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Sunday, November 23, 2008

WaPo: Regulatory Failure at the Office of Thrift Supervision

by Calculated Risk on 11/23/2008 01:15:00 AM

The WaPo has an article reviewing how the Office of Thrift Supervision (OTS) failed to properly regulate lenders: Banking Regulator Played Advocate Over Enforcer

OTS is responsible for regulating thrifts, also known as savings and loans, which focus on mortgage lending. As the banks under OTS supervision expanded high-risk lending, the agency failed to rein in their destructive excesses despite clear evidence of mounting problems, according to banking officials and a review of financial documents.

Instead, OTS adopted an aggressively deregulatory stance toward the mortgage lenders it regulated. It allowed the reserves the banks held as a buffer against losses to dwindle to a historic low.
The agency championed the thrift industry's growth during the housing boom and called programs that extended mortgages to previously unqualified borrowers as "innovations." In 2004, the year that risky loans called option adjustable-rate mortgages took off, then-OTS director James Gilleran lauded the banks for their role in providing home loans. "Our goal is to allow thrifts to operate with a wide breadth of freedom from regulatory intrusion," he said in a speech.
The article references the infamous chainsaw incident:
In the summer of 2003, leaders of the four federal agencies that oversee the banking industry gathered to highlight the Bush administration's commitment to reducing regulation. They posed for photographers behind a stack of papers wrapped in red tape. The others held garden shears. Gilleran ... hefted a chain saw.
Cutting Red Tape This photo from 2003 shows two regulators: John Reich (then Vice Chairman of the FDIC and later at the OTS) and James Gilleran of the Office of Thrift Supervision (with the chainsaw) and representatives of three banker trade associations: James McLaughlin of the American Bankers Association, Harry Doherty of America's Community Bankers, and Ken Guenther of the Independent Community Bankers of America.
The article also discusses how the OTS dragged their feet when new lending guidelines were proposed by the Office of the Comptroller of the Currency:
In 2006, at the peak of the boom, lenders made $255 billion in option ARMs ... Most option ARMs were originated by OTS-regulated banks.

Concerns about the product were first raised in late 2005 by another federal regulator, the Office of the Comptroller of the Currency. The agency pushed other regulators to issue a joint proposal that lenders should make sure borrowers could afford their full monthly payments. "Too many consumers have been attracted to products by the seductive prospect of low minimum payments that delay the day of reckoning," Comptroller of the Currency John C. Dugan said in a speech advocating the proposal.

OTS was hesitant to sign on ... [John] Reich, the new director of OTS, warned against excessive intervention. He cautioned that the government should not interfere with lending by thrifts "who have demonstrated that they have the know-how to manage these products through all kinds of economic cycles."
Back in 2005 I posted frequently on the progress of the proposed new guidance. I spoke with a number of regulators in 2005 and 2006 who were involved in the process, and a number of them expressed frustration with the OTS and the Fed.

Here is an excerpt from the NY Times from July 2005: A Hands-Off Policy on Mortgage Loans
For two months now, federal banking regulators have signaled their discomfort about the explosive rise in risky mortgage loans.

First they issued new "guidance" to banks about home-equity loans, warning against letting homeowners borrow too much against their houses. Then they expressed worry about the surge in no-money-down mortgages, interest-only loans and "liar's loans" that require no proof of a borrower's income.

The impact so far? Almost nil.

"It's as easy to get these loans now as it was two months ago," said Michael Menatian, president of Sanborn Mortgage, a mortgage broker in West Hartford, Conn. "If anything, people are offering them even more than before."

The reason is that federal banking regulators, from the Federal Reserve to the Office of the Comptroller of the Currency, have been reluctant to back up their words with specific actions. For even as they urge caution, officials here are loath to stand in the way of new methods of extending credit.
I was outraged by the foot dragging at the time ... the regulators knew there was a lax lending problem in early 2005 (they were already late), and the continual foot dragging just made the inevitable crisis worse (as an example the peak year for Option ARM lending was in 2006).

This willful lack of oversight by certain regulators was outrageous.