTSEMS05-004 0001911-12, Hearing Exhibit 4/16-30.
nice if they [higher risk loan portfolios] could meet even higher expectations, but that
would require us to agree on what the standard should be.”822
At another point, the same Examiner-in-Charge wrote a long email discussing issues
related to a decision by WaMu to qualify borrowers for adjustable rate mortgages using an
interest rate that was less than the highest rate that could be charged under the loan. He
complained that it was difficult to force WaMu to comply with the OTS “policy of underwriting
at or near the fully indexed rate,” when “in terms of policy, I am not sure we have ever had a
really hard rule that institutions MUST underwrite to the fully indexed rate.”823
NTM Guidance. While some OTS examiners were complaining about the agency’s
weak standards, other OTS officials worked to ensure that new standards being developed for
high risk mortgages would not restrain WaMu’s lending practices. The effort began in 2006 with
an aim to address concerns about lax lending standards and the risks posed by subprime,
negatively amortizing, and other exotic home loans. The federal banking agencies convened a
joint effort to reduce the risk associated with those mortgages by issuing interagency guidance
for “nontraditional mortgage” products (“NTM Guidance”). Washington Mutual filed public
comments on the proposed NTM Guidance and argued that Option ARM and Interest-Only loans
were “considered more safe and sound for portfolio lenders than many fixed rate mortgages,” so
regulators should “not discourage lenders from offering these products.”
He also noted
that OTS sometimes made an exception to that rule for loans held for sale.
824 It also stated that
calculating a potential borrower’s “DTI [debt-to-income ratio] based on the potential payment
shock from negative amortization would be highly speculative” and “inappropriate to use in
lending decisions.”825 During subsequent negotiations to finalize that guidance, OTS argued for
less stringent lending standards than other regulators were advocating and bolstered its points
using data supplied by Washington Mutual.826
In one July 2006 email, for example, an OTS official expressed the view that early
versions of the new guidance focused too much on negative amortization loans, which were
popular with several thrifts and at WaMu in particular, and failed to also look closely at other
high risk lending products more common elsewhere.827 He also wrote that OTS needed to
address this issue and “should consider going on the offensive, rather than defensive to refute the
OCC’s positions” on negatively amortizing loans, defending the loans using WaMu Option
ARM loan data.828
822 Id.
In August, several OTS officials discussed over email how to prevent the
823 9/15/2005 email from OTS Examiner-in-Charge Lawrence Carter to OTS Western Region Deputy Director
Darrel Dochow, OTSWMS05-002 0000535, Hearing Exhibit 4/16-6.
824 3/29/2006 letter from Washington Mutual Home Loans President David C. Schneider to OTS Chief Counsel,
Proposed Guidance – Interagency Guidance on Nontraditional Mortgage Products 70 Fed. Reg. 77249,
825 Id. at JPM_WM04473298.
826 Subcommittee interviews of Sheila Bair (4/5/2010) and George Doerr (3/30/2010). The Subcommittee was told
that OTS was the “most sympathetic to industry” concerns of the participating agencies and was especially
protective of Option ARMs.
827 7/27/2006 email from Steven Gregovich to Grovetta Gardineer and others, “NTM Open Issues,” OSWMS06-008
0001491-495, Hearing Exhibit 4/16-71.
828 Id.
proposed restrictions on negatively amortizing loans from going farther than they believed
necessary, noting in part the “profitable secondary market” for Option ARMs and the fact that
“hybrid IO [interest only] ARMs are a huge product for Wamu.” One OTS official wrote:
“We have dealt with this product [negatively amortizing loans] 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.”829
OTS officials argued variously that the new proposal would wrongly put the focus on
“products” instead of “underwriting,” as well as that it would hurt the business of large thrifts
like WaMu.830
The NTM Guidance was finally issued on October 4, 2006.831
evaluate a borrower’s ability to fully repay a prospective loan, including any balance
increase from negative amortization;
The final version did not
fully reflect the recommendations of OTS on negatively amortizing loans. Among other matters,
it called on banks to:
qualify borrowers using the higher interest rate that would apply after any teaser or
introductory interest rate;
avoid loans whose repayment was dependent solely upon the value of the collateral or
the borrower’s ability to refinance the loan; and
implement strong quality control and risk mitigation procedures for loans containing
layers of risk, including loans with no documentation requirements, no verification of
the borrower’s income or assets, or high loan-to-value ratios.
The Guidance also called for capital levels commensurate with risk and adequate allowances for
loan losses.
The Guidance was not promulgated as a bank regulation that could be enforced in court,
and it contained no explicit deadline for compliance. Instead, it provided policies and procedures
that regulators could use as benchmarks during examinations. Agencies could penalize
noncompliance with the standards through lower CAMELS ratings or enforcement actions.
FDIC officials told the Subcommittee that the FDIC expected banks to come into immediate
829 8/14/2006 email from Kurt Kirch to David Henry and Steven Gregovich, “Latest AMP Guidance,” Hearing
Exhibit 4/16-72.
830 7/27/2006 email from Steven Gregovich to Grovetta Gardineer, et al., “NTM Open Issues,” OSWMS06-008
0001491-495, Hearing Exhibit 4/16-71.
831 10/4/2006 “Interagency Guidance on Nontraditional Mortgage Product Risks,” (NTM Guidance), 71 Fed. Reg.
192 at 58609.
compliance with the Guidance, and that no agency should have been telling a bank that it did not
have to comply with the new standards.832
A few days after the NTM Guidance went into effect, WaMu officials met with OTS
about implementation and reported back that OTS had indicated that compliance was something
institutions “should” do, not something they “must” do.833 According to a written summary by
WaMu of its October 12, 2006 meeting with OTS to discuss the new rules, OTS told the bank
that it “view[ed] the guidance as flexible” and “specifically pointed out that the language in the
guidance says ‘should’ vs. ‘must’ in most cases and they [were] looking to WaMu to establish
our position on how the guidance impacts our business processes.”834
In 2007, OTS conducted a review of WaMu’s Option ARM activities and compliance
efforts and found that three months after the NTM Guidance had become effective, the bank was
not yet complying with the new standards when issuing Option ARMs.835 The OTS review
noted that as of January 31, 2007, the bank had a total of $62 billion in outstanding Option
ARMs in its investment portfolio, of which 80% were negatively amortizing.836 The review
stated that, as of December 31, 2006, WaMu was not in compliance with the NTM Guidance,
because it continued not to consider potential negative amortization amounts when qualifying
borrowers for Option ARMs; placed too much reliance on FICO scores instead of income
verification to qualify borrowers for nontraditional mortgages; failed to consider amortizing
payments or payment shocks when qualifying borrowers for interest only loans; and placed too
much reliance on collateral, rather than borrower income, as the primary repayment source in the
event of a loan default.837
In April 2007, the FDIC asked OTS for permission to conduct its own review of WaMu
loan files to evaluate the bank’s compliance with the NTM Guidance.
The review contained no recommendations for actions to ensure
WaMu changed its procedures.
838 OTS refused, however,
to provide the FDIC with access to the relevant loan files and effectively blocked the review.839
832 Subcommittee interviews of Sheila Bair (4/5/2010) and George Doerr (3/30/2010).
The FDIC Assistant Regional Director George Doerr told the Subcommittee that when he
833 See 10/2006 OTS Meeting, “Washington Mutual Alternative Mortgage Guidance Implementation Plan,”
JPM_WM02549033, Hearing Exhibit 4/16-73.
834 Id. at JPM_WM02549037. Subcommittee interview of Darrel Dochow (3/3/2010) (indicating that the NTM
Guidance used “should” instead of “must” to avoid being a “one-size-fits-all” set of requirements). See also
Subcommittee interview of John Bowman (4/6/2010) (indicating that guidance is not enforceable and that giving
banks more time to comply was a reasonable approach).
835 See undated OTS document, “Option ARM Neg Am Review Workprogram 212A(1) & Nontraditional Mortgage
Guidance Review,” OTSWMEF-0000009888, Hearing Exhibit 4/16-74. The document quotes Option ARM data
from March 31, 2007, indicating that the document was prepared after that date.
836 Id. at OTSWMEF-0000009890.
837 Id. at OTSWMEF-0000009893-94.
838 See, e.g., 4/30/2007 email from FDIC Western Region Assistant Director George Doerr to FDIC official David
Collins, FDIC_WAMU 000014457, Hearing Exhibit 4/16-57.
839 See April 16, 2010 Subcommittee Hearing at 33 (Testimony of FDIC IG John Rymer: “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.”); See also
April 16, 2010 Subcommittee Hearing at 187 (Testimony of George Doerr, FDIC).
contacted OTS official Mike Finn about the FDIC’s request to review WaMu loan files to test
NTM compliance, Mr. Finn said that OTS was giving its institutions more time to comply with
the guidance, even though it had taken effect more than six months earlier.840 The FDIC
Chairman Sheila Bair told the Subcommittee that the FDIC had not known until then that OTS
was allowing institutions to delay compliance with the NTM Guidance and were “surprised” by
the agency’s actions. She said that normally, if an institution needs more time to comply with
new standards, a regulator required it to provide a written plan with milestones for achieving
Documents uncovered by the Subcommittee show how WaMu took advantage of the
delay to continue its high risk lending practices. The NTM Guidance directed banks, for
example, to evaluate a borrower’s ability to repay a mortgage using the highest interest rate that
would be charged under the loan and the fully amortized payment amount rather than any
smaller or minimum payment amount. After determining that those new requirements could lead
to a 33% drop in Option ARM loan volume due to borrowers who would no longer qualify for
the loans, WaMu’s Chief Enterprise Risk Officer, Ron Cathcart, advised “holding off on
implementation until required to act for public relations (CFC [Countrywide] announces
unexpectedly) or regulatory reasons.”842 When he made that suggestion in March 2007, OTS
had already allowed Washington Mutual to delay its compliance with the Guidance for six
months, resulting in the bank’s originating billions of dollars in new Option ARM loans that
would later suffer significant losses.843
In addition, in May 2007, when an OTS official attempted to stop WaMu from issuing
mortgages without verifying borrower incomes, relying on the NTM Guidance and other rules as
justification, OTS senior management rebuffed the official’s efforts. Instead, OTS senior
managers interpreted its standards as allowing thrifts to continue issuing “stated income loans,”
also called “No Income No Asset” (NINA) or “no doc” loans, because they permitted lenders to
provide credit without verifying the borrower’s income or assets. On May 15, 2007, after
reviewing a summary of WaMu’s loans, an OTS official in Washington, Bill Magrini, sent an
email to the OTS Examiner-in-Charge with responsibility for WaMu stating:
Instead of using the NTM Guidance as an opportunity to
strengthen WaMu’s lending standards and reduce its loan risk, OTS chose to delay its
“I note that WAMU makes a significant amount of No-doc loans. OTS policy states that
no-doc loans are unsafe and unsound. I assume they mean no doc regarding NINA or no
income-no asset loans.
840 Subcommittee interview of George Doerr (3/30/2010).
841 Subcommittee interview of Sheila Bair (4/5/2010).
842 3/19/2007 email from Ron Cathcart to David Schneider, JPM_WM02571598, Hearing Exhibit 4/16-75.
843 See (subscription website maintained by JPMorgan Chase with data on Long Beach and
WaMu mortgage backed securities showing, as of January 2011, delinquency rates for particular mortgage backed
securities, including WMALT 2006 OA-3 – 57.87%).
Without even asking for income or assets/liabilities, the loans are collateral-dependent.
This is imprudent … [T]he interagency NTM Guidance states specifically that collateral
dependent loans are unsafe and unsound. …
Does WAMU have any plans to amend its policies per no doc loans?”844
The Examiner-in-Charge, Benjamin Franklin, relayed the inquiry to the then Director of
the OTS Western Region Office, Darrel Dochow, and stated that, while WaMu had not issued
“true NINAs” in the past, the bank had begun “doing NINA’s in 2006 through their conduit
program. As such, all these loans are held for sale.” He estimated WaMu then had about $90
million of NINA loans held for sale, had originated about $600 million in 2006, and would
originate the same amount again in 2007.845
Mr. Dochow responded that he was already in regular contact with OTS officials in
Washington about WaMu and “there is no need to duplicate with Bill Magrini as far as I
“I am being told that Bill’s views may not necessarily represent OTS policy in these
matters. I value Bill’s input, but we should be careful about relaying his views to others
as being OTS policy, absent collaborating written guidance. [His] views … are
somewhat inconsistent with NTM guidance and industry practice. I also understand
Grovetta [another OTS official] promised to clarify section 212 of the handbook in
several areas as a result of the NTM roundtable discussion in Wash DC last month.”
Later the same day, Mr. Dochow wrote:
That same day, another OTS official, Mark Reiley, sent an email indicating his belief that
sections of the OTS handbook barred WaMu from issuing NINA loans, even when those loans
were originated for sale to Wall Street:
“The Handbook guidance Section 212 states that no-doc loans (NINAs) are unsafe and
unsound loans (Pg. 212.7). Furthermore, even if the no-doc (NINA) loans are originated
and held for sale the guidance indicates (pg. 212.8) the association must use prudent
underwriting and documentation standards and we have already concluded they are
unsafe and unsound. Even if the institution holds the loans for a short period of time. …
[T]his is a hot topic in DC and we are getting a significant amount of push back from the
844 See 5/15/2007 email from OTS Examiner-in-Charge Benjamin Franklin to OTS Western Region Director Darrel
Dochow, Franklin_Benjamin-00020449_001, Hearing Exhibit 4/16-79 (quoting email from Bill Magrini). See also
3/27/2007 email from OTS official Bill Magrini to OTS colleagues, Quigley_Lori-00110324, Hearing Exhibit 4/16-
76 (“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. … It is not at all surprising that delinquencies are up,
even among Alt-A. In my opinion, credit standards have gone too low.”). See also undated OTS document,
“Option ARM Neg Am Review Workprogram 212A(1) & Nontraditional Mortgage Guidance Review,” at
OTSWMEF-0000009891, Hearing Exhibit 4/16-74 (determining that 73% of the Option ARMs in WaMu’s portfolio
were “low doc” loans).
845 5/16/2007 email from OTS Western Region Director Darrel Dochow to OTS Examiner-in-Charge Benjamin
Franklin, Franklin_Benjamin-00020449_001, Hearing Exhibit 4/16-79.
846 Id.
847 Id.
industry. … At this point I don’t think a memo is the best avenue, I think we need to
request in writing that WAMU respond to us on how the NINA’s comply with the
handbook guidance?”
The WaMu Examiner-in-Charge, Benjamin Franklin, responded:
“I didn’t intend to send a memo until I got a blessing from [the Western Region Director]
or DC on what our official policy is on this. … [M]any of our larger institutions now do
NINAs (including Countrywide) .… Apparently [OTS policy official] Bill Magrini is the
lone ranger in his view that NINA’s are imprudent. West region position seems to be that
FICO, appraisal, and other documentation … is sufficient to assess the borrower’s ability
to repay in all but subprime loans. While I probably fall more into the Magrini camp
(until we get empirical data to support NINAs are not imprudent) we will just document
our findings … until the ‘official’ policy on this has been worked out.”848
A year later, in October 2008, after WaMu’s failure, the same Examiner-in-Charge,
Benjamin Franklin, wrote to a colleague:
“[N]ot one regulatory agency had a rule or guideline saying you couldn’t do stated
income lending, even to this day. That, I find incredible. We criticized stated income
lending at WaMu but they never got it completely fixed. … [I]n hindsight, I’m
convinced that it is just a flawed product that can’t be fixed and never should have been
allowed in the first place. How do you really assess underwriting adequacy when you
allow the borrower to tell you what he makes without verification. We used to have
documentation requirements for underwriting in the regs, but when those were taken out,
the industry slowly migrated to an anything goes that got us into this mess. … When I
told Scott Polakoff [OTS Deputy Director] that stated income subprime should not be
made under any circumstance, I was corrected by Mike Finn [OTS Western Region head]
that that was not the West Region’s position. I rest my case.”849
Data compiled by the Treasury and FDIC Inspectors General shows that, by the end of
2007, stated income loans – loans in which the bank did not verify the borrower’s income –
represented 50% of WaMu’s subprime loans, 73% of its Option ARMs, and 90% of its home
equity loans.850 At the Subcommittee hearing, virtually every witness condemned stated income
loans as unsafe and unsound.851 OTS Director John Reich testified that he regretted not doing
more to prevent supervised thrifts from issuing stated income loans.852
Subcommittee interviews with OTS examiners who worked at WaMu found those
examiners to be demoralized and frustrated at their inability to effect change at the bank. They
848 Id.
849 10/7/2008 email exchange between OTS Examiner-in-Charge Benjamin Franklin and OTS examiner Thomas
Constantine, “West Region Update,” Franklin_Benjamin-00034415_001, Hearing Exhibit 4/16-14.
850 4/2010 “Evaluation of Federal Regulatory Oversight of Washington Mutual Bank,” prepared by the Offices of
Inspector General at the Department of the Treasury and Federal Deposit Insurance Corporation, at 10, Hearing
Exhibit 4/16-82.
851 See, e.g., April 16, 2010 Subcommittee Hearing at 14-15, 41-42.
852 Id. at 42 (“In hindsight, I regret it.”).
had identified serious deficiencies at the bank year after year, with no enforcement
consequences; some tried to interpret OTS standards in ways that would reduce risk, only to be
rebuffed by their leaders; and others were told that the NTM Guidance being enforced by other
agencies did not have standards that could be enforced by OTS examiners. Days after WaMu’s
failure, one OTS examiner had this to say about OTS leadership:
“My examination history here is filled with the editing and removal of my comments as
well as predictions (that turned out to be true) by EICs [Examiners-in-Charge]. No
system in place to keep that from happening. Instead we put whitewashers and scaredity
cats in charge of the most problematic shops. I don’t know what happened to you at
WAMU, but I was critical of their accounting at Card Services and the AP. Fortunately, I
think I made the ‘don’t let him come back here’ list. … [O]ur leadership screwed us and
can’t acknowledge it. They should resign.”853
(c) Narrow Regulatory Focus
In addition to a policy of deference to management, weak standards, and demoralized
examiners, OTS employed an overly narrow regulatory focus that allowed WaMu’s short term
profits to excuse its risky practices and that ignored systemic risk. For a time, its short term
profits masked the problems at Washington Mutual, and regulators allowed practices which they
knew to be risky and problematic to continue. Because it mishandled its responsibilities, OTS
gave the illusion to investors, economists, policy makers, and others that the bank was sound,
when in reality, it was just the opposite. Unfortunately, the truth of the matter was not revealed
until it was too late, and the bank collapsed.
Using Short Term Profits to Excuse Risk. OTS justified not taking enforcement action
against WaMu in part by pointing to Washington Mutual’s profits and low loss rates during the
height of the mortgage boom, claiming they made it difficult to require the bank to reduce the
risks threatening its safety and soundness. In 2005, when faced with underwriting problems at
WaMu, the OTS Examiner-in-Charge put it this way:
“It has been hard for us to justify doing much more than constantly nagging (okay,
‘chastising’) through ROE [Reports of Examination] and meetings, since they [WaMu]
have not been really adversely impacted in terms of losses. It has been getting better and
has not recently been bad enough to warrant any ratings downgrade.”854
The OTS Handbook was explicit, however, in stating that profits should not be used to
overlook or excuse high risk activities:
853 10/7/2008 emails from OTS examiner Thomas Constantine to OTS Examiner-in-Charge Benjamin Franklin,
“West Region Update,” Franklin_Benjamin-00034415_002, Hearing Exhibit 4/16-14.
854 9/15/2005 email from Examiner-in-Charge Lawrence Carter to Western Region Deputy Director Darrel Dochow,
OTSWMS05-002 0000535, Hearing Exhibit 4/16-6.
“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 insignificant losses in
the near term.”855
But in the case of Washington Mutual, profits did make a difference. At the
Subcommittee hearing, when asked by Senator Kaufman to identify one or two reasons why no
regulatory action was taken against WaMu, the FDIC IG Jon Rymer testified as follows:
“[L]et 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 [take action], even
though problems were there in underwriting, the product mix, the distribution process,
the origination process, all in my view extraordinarily risky .… [T]he people in [agency]
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.”856
In his prepared statement, the Treasury Inspector General, Eric Thorson, noted
that OTS examiners told his staff they did not lower WaMu’s CAMELS ratings because
“even though underwriting and risk management practices were less than satisfactory,
WaMu was making money and loans were performing.”857
This problem was not isolated within OTS, however, but applied to other regulatory
agencies as well. The FDIC Inspector General noted, for example, that the bank’s profitability
also tempered the FDIC views of the bank. He explained that, prior to 2008, the FDIC did not
challenge WaMu’s 2 CAMELS ratings, because “the risks in WaMu’s portfolio had not
manifested themselves as losses and nonperforming loans, and therefore did not impact WaMu’s
financial statements.”858 At the same time, an internal FDIC analysis of the bank identified a
long list of “embedded risk factors” in WaMu’s home loans that, despite the bank’s profitability,
exposed the bank to losses in the event of “a widespread decline in housing prices.”859
In the financial industry, high risk activities are undertaken by financial institutions to
earn higher marginal returns. The role of the regulator is to enforce rules that ensure the risks an
institution undertakes do not unfairly transfer that risk to others or threaten the safety and
soundness of the economy, despite any short term profits. In the case of the FDIC, the judgment
855 11/2004 Office of Thrift Supervision Examination Handbook, at 070.8, OTSWMEF-0000032053; 2/2011 Office
of Thrift Supervision Examination Handbook, at 070.9, (quote is the
same in updated version of handbook). See also April 16, 2010 Subcommittee Hearing at 19 (testimony of FDIC and
Treasury Inspectors General).
856 April 16, 2010 Subcommittee Hearing at 24-26.
857 Thorson prepared statement at 10, April 16, 2010 Subcommittee Hearing at 110.
858 Rymer prepared statement at 10, April 16, 2010 Subcommittee Hearing at 129.
859 Undated draft memorandum from the WaMu examination team at the FDIC to the FDIC Section Chief for Large
Banks, FDIC-EM_00251205-10, Hearing Exhibit 4/16-51a (likely mid-2005).
includes whether the risk threatens loss to the Deposit Insurance Fund. Any firm that decides to
take a risk should be the only firm, along with its investors, to bear the brunt of the problem if it
turns out to have been a mistake. Regulators that, when faced with short term profits, stop
evaluating or downplay attendant risks that could produce later losses fail in their obligation to
ensure the safety and soundness of the financial institutions they are regulating. In the case of
WaMu, both OTS and the FDIC allowed the bank’s success in the short term to paper over its
underlying problems.
In October 2008, after Washington Mutual failed, the OTS Examiner-in-Charge at the
bank, Benjamin Franklin, deplored OTS’ failure to prevent its thrifts from engaging in high risk
lending because “the losses were slow in coming”:
“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 stated income, subprime, 100% CLTV [Combined Loan-to-Value], lending, we were
on the figurative bridge to nowhere. Even those of us that were early opponents let
ourselves be swayed somewhat by those that accused us of being ‘chicken little’ because
the losses were slow in coming, and let[’]s not forget the mantra that ‘our shops have to
make these loans in order to be competitive’. I will never be talked out of something I
know to be fundamentally wrong ever again!!”860
Failure to Consider Financial System Impacts. A related failing was that OTS took a
narrow view of its regulatory responsibilities, evaluating each thrift as an individual institution
without evaluating the effect of thrift practices on the financial system as a whole. The U.S.
Government Accountability Office, in a 2009 evaluation of how OTS and other federal financial
regulators oversaw risk management practices, concluded that none of the regulators took a
systemic view of factors that could harm the financial system:
“Even when regulators perform horizontal examinations across institutions in areas such
as stress testing, credit risk practices, and the risks of structured mortgage products, they
do not consistently use the results to identify potential system risks.”861
Evidence of this narrow regulatory focus includes the fact that OTS examiners carefully
evaluated risk factors affecting home loans that WaMu kept on its books in a portfolio of loans
held for investment, but paid less attention to the bank’s portfolio of loans held for sale. OTS
apparently reasoned that the loans held for sale would soon be off WaMu’s books so that little
analysis was necessary. From 2000 to 2007, WaMu securitized about $77 billion in subprime
860 10/7/2008 email from OTS Examiner-in-Charge Benjamin Franklin to OTS Examiner Thomas Constantine,
Franklin_Benjamin-00034415, Hearing Exhibit 4/16-14.
861 3/18/2009 Government Accountability Office, “Review of Regulators’ Oversight of Risk Management Systems
at a Limited Number of Large, Complex Financial Institutions,” Testimony of Orice M. Williams, Hearing Exhibit
4/16-83 (GAO reviewed risk management practices of OTS, as well as the Federal Reserve, the Office of the
Comptroller of the Currency, the SEC, and self-regulatory organizations.).
loans, mostly from Long Beach, as well as about $115 billion in Option ARM loans.862
Numerous documents show that OTS and the FDIC were, in fact, aware that WaMu was
issuing high risk loans that led to poor quality securitizations:
documents indicate that OTS did not consider the problems that could result from widespread
defaults of poorly underwritten mortgage securities from WaMu and other thrifts.
2005 OTS email describing poor quality Long Beach mortgage backed securities:
“Performance data for 2003 and 2004 vintages appear to approximate industry average
while issues [of securities] prior to 2003 have horrible performance. ... [Long Beach]
finished in the top 12 worst annualized [net credit losses] in 1997 and 1999 thru 2003. …
At 2/05, [Long Beach] was #1 with a 12% delinquency rate. Industry was around
2005 FDIC analysis of WaMu high risk loans: “Management acknowledges the risks
posed by current market conditions and recognizes that a potential decline in housing
prices is a distinct possibility. Management believes, however that the impact on
[WaMu] would be manageable, since the riskiest segments of production are sold to
investors, and that these investors will bear the brunt of a bursting housing bubble.”864
2005 OTS email discussing allowing lower standards for loans held for sale: “[L]oans
held for sale could be underwritten to secondary market standards …. I believe we would
still find that secondary market requirements are more lax than our policy on
underwriting to fully indexed rates. … [I]f you allow them [WaMu] the exception for
loans held for sale … they probably do not have a ton of loans that fall far outside our
policy guidance.”865
2006 OTS email discussing Long Beach loans that had to be repurchased from buyers:
“The primary reasons for the problem were … [g]eneral lower quality 2005 production
due to economy and lowered standards …. The $4.749 billion in loans on [Long Beach]
books at 12/31/05 are largely comprised of the same 2005 vintage production that was
sold in the whole loan sales and are now subject to the increased repurchases. …
Management is balancing the probability that these loans will perform worse than
expected and priced for, versus the increased income they generate … in considering
whether to [sell] some or all of the portfolio.”866
862 “Securitizations of Washington Mutual and Long Beach Subprime Home Loans,” chart prepared by the
Subcommittee, Hearing Exhibit 4/13-1c; 10/17/2006 “Option ARM” draft presentation to the WaMu Board of
Directors, JPM_WM02549027, chart at 2, Hearing Exhibit 4/13-38.
863 4/14/2005 email from OTS examiner to colleagues, OTSWME05-0120000806, Hearing Exhibit 4/13-8a.
864 Undated draft memorandum from WaMu examination team to the FDIC Section Chief for Large Banks, FDICEM_
00251205-10, Hearing Exhibit 4/16-51a (likely mid-2005).
865 9/16/2005 email from OTS Examiner-in-Charge at WaMu, OTSWMS05-002 0000535, Hearing Exhibit 4/16-6.
866 1/20/2006 email from Darrel Dochow to Michael Finn and others, OTSWMS06-007 0001020.
2008 OTS email after WaMu’s failure: “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.”867
2005 WaMu audit of Loan Sales and Securitization planned no further audit for three
years. In March 2007, OTS informally suggested that more frequent audits would be
appropriate given the high volume and high risk nature of WaMu’s securitization activity
and “data integrity issues surrounding the creation of securitization trusts, resulting in
loan repurchases from those trusts.”868
Neither OTS nor the FDIC saw preventing WaMu’s sale of high risk mortgages into U.S.
securitization markets as part of its regulatory responsibilities.
OTS was two years too late, however; the
secondary market for subprime securities collapsed four months later.
(d) Inflated CAMELS Ratings
Still another possible explanation for OTS’ inaction may have been the overly positive
CAMELS ratings it assigned WaMu. From 2004 until early 2008, WaMu held a 2 rating, which
meant that it was “fundamentally sound,” had “satisfactory risk management,” and had “only
moderate weaknesses that [were] within the board’s and management’s capability and
willingness to correct.”869
Both the Treasury and the FDIC Inspector General criticized the assignment of the 2
ratings as inaccurate and inappropriate, highlighting how those inflated ratings masked the true
A lower CAMELS rating would have represented one of the strongest
actions that OTS and the FDIC could have taken, because it would have required changes from
“[W]e find it difficult to understand how OTS could assign WaMu a satisfactory asset
quality 2-rating for so long. Assigning a satisfactory rating when conditions are not
satisfactory sends a mixed and inappropriate supervisory message to the institution
and its board. It is also contrary to the very purpose for which regulators use the
CAMELS rating system.”
Treasury IG Thorson focused in particular on the 2 rating assigned to WaMu’s high
risk home loans:
Inspector General Thorson also criticized the 2 rating assigned to WaMu’s management,
which signaled “satisfactory performance by management and the Board of Directors and
867 10/7/2008 email from OTS examiner Thomas Constantine to OTS colleague Benjamin Franklin,
Franklin_Benjamin-00034415_001, Hearing Exhibit 4/16-14.
868 See 3/5/2007 WAMU Examination “Review of Securitization,” OTSWME07-075 0000780-791 at 789 (data
gathered from WaMu’s Market Risk Committee minutes, Dec. 2006 and Jan. 2007).
869 Thorson prepared statement at 7, April 16, 2010 Subcommittee Hearing at 107.
870 See, e.g., Treasury and FDIC IG Report at 16.
871 Thorson prepared statement at 10, April 16, 2010 Subcommittee Hearing at 110. See also id. at 8, April 16, 2010
Subcommittee Hearing at 108.
satisfactory risk management practices.”872
“[T]he 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. … I find it difficult to understand why the management rating at a minimum
was not lowered much earlier on.”
He noted that OTS gave management this positive
rating until June 2008, despite the bank’s ongoing failure to correct the many deficiencies
identified by OTS examiners and the fact that management problems at WaMu were
longstanding. At the Subcommittee hearing, the FDIC Inspector General Rymer also criticized
the 2 rating assigned to WaMu’s management:
The FDIC Inspector General also noted that, from 2004 to 2008, the FDIC had assigned
LIDI ratings to WaMu that indicated a higher degree of risk at the bank than portrayed by the
bank’s CAMELS ratings. He observed that LIDI ratings, which are intended to convey the
degree of risk that a bank might cause loss to the Deposit Insurance Fund, are designed to be
more forward-looking and incorporate consideration of future risks to a bank, as compared to
CAMELS ratings, which are designed to convey the state of an institution at a particular point in

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