Wall Street and the Financial Crisis: Anatomy of a Financial Collapse


B. Background

At the time of its collapse, Washington Mutual Savings Bank was a federally chartered thrift with over $188 billion in federal insured deposits. Its primary federal regulator was OTS. Due to its status as an insured depository institution, it was also overseen by the FDIC.

The Office of Thrift Supervision was created in 1989, in response to the savings and loan crisis, to charter and regulate the thrift industry. |597| Thrifts are required by their charters to hold most of their assets in mortgage lending, and have traditionally focused on the issuance of home loans. |598| OTS was part of the U.S. Department of the Treasury and headed by a presidentially appointed director. Like other bank regulators, OTS was charged with ensuring the safety and soundness of the financial institutions it oversaw. Its operations were funded through semiannual fees assessed on the institutions it regulated, with the fee amount based on the size, condition, and complexity of each institution's portfolio. Washington Mutual was the largest thrift overseen by OTS and, from 2003 to 2008, paid at least $30 million in fees annually to the agency, which comprised 12-15% of all OTS revenue. |599|

In 2009, OTS oversaw about 765 thrift-chartered institutions. |600| OTS supervised its thrifts through four regional offices, each led by a Regional Director, Deputy Director, and Assistant Director. Regional offices assigned an Examiner-in-Charge to each thrift in its jurisdiction, along with other supporting examination personnel. Approximately three-quarters of the OTS workforce reported to its four regional offices, while the remaining quarter worked at OTS headquarters in Washington, D.C. Washington Mutual, whose headquarters were located in Seattle, was supervised by the Western Region Office which, through the end of 2008, was based in Daly City, California.

During the years reviewed by the Subcommittee, the OTS Executive Director was John Reich; the Deputy Director was Scott Polakoff; the Western Region Office Director was Michael Finn and later Darrel Dochow; and the Examiners-in-Charge at WaMu were Lawrence Carter and later Benjamin Franklin.

WaMu's secondary federal regulator was the FDIC. The FDIC's mission is to maintain stability and public confidence in the nation's financial system by insuring deposits, examining and supervising financial institutions for safety and soundness and consumer protection, and managing failed institutions placed into receivership. |601| The FDIC administers the Deposit Insurance Fund, which is the primary mechanism used to protect covered deposits at U.S. financial institutions from loss. The Deposit Insurance Fund is financed through fees assessed on the insured institutions, with assessments based on the amount of deposits requiring insurance, the amount of assets at each institution, and the degree of risk posed by each institution to the insurance fund.

To minimize withdrawals from the Deposit Insurance Fund, the FDIC is assigned backup supervisory authority over approximately 3,000 federally insured depository institutions whose primary regulators are the Federal Reserve, OCC, and, until recently, OTS. Among other measures, the FDIC is authorized to conduct a "special examination" of any insured institution "to determine the condition of such depository institution for insurance purposes." |602| To facilitate and coordinate its oversight obligations with those of the primary bank regulators and ensure it is able to protect the Deposit Insurance Fund, the FDIC has entered into an inter-agency agreement with the primary bank regulators. |603| The 2002 version of that agreement, which was in effect until 2010, stated that the FDIC was authorized to request to participate in examinations of large institutions or higher risk financial institutions, recommend enforcement actions to be taken by the primary regulator, and if the primary regulator failed to act, take its own enforcement action with respect to an insured institution.

For the eight largest insured institutions at the time, the FDIC assigned at least one Dedicated Examiner to work on-site at the institution. The examiner's obligation is to evaluate the institution's risk to the Deposit Insurance Fund and work with the primary regulator to lower that risk. During the period covered by this Report, Washington Mutual was one of the eight and had an FDIC-assigned Dedicated Examiner who worked with OTS examiners to oversee the bank.

During the years examined by the Subcommittee, the FDIC Chairman was Sheila Bair; the Acting Deputy Director for the FDIC's Division of Supervision and Consumer Protection's Complex Financial Institution Branch was John Corston; in the San Francisco Region, the Director was John Carter and later Stan Ivie, and the Assistant Director was George Doerr. At WaMu, the FDIC's Dedicated Examiner was Stephen Funaro.

The stated mission of OTS was "[t]o supervise savings associations and their holding companies in order to maintain their safety and soundness and compliance with consumer laws, and to encourage a competitive industry that meets America's financial services needs." The OTS Examination Handbook required "[p]roactive regulatory supervision" with a focus on evaluation of "future needs and potential risks to ensure the success of the thrift system in the long term." |604| OTS, like other bank regulators, had special access to the financial information of the thrifts under its regulation, which was otherwise kept confidential from the market and other parties.

To carry out its mission, OTS traditionally conducted an examination of each of the thrifts within its jurisdiction every 12 to 18 months and provided the results in a Report of Examination ("ROE"). In 2006, OTS initiated a "continuous exam" program for its largest thrifts, requiring its examiners to conduct a series of specialized examinations during the year with the results from all of those examinations included in an annual ROE. The Examiner-in- Charge led the examination activities which were organized around the CAMELS rating system used by all federal bank regulators. The CAMELS rating system evaluates a bank's: (C) capital adequacy, (A) asset quality, (M) management, (E) earnings, (L) liquidity, and (S) sensitivity to market risk. A CAMELS rating of 1 is the best rating, while 5 is the worst. In the annual ROE, OTS provided its thrifts with an evaluation and rating for each CAMELS component, as well as an overall composite rating on the bank's safety and soundness. |605|

At Washington Mutual, OTS examiners conducted both on-site and off-site activities to review bank operations, and maintained frequent communication with bank management through emails, telephone conferences, and meetings. During certain periods of the year, OTS examiners had temporary offices at Washington Mutual for accessing bank information, collecting data from bank employees, performing analyses, and conducting other exam activities. Washington Mutual formed a Regulatory Relations office charged with overseeing its interactions and managing its relationships with personnel at OTS, the FDIC, and other regulators.

During the year, OTS examiners issued "findings memoranda," which set forth particular examination findings, and required a written response and corrective action plan from WaMu management. The memoranda contained three types of findings. The least severe was an "observation," defined as a "weakness identified that is not of regulatory concern, but which may improve the bank's operating effectiveness if addressed. … Observations may or may not be reviewed during subsequent examinations." The next level of finding was a "recommendation," defined as a "secondary concern requiring corrective action. … They may be included in the Report of Examination … Management's actions to address Recommendations are reviewed at subsequent or follow-up examinations." The most severe type of finding was a "criticism," defined as a "primary concern requiring corrective action … often summarized in the ‘Matters Requiring Board Attention' … section of the Report of Examination. … They are subject to formal follow-up by examiners and, if left uncorrected, may result in stronger action." |606|

The most serious OTS examination findings were elevated to Washington Mutual Bank's Board of Directors by designating them as a "Matter Requiring Board Attention" (MRBA). MRBAs were set forth in the ROE and presented to the Board in an annual meeting attended by OTS and FDIC personnel. Washington Mutual tracked OTS findings, along with its own responses, through an internal system called Enterprise Risk Issue Control System (ERICS). ERICS was intended to help WaMu manage its relationship with its regulators by storing the regulators' findings in one central location. In one of its more unusual discoveries, the Subcommittee learned that OTS also came to rely largely on ERICS to track its dealings with WaMu. OTS' reliance on WaMu's tracking system was a unique departure from its usual practice of separately tracking the status of its past examination findings and a bank's responses. |607|

The FDIC also participated in the examinations of Washington Mutual. Because WaMu was one of the eight largest insured banks in the country, the FDIC assigned a full-time Dedicated Examiner to oversee its operations. Typically, the FDIC examiners worked with the primary regulator and participated in or relied upon the examinations scheduled by that regulator, rather than initiating separate FDIC examinations. At least once per year, the FDIC examiner performed an evaluation of the institution's risk to the Deposit Insurance Fund, typically relying primarily on the annual Report on Examination (ROE) issued by the primary regulator and the ROE's individual and composite CAMELS ratings for the institution. After reviewing the ROE as well as other examination and financial information, the FDIC examiner reviewed the CAMELS ratings for WaMu to ensure they were appropriate.

In addition, for institutions with assets of $10 billion or more, the FDIC had established a Large Insured Depository Institutions ("LIDI") Program to assess and report on emerging risks that may pose a threat to the Deposit Insurance Fund. Under that program, the FDIC Dedicated Examiner and other FDIC regional case managers performed ongoing analysis of emerging risks within each covered institution and assigned it a quarterly risk rating, using a scale of A to E, with A being the best rating and E the worst. In addition, senior FDIC analysts within the Complex Financial Institutions Branch analyzed specific bank risks and developed supervisory strategies. If the FDIC viewed an institution as imposing an increasing risk to the Deposit Insurance Fund, it could perform one or more "special examinations" to take a closer look.


597. Twenty years after its establishment, OTS was abolished by the Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 111-203, (Dodd-Frank Act) which has transferred the agency's responsibilities to the Office of the Comptroller of the Currency (OCC), and directed the agency to cease all operations by 2012. This Report focuses on OTS during the time period 2004 through 2008. [Back]

598. 6/19/2002 OTS Regulatory Bulletin, "Thrift Activities Regulatory Handbook Update" (some educational loans, SBLs, and credit card loans also count towards qualifying as a thrift), http://files.ots.treas.gov/74081.pdf. [Back]

599. See April 16, 2010 Subcommittee Hearing at 11 (testimony of Treasury IG Eric Thorson). [Back]

600. 2009 OTS Annual Report, "Agency Profile," http://www.ots.treas.gov/_files/482096.pdf. [Back]

601. See "FDIC Mission, Vision, and Values," http://www.fdic.gov/about/mission/index.html. [Back]

602. 12 U.S.C. § 1820(b)(3). [Back]

603. The interagency agreement is entitled, "Coordination of Expanded Supervisory Information Sharing and Special Examinations." During the time period of the Subcommittee's investigation, the 2002 version of the interagency agreement, signed by the FDIC, Federal Reserve, OCC, and OTS, was in effect. In July 2010, the federal financial regulators agreed to adopt a stronger version, discussed later in this Report. [Back]

604. 2004 OTS Examination Handbook, Section 010.2, OTSWMEF-0000031969, Hearing Exhibit 4/16-2. [Back]

605. A 1 composite rating in the CAMELS system means "sound in every respect"; a 2 rating means "fundamentally sound"; a 3 rating means "exhibits some degree of supervisory concern in one or more of the component areas"; a 4 rating means "generally exhibits unsafe and unsound practices or conditions"; and a 5 rating means "exhibits extremely unsafe and unsound practices or conditions" and is of "greatest supervisory concern." See chart in the prepared statement of Treasury IG Eric Thorson at 7, reprinted in April 16, 2010 Subcommittee Hearing at 107. [Back]

606. Descriptions of these terms appeared in OTS findings memoranda. See, e.g., 6/19/2008 OTS Findings Memorandum of Washington Mutual Bank, at Bisset_John-00046124_002, Hearing Exhibit 4/16-12a. [Back]

607. See April 16, 2010 Subcommittee Hearing at 21 (information supplied by Treasury IG Thorson for the record). [Back]

Back to Contents
A. Subcommittee Investigation and Findings of Fact C. Washington Mutual Examination History

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