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The Office of Thrift Supervision: A Case Study in Republican Regulatory Neglect

Bush and company failed in ways that have undermined Americans' confidence in the ability of government to solve the country's most pressing problems.

There probably couldn't be a worse time than now for Americans to have lost faith in their government. And yet, that is the case. The most recent survey issued by the Pew Research Center a few days ago tells us that a scant 22% of Americans trust the federal government "almost always or most of the time." Half the people in the country believe that when government runs something, it is usually inefficient and wasteful. Further, 58% of Americans say the government has gone too far in regulating business. 

Two reasons seem to stand out as explanations: From 2000-2008, the Bush Administration showed us it had little interest and, frankly, limited capacity to actually govern. Bush and company failed in ways that have undermined Americans' confidence in the ability of government to solve the country's most pressing problems. Second, the massive bailout of Wall Street didn't help improve the image of the federal government in the eyes of its citizens. In fact, it had quite the opposite effect.

These combined factors have made the job of leading the country more difficult for President Obama. But do most Americans really want to drown government in a bathtub, as Grover Norquist famously said? The good news from the Pew Center is that most Americans (61%) do support stricter regulation of the financial services industry. Still, whatever financial overhaul bill emerges from Congress won't matter much if the rules aren't enforced. A little history with a focus on a little-known agency is in order.

Financial regulators during the Bush era kept their foot off the pedal for ideological reasons. At the Securities and Exchange Commission, for example, Republican Christopher Cox and his colleagues failed to spot Bernie Madoff's Ponzi scheme and totally missed the accounting shenanigans at Lehman Brothers.

Another agency on few people's radar screen is the Office of Thrift Supervision (OTS). The mission of the OTS is to regulate federal thrifts.

Exhibit 1: Indy Mac -- On February 26, 2009, the Treasury Department's Inspector General issued a report critical of the OTS under former director John Reich. The report said that regulators ignored repeated warning signs and should have seen that Indy Mac was “built” – I use that term loosely - on shaky loans based on inflated property values. The inspector general said the OTS should have taken enforcement action against Indy Mac more than two years before the bank was finally seized by the FDIC on July 11, 2008. The bank was finally undone by its lax loan standards that allowed people to borrow money without documenting their income. The report concluded that OTS laxity added significantly to the FDIC's substantial losses from the bank's failure.

Exhibit 2: Washington Mutual -- The failure of WaMu, as it was known, was almost a carbon copy of the Indy Mac collapse, except for its scale. This was the largest bank failure in U.S. history. Senate investigators placed the primary blame on WaMu executives whose search for profits led to the bank's failure and sale to JPMorgan Chase in 2008. Former CEO Kerry Killinger steered the bank into adjustable-rate subprime mortgages, only to discover too late that the thrift was lending to many unqualified borrowers. Senate investigators also found fault with Washington Mutual's compensation system, which gave bonuses to loan officers who made subprime loans even if the borrower qualified for a conventional loan.

But Senator Carl Levin also unloaded on Mr. Reich at his subcommittee's hearing into the matter on April 16th. Said the senior Senator from Michigan: “Washington Mutual's collapse is a tale of greed and mismanagement, but it is also a case history of ineffective bank regulators who saw years of unsafe and unsound banking practices, but failed to stop them. OTS was more of a spectator on the sidelines, a watchdog with no bite, not acting to correct the flaws and failures it saw." Senate staffers also called out Mr. Reich by name for…