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


C. Washington Mutual Examination History

For the five-year period, from 2004 to 2008, OTS repeatedly identified significant problems with Washington Mutual's lending practices, risk management, appraisal procedures, and issued securities, and requested corrective action. WaMu promised to correct the identified deficiencies, but failed to do so. OTS failed, in turn, to take enforcement action to ensure the corrections were made, until the bank began losing billions of dollars. OTS also resisted and at times impeded FDIC examination efforts at Washington Mutual.

Washington Mutual was a larger and more complex financial institution than any other thrift overseen by OTS, and presented numerous regulatory challenges. By 2007, Washington Mutual had over $300 billion in assets, 43,000 employees, and over 2,300 branches in 15 states, including a securitization office on Wall Street, a massive loan portfolio, and several lines of business, including home loans, credit cards, and commercial real estate.

Integration Issues. During the 1990s, as described in the prior chapter, WaMu embarked upon a strategy of growth through acquisition of smaller institutions, and over time became one of the largest mortgage lenders in the United States. One consequence of its acquisition strategy was that WaMu struggled with the logistical and managerial challenges of integrating a variety of lending platforms, information technology systems, staff, and policies into one system.

OTS was concerned about and critical of WaMu's integration efforts. In a 2004 Report on Examination (ROE), OTS wrote:

    "Our review disclosed that past rapid growth through acquisition and unprecedented mortgage refinance activity placed significant operational strain on [Washington Mutual] during the early part of the review period. Beginning in the second half of 2003, market conditions deteriorated, and the failure of [Washington Mutual] to fully integrate past mortgage banking acquisitions, address operational issues, and realize expectations from certain major IT initiatives exposed the institution's infrastructure weaknesses and began to negatively impact operating results." |608|

Long Beach. One of WaMu's acquisitions, in 1999, was Long Beach Mortgage Company (Long Beach), a subprime lender that became a source of significant management, asset quality, and risk problems. Long Beach's headquarters were located in Long Beach, California, but as a subsidiary of Washington Mutual Inc., the parent holding company of Washington Mutual Bank, it was subject to regulation by the State of Washington Department of Financial Institutions and the FDIC. Long Beach's business model was to purchase subprime loans from third party mortgage brokers and lenders and then sell or securitize the loans for sale to investors.

For the first seven years, from 1999 to 2006, OTS had no direct jurisdiction over Long Beach, since it was a subsidiary of WaMu's parent holding company, but not a subsidiary of the bank itself. OTS was limited to reviewing Long Beach indirectly by examining its effect on the holding company and WaMu. In late 2003, OTS examiners took greater notice of Long Beach after WaMu's legal department halted Long Beach's securitizations while it helped the company strengthen its internal controls. As many as 4,000 Long Beach loans were of such poor quality that three quarters of them could not be sold to investors. In 2005, Long Beach experienced a surge in early payment defaults, was forced to repurchase a significant number of loans, lost over $107 million, and overwhelmed its loss reserves. Washington Mutual requested permission to make Long Beach a division of the bank, so that it could assert greater control over Long Beach's operations, and in March 2006, OTS approved the purchase with conditions. In 2006, Long Beach experienced another surge of early payment defaults and was forced to repurchase additional loans. When Long Beach loans continued to have problems in 2007, Washington Mutual eliminated Long Beach as a separate operation and rebranded it as a Washington Mutual "Wholesale Specialty Lending" division. In August 2007, after the collapse of the subprime secondary market, WaMu stopped offering subprime loans and discontinued the last vestiges of the Long Beach operation.

High Risk Lending. In 2004, Washington Mutual shifted its strategy toward the issuance and purchase of higher risk home loans. OTS took note of the strategic shift in WaMu's 2004 ROE:

    "Management provided us with a copy of the framework for WMI's 5-year (2005-2009) strategic plan [which] contemplates asset growth of at least 10% a year, with assets increasing to near $500 billion by 2009." |609|

OTS recommended, and the bank agreed, to spell out its new lending strategy in a written document that had to be approved by the WaMu Board of Directors. |610|

The result was the bank's January 2005 High Risk Lending Strategy, discussed in the prior chapter, in which WaMu management obtained the approval of its Board to shift its focus from originating lower risk fixed rate and government backed loans to higher risk subprime, home equity, and Option ARM loans. |611| The High Risk Lending Strategy also outlined WaMu's plans to increase its issuance of higher risk loans to borrowers with a higher risk profile. The purpose of the shift was to maximize profits by originating loans with the highest profit margins, which were usually the highest risk loans. According to actual loan data analyzed by WaMu, higher risk loans, such as subprime, Option ARM, and home equity loans, produced a higher "gain on sale" or profit for the bank compared to lower risk loans. For example, a presentation supporting the High Risk Lending Strategy indicated that selling subprime loans garnered more than eight times the gain on sale as government backed loans. |612|

The WaMu submission to the Board noted that, in order for the plan to be successful, WaMu would need to carefully manage its residential mortgage business as well as its credit risk, meaning the risk that borrowers would not repay the higher risk loans. |613| During the Board's discussion of the strategy, credit officers noted that losses would likely lag by several years. |614| WaMu executives knew that even if loan losses did not immediately materialize, the strategy presented potentially significant risks down the road. OTS did not object to the High Risk Lending Strategy, even though OTS noted that the bank's five-year plan did not articulate a robust plan for managing the increased risk. |615|

Even before it received formal Board approval, Washington Mutual had begun shifting its loan originations toward higher risk loans. By 2007, rising defaults and the collapse of the subprime secondary market prevented WaMu from fully implementing its plans, but it did have time to shift the composition of the loans it originated and purchased, increasing the percentage of higher risk home loans from at least 19% in 2003, to over 47% in 2007. |616|

Over the course of nearly three years, from 2005 to 2007, WaMu issued and securitized hundreds of billions of high risk loans, including $49 billion in subprime loans |617| and $59 billion in Option ARMs. |618| Data compiled by the Treasury and the FDIC Inspectors General showed that, by the end of 2007, Option ARMs constituted about 47% of all home loans on WaMu's balance sheet, of which about 56% of the borrowers were making the minimum payment amounts. |619| The data also showed that 84% of the total value of the Option ARMs was negatively amortizing, meaning that the borrowers were going into deeper debt rather than paying off their loan balances. |620| In addition, by the end of 2007, stated income loans – loans in which the bank had not verified the borrower's income – represented 73% of WaMu's Option ARMs, 50% of its subprime loans, and 90% of its home equity loans. |621| WaMu also originated numerous loans with high loan-to-value (LTV) ratios, in which the loan amount exceeded 80% of the value of the underlying property. The Inspectors General determined, for example, that 44% of WaMu's subprime loans and 35% of its home equity loans had LTV ratios in excess of 80%. |622| Still another problem was that WaMu had high concentrations of its home loans in California and Florida, states that ultimately suffered above-average home value depreciation. |623|

WaMu issued loans through its own retail loan offices, through Long Beach, which issued subprime loans initiated by third party mortgage brokers, and through correspondent and conduit programs in which the bank purchased loans from third parties. The Treasury and the FDIC Inspectors General observed that, from 2003 to 2007, 48 to 70% of WaMu's residential mortgages came from third party mortgage brokers, and that only 14 WaMu employees were responsible for overseeing more than 34,000 third party brokers, requiring each WaMu employee to oversee more than 2,400 third party brokers. |624|

When the subprime market collapsed in July 2007, Washington Mutual was left holding a portfolio saturated with high risk, poorly performing loans. Prior to the collapse, WaMu had sold or securitized the majority of the loans it had originated or purchased, undermining the U.S. home loan mortgage market with hundreds of billions of dollars in high risk, poor quality loans. OTS documentation shows that WaMu's regulators saw what was happening, identified the problems, but then took no enforcement actions to protect either Washington Mutual or the U.S. financial system from the bank's shoddy lending practices.

An overview of Washington Mutual's ratings history shows how OTS and the FDIC were required to work together to oversee Washington Mutual, which the two agencies did with varying levels of success. At times, the relationship was productive and useful, while at others they found themselves bitterly at odds over how to proceed. As Washington Mutual's problems intensified, the working relationship between OTS and the FDIC grew more dysfunctional.

From 2004 to 2006, Washington Mutual was a profitable bank and enjoyed a 2 CAMELS rating from both agencies, signifying it was a fundamentally sound institution. In late 2006, as housing prices began to level off for the first time in years, subprime loans began to experience delinquencies and defaults. In part because borrowers were unable to refinance their loans, those delinquencies and defaults accelerated in 2007. The poorly performing loans began to affect the payments supporting subprime mortgage backed securities, which began to incur losses. In July 2007, the subprime market was performing so poorly that the major credit rating agencies suddenly downgraded hundreds of subprime mortgage backed securities, including over 40 issued by Long Beach. The subprime market slowed and then collapsed, and Washington Mutual was suddenly left with billions of dollars in unmarketable subprime loans and securities that were plummeting in value. WaMu stopped issuing subprime loans. In the fourth quarter of 2007, WaMu reported a $1 billion loss.

As housing prices slowed and even began declining in some parts of the country, high risk prime loans, including hybrid adjustable rate mortgages, Alt A, and Option ARMs, also began incurring delinquencies and defaults. |625| By March 2008, the total delinquency rate for prime/Alt A loans underlying WaMu and Long Beach securitizations was 8.57%, more than twice the industry average. |626| In 2008, WaMu did not issue any new high risk, nonconforming mortgage securitizations due to, in the words of OTS, "continued market illiquidity, deterioration in the financial condition of the market, and the poor performance of WaMu's outstanding securitizations." |627|

In the first quarter of 2008, WaMu continued to incur losses as the value of its loan portfolio and mortgage backed securities continued to drop. In February 2008, OTS downgraded Washington Mutual for the first time, changing its CAMELS rating from a 2 to a 3, signifying that the bank was in trouble. Unfortunately, OTS did not follow up with a suitable enforcement action. Consistent with its own practice, OTS should have required WaMu to enter into a public Memorandum of Understanding specifying the measures WaMu would take to remedy its problems. Instead, in March, OTS allowed WaMu to issue a nonpublic Board Resolution in which the WaMu Board generally promised to address various problems, but did not identify any specific actions or deadlines. |628|

Also in March 2008, at the urging of the FDIC, OTS required Washington Mutual to allow potential buyers of the bank to conduct due diligence of its assets and operations. |629| Several institutions participated, and JPMorgan Chase made an offer to buy the bank which Washington Mutual turned down. By the end of the first quarter of 2008, Washington Mutual had lost another $1 billion. In April 2008, to reassure the market and its depositors, the holding company raised additional capital of $7 billion from the private sector and provided $3 billion of those funds to the bank. But by the end of the second quarter, WaMu lost another $3.2 billion. Its stock price plummeted, and depositors began withdrawing substantial sums from the bank.

In June 2008, as a result of the bank's financial and deposit losses, the FDIC downgraded WaMu to its lowest internal LIDI rating, an E, indicating "serious concern" that the bank would cause a loss to the Deposit Insurance Fund. It also initiated a special insurance examination of WaMu, which it conducted concurrently with ongoing OTS examination efforts. |630|

Other financial institutions were also failing, compounding the concern of those who worried whether the Deposit Insurance Fund had sufficient funds. In July 2008, IndyMac Bank, another thrift with high risk loans, failed and was taken over by the FDIC. |631| In response, Washington Mutual depositors began to withdraw more funds from the bank, eventually removing over $10 billion. |632| The Federal Home Loan Bank of San Francisco also began to limit WaMu's borrowing, further straining its liquidity. |633| The parent holding company supplied an additional $2 billion in capital to the bank.

In the final three months before WaMu's collapse, tensions increased further between OTS and the FDIC as they disagreed on the course of action. On July 3, 2008, the head of OTS sent an email to the CEO of WaMu informing him that the agency had decided to require the bank to issue a nonpublic Memorandum of Understanding (MOU). |634| On July 15, OTS and the FDIC met with the WaMu Board of Directors to discuss the latest examination findings and formally advise the Board of the OTS decision to require the MOU. On July 21, 2008, the FDIC sent a letter to OTS urging it to take tough supervisory action in the MOU, including by requiring WaMu to increase its loan loss reserves, begin providing regular financial updates, and raise an additional $5 billion in capital. |635| OTS rejected the FDIC's advice. |636| On July 31, 2008, both OTS and FDIC officials met with WaMu's Board. An FDIC official suggested at the Board meeting that WaMu look for a strategic partner to buy or invest in the bank; OTS expressed anger that the FDIC had raised the issue without first clearing it with OTS. |637|

On August 1, 2008, the FDIC informed OTS that it thought WaMu should be downgraded to a 4 CAMELS rating, signaling it was a troubled bank exhibiting unsafe and unsound practices. |638| OTS strongly disagreed. |639| Also on August 1, OTS provided WaMu with the proposed MOU. The proposed MOU would require the bank to correct lending and risk management deficiencies identified in a June 30 examination report, develop a capital contingency plan (rather than, as the FDIC originally urged, raise additional capital), submit a 3- year business plan, and engage a consultant to review its underwriting, risk management, management, and board oversight. On August 4, WaMu asked OTS to drop the requirement that the consultant review the Board's oversight efforts, and OTS agreed.

On August 6, the FDIC Chairman asked the OTS Director to discuss contingency plans for an emergency closure of the bank. The OTS Director reacted negatively and sent an email criticizing the FDIC Chairman for acting as if it were the primary regulator of the bank. |640| As the agencies argued amongst themselves, the bank's condition continued to deteriorate.

By August 25, OTS and WaMu reached agreement on the terms of the MOU, but it was not actually signed until September 7, 2008. |641| Apart from the capitalization plan, OTS Deputy Director Scott Polakoff described the final MOU as a "benign supervisory document," |642| meaning it would not bring about meaningful change at WaMu. |643|

On September 10, 2008, the FDIC Chairman, Sheila Bair, informed WaMu that there was a ratings disagreement between the FDIC and OTS, and that the FDIC was likely to downgrade WaMu to a 4. When she informed the OTS Director, John Reich, of her conversation with WaMu, he sent an internal email to his deputy, Scott Polakoff, venting his frustration that she had not discussed the matter with him first and allowed OTS to break the news to the bank: "I cannot believe the continuing audacity of this woman." |644|

Six days later, on September 16, 2008, Lehman Brothers declared bankruptcy, triggering another run on Washington Mutual. Over the next eight days, depositors pulled $17 billion in cash from WaMu's coffers, leading to a second liquidity crisis. |645| On September 18, the FDIC downgraded the bank to a 4 rating, and OTS agreed to the lower rating. Within days, because of the bank's accelerating liquidity problems, portfolio losses, share price decline, and other problems, OTS and the FDIC decided they had to close the bank. |646|

Due to the bank's worsening liquidity crisis, the regulators abandoned their customary practice of waiting until markets closed on Friday, and on Thursday, September 25, 2008, OTS closed Washington Mutual Bank and appointed the FDIC as receiver. The FDIC immediately sold the bank to JPMorgan Chase for $1.9 billion. If the sale had not gone through, Washington Mutual's $300 billion failure might have exhausted the entire $45 billion Deposit Insurance Fund.

During the five-year period reviewed by the Subcommittee, from 2004 through 2008, OTS examiners identified over 500 serious deficiencies in Washington Mutual's lending, risk management, and appraisal practices. |647| OTS examiners also criticized the poor quality loans and mortgage backed securities issued by Long Beach, and received FDIC warnings regarding the bank's high risk activities. When WaMu failed in 2008, it was not a case of hidden problems coming to light; the bank's examiners were well aware of and had documented the bank's high risk, poor quality loans and deficient lending practices.

From 2004 to 2008, OTS Findings Memoranda and annual Reports of Examination (ROE) repeatedly identified deficiencies in WaMu's lending standards and practices. Lending standards, also called "underwriting" standards, determine the types of loans that a loan officer may offer or purchase from a third party mortgage broker. These standards determine, for example, whether the loan officer may issue a "stated income" loan without verifying the borrower's professed income, issue a loan to a borrower with a low FICO score, or issue a loan providing 90% or even 100% of the appraised value of the property being purchased.

When regulators criticize a bank's lending or "underwriting" standards as weak or unsatisfactory, they are expressing concern that the bank is setting its standards too low, issuing risky loans that may not be repaid, and opening up the bank to later losses that could endanger its safety and soundness. When they criticize a bank for excessively high lending or underwriting "errors," regulators are expressing concern that the bank's loan officers are failing to comply with the bank's standards, such as by issuing a loan that finances 90% of a property's appraised value when the bank's lending standards prohibit issuing loans that finance more than 80% of the appraised value.

In addition to errors, regulators may express concern about the extent to which a bank allows its loan officers to make "exceptions" to its lending standards and issue a loan that does not comply with some aspects of its lending standards. Exceptions that are routinely approved can undermine the effectiveness of a bank's formal lending standards. Another common problem is inadequate loan documentation indicating whether or not a particular loan complies with the bank's lending standards, such as loan files that do not include a property's appraised value, the source of the borrower's income, or key analytics such as the loan-to-value or debt-toincome ratios. In the case of Washington Mutual, from 2004 to 2008, OTS examiners routinely found all four sets of problems: weak standards, high error and exception rates, and poor loan documentation.

2004 Lending Deficiencies. In 2004, OTS examiners identified a variety of problems with WaMu's lending standards. In May of that year, an OTS Findings Memorandum stated:

    "Several of our recent examinations concluded that the Bank's single family loan underwriting was less than satisfactory due to excessive errors in the underwriting process, loan document preparation, and in associated activities." |648|

After reviewing an OTS examination of a loan sample, the FDIC examiner wrote that the loans:

    "reflected inconsistencies with underwriting and documentation practices, particularly in the brokered channel. Additionally, examiners noted that Washington Mutual's SFR [Single Family Residential] portfolio has an elevated level of risk to a significant volume of potential negative amortization loans, high delinquency and exception rates, and a substantial volume of loans with higher risk characteristics, such as low FICO scores." |649|

A few months later, in September, an OTS review of a sample of 2003 WaMu loans found "critical error rates as high as 57.3%":

"[Residential Quality Assurance]'s review of 2003 originations disclosed critical error rates as high as 57.3 percent of certain loan samples, thereby indicating that SFR [Single Family Residential] underwriting still requires much improvement. While this group has appropriately identified underwriting deficiencies, it has not been as successful in effecting change." |650|

The same OTS Report of Examination observed that one of the three causes of underwriting deficiencies was "a sales culture focused on building market share." It also stated:

    "Notwithstanding satisfactory asset quality overall, some areas still require focused management and Board attention. Most important is the need to address weaknesses in single-family residential (SFR) underwriting, which is an ongoing issue from prior exams." |651|

The OTS ROE concluded: "Underwriting of SFR loans remains less than satisfactory." |652|

The next month, when OTS conducted a field visit to follow up on some of the problems identified earlier, it concluded:

    "The level of SFR [Single Family Residential] underwriting exceptions in our samples has been an ongoing examination issue for several years and one that management has found difficult to address. The institution instituted a major organizational/staffing realignment in September 2003 and has continued to make additional adjustments since that time to address accumulating control issues." |653|

2005 Lending Deficiencies. In early 2005, OTS elevated the problems with the bank's lending standards to the attention of the WaMu Board of Directors. In a letter to the Board, OTS wrote:

    "SFR Loan Underwriting – This has been an area of concern for several exams. As management continues to make change in organization, staffing, and structure related to SFR loan underwriting, delays in meeting target dates become inevitable. The board should closely monitor these delays to ensure they do not become protracted." |654|

OTS officials attended a Board meeting to address this and other concerns. Yet a few months later, in June, an OTS examiner wrote: "We continue to have concerns regarding the number of underwriting exceptions and with issues that evidence lack of compliance with Bank policy." |655| The examination findings memorandum also noted that, while WaMu tried to make changes, those changes produced "only limited success" and loan underwriting remained "less than satisfactory." |656|

In August 2005, the OTS ROE for the year indicated that the lending standards problem had not been resolved:

    "[W]e remain concerned with the number of underwriting exceptions and with issues that evidence lack of compliance with bank policy …. [T]he level of deficiencies, if left unchecked, could erode the credit quality of the portfolio. Our concerns are increased with the risk profile of the portfolio is considered, including concentrations in Option ARM loans to higher-risk borrowers, in low and limited documentation loans, and loans with subprime or higher-risk characteristics. We are concerned further that the current market environment is masking potentially higher credit risk." |657|

2006 Lending Deficiencies. The same problems continued into 2006. In March 2006, OTS issued the same strong warning about WaMu's loan portfolio that it had provided in August 2005:

    "We believe the level of delinquencies, if left unchecked, could erode the credit quality of the portfolio. Our concerns are increased when the risk profile of the portfolio is considered, including concentrations in Option ARMS to higher-risk borrowers, in low and limited documentation loans, and loans with subprime or higher-risk characteristics. We are concerned further that the current market environment is masking potentially higher credit risk." |658|

    Two months later, in May 2006, an OTS examiner wrote:

    "During the prior examination, we noted numerous instances of underwriters exceeding underwriting guidelines, errors in income calculations, errors in debt-to-income (DTI) calculations, lack of sufficient mitigating factors for credit-quality related issues, and insufficient title insurance coverage on negative amortization loans. . . . . [U]nderwriting errors [] continue to require management's attention." |659|

While OTS was documenting its concerns, however, it is apparent in hindsight that the agency tempered its criticism. The OTS examiner who authored the memo found that in his review, none of the negatively amortizing loans he analyzed for safety and soundness carried an "exception," meaning it "probably should not have been made." |660| Many of the loans made in this time period would later default.

Another OTS Findings Memorandum the same month concluded: "Overall, we concluded that the number and severity of underwriting errors noted remain at higher than acceptable levels." |661|

The 2006 OTS ROE for the year concluded:

    "Subprime underwriting practices remain less than satisfactory. . . . [T]he number and severity of underwriting exceptions and errors remain at higher than acceptable levels. . . . The findings of this judgmental sample are of particular concern since loans with risk layering . . . should reflect more, rather than less, stringent underwriting." |662|

2007 Lending Deficiencies. In 2007, the problems with WaMu's lending standards were no better, and the acceleration of high risk loan delinquencies and defaults threatened serious consequences.

By July 2007, the major credit rating agencies had begun mass ratings downgrades of hundreds of mortgage backed securities, the subprime secondary market froze, and WaMu was left holding billions of dollars worth of suddenly unmarketable subprime and other high risk loans. In September, the OTS ROE for the year concluded:

    "Underwriting policies, procedures, and practices were in need of improvement, particularly with respect to stated income lending. Based on our current findings, and the fact that a number of similar concerns were raised at prior examinations, we concluded that too much emphasis was placed on loan production, often at the expense of loan quality." |663|

The ROE also reported on an unsatisfactory review of loans that had been originated by Long Beach and warned that, if the problems were not promptly corrected, "heightened supervisory action would be taken":

    "Based on our review of 75 subprime loans originated by [Long Beach], we concluded that subprime underwriting practices remain less than satisfactory . . . . Given that this is a repeat concern and MRBA [Matter Requiring Board Attention], we informed management that underwriting must be promptly corrected, or heightened supervisory action would be taken, including limiting the Bank's ability to continue SFR subprime underwriting." |664|

In the fourth quarter of 2007, WaMu's loan portfolio lost $1 billion in value. Despite that loss, and the strong language in the 2007 examinations, OTS took no enforcement action against the bank that would result in WaMu's tightening its lending standards or strengthening compliance with the standards it had.

2008 Lending Deficiencies. In the first six months of 2008, WaMu continued to incur billions of dollars in losses, as its high risk loan portfolio lost value and its share price fell. In July 2008, about two months before the bank failed, OTS met with the WaMu Board of Directors to discuss, among other matters, the bank's deficient lending standards. While the presentation to the Board reiterated the concerns from past years, it failed to convey a sense of urgency to a bank on the verge of collapse. Instead, the presentation focused on long term corrective action that WaMu should take. The OTS written presentation to the Board included the following:

    "High SFR [Single Family Residential] losses due in part to downturn in real estate market but exacerbated by: geographic concentrations[,] risk layering[,] liberal underwriting policy[,] poor underwriting. … Discontinuing higher risk lending and tightened underwriting policy should improve asset quality; however, actions should have been taken sooner. …

    Significant underwriting and process weaknesses noted again in the Home Loans Group[.] ... Reducing higher risk lending products and practices should have been done sooner." |665|

Failure to Correct Deficient Lending Practices. In various reports for nearly five consecutive years, OTS criticized WaMu's lending standards, error and exception rates, and loan documentation, and directed the bank to improve its performance. When WaMu failed to improve during that span, OTS failed to take action, such as requiring a board resolution, memorandum of understanding, or cease and desist order compelling WaMu to tighten its lending standards and increase oversight of its loan officers to reduce underwriting error and exception rates and improve loan documentation. The result was that WaMu originated or purchased hundreds of billions of dollars of high risk loans, including stated income loans without verification of the borrower's assets or ability to repay the loan; loans with low FICO scores and high loan-to-value ratios; loans that required interest-only payments; and loan payments that did not cover even the interest owed, much less the principal.

Over the same five-year period, from 2004 to 2008, in addition to identifying deficiencies associated with WaMu's lending practices, OTS repeatedly identified problems with WaMu's risk management practices. Risk management involves identifying, evaluating, and mitigating the risks that threaten the safety, soundness, and profitability of an institution. At thrifts, the primary risk issues include setting lending standards that will produce profitable loans, enforcing those standards, evaluating the loan portfolio, identifying home loans that may default, establishing adequate reserves to cover potential losses, and advising on measures to lower the identified risks. When regulators criticize a bank's risk management practices as weak or unsatisfactory, they are expressing concern that the bank is failing to identify the types of risk that threaten the bank's safety and soundness and failing to take actions to reduce and manage those risks.

Within WaMu, from 2004-2005, oversight of risk management practices was assigned to a Chief Risk Officer. In 2006, it was assigned to an Enterprise Risk Management (ERM) Department headed by a Chief Enterprise Risk Officer. ERM employees reported, not only to the department, but also to particular lines of business such as the WaMu Home Loans Division, and reported both to the Chief Risk Officer and to the head of the business line, such as the president of the Home Loans Division. WaMu referred to this system of reporting as a "Double- Double." |666|

As with the bank's poor lending standards, OTS allowed ongoing risk management problems to fester without taking enforcement action. From 2004 to 2008, OTS explicitly and repeatedly alerted the WaMu Board of Directors to the need to strengthen the bank's risk management practices.

2004 Risk Management Deficiencies. In 2004, prior to the bank's adoption of its High Risk Lending Strategy, OTS expressed concern about the bank's risk management practices, highlighted the issue in the annual ROE, and brought it to the attention of the WaMu Board of Directors. The 2004 ROE stated:

    "Board oversight and management performance has been satisfactory … but … increased operational risks warrant prompt attention. These issues limit the institution's flexibility and may threaten its ability to remain competitive and independent." |667|

At another point, the ROE warned: "Ensure cost-cutting measures are not impacting critical risk management areas." |668|

Another OTS examination that focused on WaMu's holding company identified multiple risks associated with Long Beach: "[P]rimary risks associated with Long Beach Mortgage Company remain regulatory risk, reputation risk, and liquidity of the secondary market in subprime loans." |669|

Its concern about WaMu's risk management practices prompted, in part, OTS' requirement that WaMu commit its high risk lending strategy to paper and gain explicit approval from the Board of Directors.

2005 Risk Management Deficiencies. In 2005, after adoption of the High Risk Lending Strategy, OTS again highlighted risk management issues in its examination reports and again brought the matter to the attention of WaMu's Board of Directors.

In March 2005, OTS observed that WaMu's five-year strategy, which increased credit risk for the bank, did not "clearly articulate the need to first focus on addressing the various operational challenges before embarking on new and potentially more risky growth initiatives." |670| OTS also wrote: "We discussed the lack of a clear focus in the plan on resolving operational challenges with CEO Killinger and the Board." |671| OTS continued to express concerns about the bank's weak risk management practices for the rest of the year, yet took no concrete enforcement action to compel the bank to address the issue. In June 2005, OTS described risk management weaknesses within WaMu's Corporate Risk Oversight group, a subgroup within the ERM Department responsible for evaluating credit and compliance risk. OTS wrote that it had deemed its comments as "criticisms" of the bank, because of the significance of the risk management function in addressing ongoing problems with the bank's lending standards and loan error rates:

    "Most of the findings are considered ‘criticisms' due to the overall significance of CRO [Corporate Risk Oversight] activities and the fact that we have had concerns with quality assurance and underwriting processes within home lending for several years." |672|

In August 2005, in its annual Report on Examination, OTS urged the WaMu Board to obtain progress reports from the ERM Department and ensure it had sufficient resources to become an effective counterweight to the increased risk-taking entailed in the High Risk Lending Strategy:

    "Monitor and obtain reports from management on status of [Enterprise Risk Management] in terms of effectiveness and resource adequacy. … ERM provides an important check and balance on the company's profit-oriented units and warrants ongoing strong Board commitment given the institution's current strategic direction." |673|

The same ROE noted that the bank did not have effective procedures in place to evaluate the many exceptions being granted to allow loan officers to issue loans that failed to comply with the bank's lending standards, and urged attention to the risks being established:

    "Until full exception data collection, reporting, and follow-up processes are in place and stabilized, senior management and the Board cannot fully assess whether quality assurance processes are having a meaningful impact on line activities, including loan underwriting. We are particularly concerned with the establishment of good quality assurance process for SFR underwriting, which has been an issue for the past several examinations." |674|

A follow-up field examination, conducted in September 2005, stated:

    "We criticized the lack of Trend and Dashboard Report to senior management and the board, without which it is impossible to determine whether line functions are performing acceptably and, more specifically, whether the quality assurance process is having a meaningful impact on improving loan underwriting." |675|

2006 Risk Management Deficiencies. In 2006, OTS again expressed concern about WaMu's risk management practices, but took no further steps to compel improvements. The annual ROE urged the Board of Directors to:

    "[c]ontinue to monitor and obtain reports from management on the status of ERM to ensure its effectiveness and adequacy of resources. . . . ERM should provide an important check and balance on profit-oriented units … particularly given the bank's current strategy involving increased credit risk." |676|

The 2006 ROE also commented that: "[w]ithin ERM, fraud risk management at the enterprise level is in the early stage of development. … Currently, fraud management is decentralized and does not provide a streamlined process to effectively track fraud events across all business lines. In addition, consistent fraud reporting capabilities are not in place to consolidate data for analysis, reporting, and risk management at the enterprise level." |677|

2007 Risk Management Deficiencies. In 2007, as high risk loan delinquencies and defaults accelerated and WaMu began to incur losses, OTS examiners used harsher language to describe the deficiencies in WaMu's risk management practices, criticizing the bank's failure to institute stronger risk controls and procedures at an earlier date, as recommended.

In June 2007, for example, OTS examiners completed a review critical of WaMu procedures to oversee the loans it purchased from third party mortgage brokers. |678| From 2003 to 2007, 48 to 70% of WaMu's loans were purchased from third parties. |679| An OTS memorandum noted that Washington Mutual had only 14 full-time employees overseeing more than 34,000 third party brokers submitting loans to the bank for approval. OTS also criticized the scorecard used to rate those brokers which, among other problems, did not include the rate at which significant lending or documentation deficiencies were attributed to the broker, the rate at which its loans were denied or produced unsaleable loans, or an indication of whether the broker was included in industry watchlists for misconduct. After describing these and other problems, rather than lower WaMu's safety and soundness scores for its poor oversight, however, the OTS memorandum made only the following observation: "Given the . . . increase in fraud, early payment defaults, first payment defaults, subprime delinquencies, etc., management should reassess the adequacy of staffing." |680| WaMu management agreed with the finding, but provided no corrective action plan, stating only that "[s]taffing needs are evaluated continually and adjusted as necessary." |681|

In the September 2007 annual ROE, OTS wrote:

    "Risk management practices in the HLG (Home Loans Group) during most of the review period were inadequate …. We believe that there were sufficient negative credit trends that should have elicited more aggressive action by management with respect to limiting credit exposure. In particular, as previously noted, the risk misrepresentation in stated income loans has been generally reported for some time. This information should have led management to better assess the prudence of stated income lending and curtail riskier products well before we indicated during this examination that we would limit the Bank's ability to continue such lending." |682|

The ROE also faulted management and Board inaction:

    "Board oversight and management's performance was less than satisfactory. … Contributing factors should have been more proactively managed by the Board and management. The most significant of these factors include Matters Requiring Board Attention that were noted in prior examinations but were not adequately addressed, including … an ERM function that was not fully effective." |683|

The ROE concluded: "The ERM function has been less than effective for some time. … ERM has not matured in a timely manner and other ERM functions have been generally ineffective." |684|

A separate OTS examination of WaMu's compliance function observed that WaMu had hired nine different compliance officers in the past seven years, and that "[t]his amount of turnover is very unusual for an institution of this size and is a cause for concern." |685|

Despite these harsh assessments in 2007, OTS again refrained from taking any enforcement action against the bank such as developing a nonpublic Memorandum of Understanding or a public Cease and Desist Order with concrete plans for strengthening WaMu's risk management efforts.

2008 Risk Management Deficiencies. In 2008, as WaMu continued to post billions of dollars in losses, OTS continued to express concerns about its risk management practices. In February 2008, OTS downgraded WaMu to a 3 CAMELS rating and required the bank to issue a Board Resolution committing to certain strategic initiatives including "a more disciplined framework for the identification and management of compliance risks." |686|

In June 2008, OTS issued a Findings Memorandum reacting to a WaMu internal review that found significant levels of loan fraud at a particular loan office, and expressed concern "as to whether similar conditions are systemic throughout the organization." |687| The memorandum noted that "a formalized process did not exist to identify, monitor, resolve, and escalate third party complaints" about loan fraud, expressed concern about "an origination culture focused more heavily on production volume rather than quality"; noted that the WaMu review had found the "loan origination process did not mitigate misrepresentation/fraud"; and described the "need to implement incentive compensation programs to place greater emphasis on loan quality."

As referenced above, in July 2008, two months before the bank's failure, OTS made a presentation to the WaMu Board which, among other problems, criticized its risk management efforts:

    "An adequate [Enterprise Risk Management] function still does not exist although this has been an MRBA [Matter Requiring Board Attention] for some time. Critical as a check and balance for profit oriented units[.] Necessary to ensure that critical risks are identified, measured, monitored and communicated[.] Even more critical given increased credit, market, and operational risk." |688|

Failure to Correct Poor Risk Management. By neglecting to exercise its enforcement authority, OTS chronicled WaMu's inadequate risk management practices over a period of years, but ultimately failed to change its course of action. During a hearing of the Subcommittee, the Department of the Treasury Inspector General, Eric Thorson, whose office conducted an in-depth review of WaMu's regulatory oversight, testified:

    "Issues related to poor underwriting and weak risk controls were noted as far back as 2003, but the problem was OTS did not ensure that WaMu ever corrected those weaknesses. We had a hard time understanding why OTS would allow these satisfactory ratings to continue given that, over the years, they found the same things over and over." |689|

    (c) Deficiencies in Home Appraisals

Still another area in which OTS failed to take appropriate enforcement action involves WaMu's appraisal practices. OTS failed to act even after other government entities accused WaMu of systematically inflating property values to justify larger and more risky home loans.

Appraisals provide estimated dollar valuations of property by independent experts. They play a key role in the mortgage lending process, because a property's appraised value is used to determine whether the property provides sufficient collateral to support a loan. Lending standards at most banks require loans to meet, for example, certain loan-to-value (LTV) ratios to ensure that, in the event of a default, the property can be sold and the proceeds used to pay off any outstanding debt.

From 2004 to mid-2006, WaMu conducted its own property appraisals as part of the loan approval process. During that period, OTS repeatedly expressed concerns about WaMu's appraisal efforts. |690| In May 2005, OTS criticized WaMu – the most severe type of finding – regarding its practice of allowing sellers to estimate the value of their property. OTS directed WaMu to stop including an Owner's Estimate of Value in documents sent to appraisers since it biased the review; this criticism had been repeatedly noted in prior examinations, yet WaMu did not satisfactorily address it until the end of 2005. |691| A second finding criticized WaMu's use of automated appraisal software, noting "significant technical document weaknesses." |692| OTS ultimately determined that none of WaMu's automated appraisals complied with standard appraisal practices and some even had "highly questionable value conclusions." |693| Despite this dramatic criticism, OTS found in the next year's examination that WaMu had continued to use noncompliant automated appraisals. |694| Before any enforcement action was taken, WaMu management agreed to cease using automated appraisals by October 2006.

To address the issue, WaMu decided in mid-2006 to outsource its appraisal function to two vendors: eAppraiseIT and Lender Service Incorporated (LSI). |695| Calling the move "Project Cornerstone," WaMu fired all of its residential staff appraisers, reducing a staff of about 400 to 30, |696| and eAppraiseIT and LSI were tasked with conducting appraisals of homes purchased with WaMu loans. |697| WaMu assigned oversight of the outside appraisals to a new Appraisal Business Oversight (ABO) group, a unit within the WaMu Home Loans Risk Management division.

The Decision to Outsource. WaMu's decision to outsource the appraisal function received minimal attention from OTS. Documentation obtained by the Subcommittee indicates only a few meetings took place between OTS examiners and the WaMu staff tasked with the outsourcing. During a Subcommittee interview, the key OTS appraisal expert, Bruce Thorvig, explained that it was his first time supervising a large institution that decided to outsource the appraisal function. |698| Though the bank had repeatedly delayed taking action or failed to respond to OTS recommendations and criticisms in the appraisal area in the past, the OTS appraisal expert told the Subcommittee that he saw nothing to indicate that WaMu management could not competently handle a large appraisal outsourcing project of this scale. |699| In one of the few meetings that did occur between WaMu and OTS staff on appraisal issues, the bank's management came away with what they thought was full OTS approval for the outsourcing project, |700| though OTS' appraisal expert disputed that he was even in a position to grant approval and was instead simply receiving notification of WaMu's plans. |701|

Appraisal Problems. Problems began almost immediately after WaMu outsourced the appraisal function. Whether appraisals are conducted internally by the bank or through a vendor, the bank must take responsibility for establishing a standard process to ensure accurate, unbiased home appraisal values. One, for example, was a repeat problem from when WaMu did its own appraisals: "WaMu allowed a homeowner's estimate of the value of the home to be included on the form sent from WaMu to third party appraisers, thereby biasing the appraiser's evaluation" toward a higher home value, in violation of standard residential appraisal methods. |702| A seasoned appraisal compliance manager, who oversaw WaMu as an FDIC examiner prior to coming to work for the bank, drafted a February 2007 Residential Appraisal Department Review which included a long list of issues. Problems included: "undefined" appraisal standards and processes; "loosely defined" vendor management; "unreasonable and imprudent sales force influence over the appraisal function;" and a "broken" third party appraisal risk control process that "may be contributing to the increasing incidence of mortgage fraud." |703|

These problems continued without resolution or enforcement action from OTS throughout 2007. In an April 2007 memorandum, OTS detailed its concerns, both old and new, with WaMu's appraisal operations. OTS found that WaMu had failed to update and revise its appraisal manual after outsourcing, which put the bank at risk of regulatory violations. In addition, an OTS review of 54 WaMu appraisals identified a number of concerns:

    "Primary appraisal issues (red flags requiring attention by the underwriter or review appraiser) included seller paid closing costs and concession, misstatements/ contradictions, inadequate/incomplete explanations and support for the value conclusion, reconciliation of the sales comparison approach, and weakness in the appraisal review process." |704|

Despite the extent of these concerns, OTS issued a "recommendation" to the bank that it address the identified problems, rather than the stronger "criticism" which would have elevated the issue to the bank's senior management or Board of Directors. |705|

Attorney General Complaint. On November 1, 2007, the New York Attorney General issued a complaint against WaMu's appraisal vendors, LSI and eAppraiseIT, alleging fraud and collusion with WaMu to systematically inflate real estate values. |706| The complaint stated in part:

    "[F]irst American and eAppraiseIT have abdicated their role in providing ‘third-party, unbiased valuations' for eAppraiseIT's largest client, WaMu. Instead, eAppraiseIT improperly allows WaMu's loan production staff to hand-pick appraisers who bring in appraisal values high enough to permit WaMu's loans to close, and improperly permits WaMu to pressure eAppraiseIT appraisers to change appraisal values that are too low to permit loans to close." |707|

Though OTS had been aware of the Attorney General's investigation in May 2007, it took no action until after the Attorney General issued the complaint. Even then, OTS did not initiate its own investigation until after an internal WaMu investigation was already underway. The OTS Western Region Director advised: "I believe OTS needs to open up its own special investigation. WaMu started their own special investigation a few days ago when this broke." |708|

It took nearly a month for OTS to launch its own investigation into the allegations set out in the New York Attorney General's complaint. |709| In November 2007, when the director of OTS, John Reich, was presented with his agency's investigation plan, he responded:

    "This appears to be a comprehensive (and impressive) review schedule. It doesn't appear, on the surface anyway, to leverage off of WaMu's own review. Do you think we might be totally reinventing the wheel and possibly taking too long to complete our review?" |710|

Despite his concerns about how long the planned investigation might take, the OTS investigation proceeded as proposed. It took over 10 months, until September 2008, for OTS to gather, analyze, and reach conclusions about WaMu's appraisal practices.

The OTS investigation uncovered many instances of improper appraisals. After reviewing 225 loan files, the OTS appraisal expert found that "[n]umerous instances were identified where, because of undue influence on the appraiser, values were increased without supporting documentation." |711| OTS also found that WaMu had violated the agency's appraisal regulations by failing to comply with appraisal independence procedures after they outsourced the function. |712| The OTS investigation concluded that WaMu's appraisal practices constituted "unsafe or unsound banking practices." |713| The OTS investigation also concluded that WaMu was not in compliance with the Uniform Standards of Professional Appraisal Practice and other minimum appraisal standards. |714|

Failure to Correct Appraisal Deficiencies. Shortly before WaMu was sold, OTS' staff prepared a draft recommendation that the agency issue a cease and desist order to bar the bank from engaging in any activity that would lead to further violation of the appraisal regulations. |715| A cease and desist order would have been the first public enforcement action against WaMu regarding its lending practices. Ultimately, the legal staff submitted the memorandum to OTS' Deputy Director and Chief Counsel on October 3, 2008, more than a week after the bank collapsed and was sold. |716| By this point, the recommendation was too late and the issue was moot.

In 1999, WaMu's parent holding company, Washington Mutual Inc., purchased Long Beach Mortgage Company (Long Beach). Long Beach's business model was to issue subprime loans initiated by third party mortgage lenders and brokers and then sell or package those loans into mortgage backed securities for sale to Wall Street firms. Beginning in 1999, Washington Mutual Bank worked closely with Long Beach to sell or securitize its subprime loans and exercised oversight over its lending and securitization operations. Because Long Beach was a subsidiary of Washington Mutual Inc., the holding company, however, and not a subsidiary of Washington Mutual Bank, OTS did not have direct regulatory authority over the company, but could review its operations to the extent they affected the holding company or the bank itself.

OTS was aware of ongoing problems with Long Beach's management, lending and risk standards, and issuance of poor quality loans and mortgage backed securities. OTS reported, for example, that Long Beach's "early operations as a subsidiary of [Washington Mutual Inc.] were characterized by a number of weaknesses" including "loan servicing weaknesses, documentation exceptions, high delinquencies, and concerns regarding compliance with securitization-related representations and warranties." |717| OTS also reported that, in 2003, "adverse internal reviews of [Long Beach] operations led to a decision to temporarily cease securitization activity" until a "special review" by the WaMu legal department ensured that file documentation "adequately supported securitization representations and warranties" made by Long Beach. |718| OTS was aware of an examination report issued by a state regulator and the FDIC after a review of 2003 Long Beach loans, which provides a sense of the extent of problems with those loans at the time:

    "An internal residential quality assurance (RQA) report for [Long Beach]'s first quarter 2003 … concluded that 40% (109 of 271) of loans reviewed were considered unacceptable due to one or more critical errors. This raised concerns over [Long Beach]'s ability to meet the representations and warranty's made to facilitate sales of loan securitizations, and management halted securitization activity. A separate credit review report … disclosed that [Long Beach]'s credit management and portfolio oversight practices were unsatisfactory. … Approximately 4,000 of the 13,000 loans in the warehouse had been reviewed … of these, approximately 950 were deemed saleable, 800 were deemed unsaleable, and the remainder contained deficiencies requiring remediation prior to sale. … [O]f 4,500 securitized loans eligible for foreclosure, 10% could not be foreclosed due to documentation issues." |719|

Despite these severe underwriting and operational problems, Long Beach resumed securitization of its subprime loans in 2004. In April 2005, OTS examiners circulated an internal email commenting on the poor quality of Long Beach loans and mortgage backed securities compared to its peers:

    "Performance data for 2003 and 2004 vintages appear to approximate industry average while issues prior to 2003 have horrible performance. . . . [Long Beach] finished in the top 12 worst annualized [Net Credit Losses] in 1997 and 1999 thru 2003. [Long Beach nailed down the number 1 spot as top loser with an [Net Credit Loss] of 14.1% in 2000 and placed 3rd in 2001 with 10.5%. … For ARM [adjustable rate mortgage] losses, [Long Beach] really outdid themselves with finishes as one of the top 4 worst performers from 1999 through 2003. For specific ARM deals, [Long Beach] made the top 10 worst deal list from 2000 thru 2002. … Although underwriting changes were made from 2002 thru 2004, the older issues are still dragging down overall performance. … At 2/05, [Long Beach] was #1 with a 12% delinquency rate. Industry was around 8.25%." |720|

Six months later, after conducting a field visit, an OTS examiner wrote: "Older securitizations of [Long Beach] continue to have some issues due to previously known underwriting issues in some vintages. The deterioration in these older securitizations is not unexpected." |721|

Purchase of Long Beach. In 2005, Washington Mutual Bank proposed purchasing Long Beach from its holding company so that Long Beach would become a wholly owned subsidiary of the bank. In making the case for the purchase, which required OTS approval, WaMu contended that making Long Beach a subsidiary would give the bank greater control over Long Beach's operations and allow it to strengthen Long Beach's lending practices and risk management, as well as reduce funding costs and administrative expenses. In addition, WaMu proposed that it could replace its current "Specialty Mortgage Finance" program, which involved purchasing subprime loans for its portfolio primarily from Ameriquest, with a similar loan portfolio provided by Long Beach. |722|

In June 2005, an OTS examiner expressed concerns about the purchase in an internal memorandum to OTS regional management and recommended that the purchase be conditioned on operational improvements:

    "At the start of this examination, it was our intent to perform a review of the operation of [Long Beach] with the expectation that [Washington Mutual Inc.] or the bank would be requesting approval to move [Long Beach] as an operating subsidiary of the bank. Such a move would obviously place the heightened risks of a subprime lending operation directly within the regulated institution structure. Because of the high profile nature of the business of [Long Beach] and its problematic history, we believe that any and all concerns regarding the subprime operation need to be fully addressed prior to any move." |723|

The memorandum identified several matters that required resolution prior to a WaMu purchase of Long Beach, including the establishment of pre- and post-funding loan quality reviews that were already in place at the bank. The memorandum also stated that Long Beach management had "worked diligently to improve its operation and correct significant deficiencies … reported in prior years," and observed, "there is definitely a new attitude and culture." |724|

OTS continued to review Long Beach's lending practices and found additional deficiencies throughout the year. Those deficiencies included errors in loan calculations of debtto- income ratios, lack of documentation to support the reasonableness of borrower income on stated income loans, and lack of explanation of a borrower's ability to handle payment shock on loans with rising interest rates. |725| OTS also determined that Long Beach's newly created portfolio of subprime loans "had attributes that could result in higher risk" than WaMu's existing subprime loan portfolio. |726|

Nevertheless, in December 2005, OTS examiners wrote that, even though Long Beach was "engaged in a high-risk lending activity and we are not yet fully satisfied with its practices," they recommended approving WaMu's purchase of the company with certain conditions. |727| Those conditions included WaMu's reconsidering its high risk lending concentration limits, including "stated income loans with low FICOs and high LTV ratios"; WaMu's assurance that Long Beach would comply with certain loan guidance; a WaMu commitment to continue to bring down its loan exception and error rates; and a WaMu commitment to ensure its Enterprise Risk Management division would provide a "countervailing balance" to "imprudent" desires to expand Long Beach's subprime lending. |728|

About the same time as this memorandum was completed, OTS learned that, during the fourth quarter of 2005, Long Beach had been required to repurchase tens of millions of dollars of loans it had sold to third parties due to early payment defaults. |729| By December, this unexpected wave of repurchases had overwhelmed Long Beach's repurchase reserves, leading to a reserve shortfall of nearly $75 million. Altogether in the second half of 2005, Long Beach had to repurchase loans with about $837 million in unpaid principal, and incurred a net loss of about $107 million. |730| In response, its auditor, Deloitte and Touche, cited Long Beach for a Significant Deficiency in its financial reporting. Despite the sudden evidence of Long Beach's poor quality loans, inadequate repurchase reserves, and negative earnings impact on its parent company, Washington Mutual Inc., OTS approved the bank's application to purchase Long Beach. OTS explained its decision to the Subcommittee by contending that the change in status gave WaMu more control over Long Beach to ensure its improvement. |731|

WaMu ultimately purchased Long Beach on March 1, 2006. |732| After the purchase, Long Beach's practices did not improve, but continued to exhibit numerous problems, as described in the prior chapter. A May 2006 OTS examination of Long Beach loans concluded, for example, "that the number and severity of underwriting errors noted remain at higher than acceptable levels." |733| In a June 2006 internal email to his colleagues, the OTS Regional Deputy Director wrote:

    "We gave them the benefit of doubt based on commitments and some progress when we allowed them to bring [Long Beach] into the bank, but … we have the same type of concerns remaining 6 months later." |734|

In the annual 2006 ROE and again in the annual 2007 ROE, OTS found that Long Beach's lending practices "remain[ed] less than satisfactory." |735| At a hearing of the Subcommittee on April 13, 2010, WaMu's chief credit risk officers from 2004 to 2008 uniformly condemned Long Beach's poor performance and testified that it had never developed an effective risk management system. |736|

As part of their review of Washington Mutual, the Treasury and the FDIC Inspectors General determined that, over a five-year period, 2004-2008, OTS examiners identified a total of over 540 criticisms, observations, and recommendations related to WaMu operations. |737| At the Subcommittee hearing, when asked whether those 540 findings constituted "serious criticisms" of the bank, Treasury IG Eric Thorson responded: "Absolutely." |738| The FDIC Inspector General, Jon Rymer, agreed:

    "[T]he examiners, from what I have seen here, were pointing out the problems, underwriting problems, riskier products, concentrations, distributions, and markets that may display more risk – they were all significant problems and they were identified. At the end of the day, though, I don't think forceful enough action was taken." |739|

As WaMu accumulated hundreds of infractions from OTS, longstanding problems with asset quality in the bank's portfolio continued. While some observers have blamed WaMu's failure on its liquidity troubles in late 2008, years of unresolved problems festered below the surface.

The consequences of WaMu's failure to address its underwriting problems, risk concentrations, risk layering, and other problems were exponential increases in its loss rates. The FDIC later calculated the loss rates for several WaMu products. In WaMu's held-forinvestment Option ARM portfolio, delinquency rates nearly doubled every year, rising from 0.48% at the end of 2005 to 0.90% a year later, to 2.63% at year end 2007, and up to 4.63% by June 30, 2008. |740| In its subprime portfolio, its delinquency rate increased from 7.39% in 2005 to 25.20% in June 2008. |741| The delinquency rate in its HELOC portfolio rose from 0.58% in 2005 to 4.00% in June 2008. |742| As a result, net charge-offs for WaMu's Option ARM portfolio rose from $15 million at year end 2005 to $37 million in 2006, to $147 million in 2007, and to $777 million by June 2008. |743| HELOC net charge-offs likewise increased, rising from $21 million in 2005, to $23 million in 2006, to $424 million in 2007, and to $1.19 billion by June 2008. |744| Subprime net charge-offs expanded even more rapidly, rising from $47 million in 2005, to $134 million in 2006, to $550 million in 2007, and $956 million by June 2008. |745| To account for these losses, WaMu's loss provisions jumped from $218 million in 2006 to over $2 billion in 2007, and an additional $6 billion by June 2008. |746|

The joint report of the Treasury and the FDIC Inspectors General specifically identified WaMu's poor quality loans and poor risk management practices as the real cause of its failure, rather than the liquidity crisis that hit the bank in 2008. |747| During the Subcommittee's hearing, when asked why WaMu failed, a senior FDIC official put it this way: "Asset quality. Weak asset quality. It brought on the liquidity problems." |748| He explained:

    "If you have strong asset quality, you will not have liquidity issues because your assets – you can borrow either against them or you can sell them. If you have weak asset quality, then you are going to have liquidity issues at some point." |749|

    (4) OTS Turf War Against the FDIC

As WaMu approached the end, tensions between OTS and the FDIC that had built up over two years evolved into a turf war. OTS examination and regional officials began to express distrust of their FDIC counterparts. The conflict was elevated to the top leaders of both agencies, who came to take different views of what to do with WaMu – the FDIC becoming more aggressive and OTS becoming more protective. When the bank's imminent collapse was no longer a question, the result was a hasty seizure and sale. Had the two government agencies acted in concert, rather than as adversaries, it is likely that WaMu's problems would have been resolved earlier and with less collateral damage. During an interview, the chairman of the FDIC, Sheila Bair, stated pointedly that WaMu "could have sold themselves in July if they had tried." |750| The same outcome was not accomplished until two months later in September when no other options remained, and OTS worked with the FDIC to make it happen.

As mentioned earlier, OTS was the primary, but not the only, federal bank regulator that oversaw Washington Mutual. Since WaMu was also an insured institution, the FDIC served as a backup examiner responsible for evaluating the risk that the bank posed to the Deposit Insurance Fund. Because WaMu was one of the eight largest insured institutions in the country, the FDIC had assigned a Dedicated Examiner whose full time responsibility was to determine whether the bank was operating in a safe and sound manner. The FDIC Examiner reviewed all OTS ROEs and examination findings, participated on many occasions in OTS examinations, and reviewed bank documents. The FDIC reviewed the CAMELS ratings for the bank, as well as LIDI ratings under its Large Insured Depository Institutions Program.

For many years, FDIC examiners worked cooperatively with OTS examiners to conduct oversight of WaMu. But beginning in 2006, OTS management expressed increasing reluctance to allow FDIC examiners to participate in WaMu examinations and review bank documents. Claiming that joint efforts created confusion about which agency was WaMu's primary regulator, |751| OTS officials employed a variety of tactics to limit the FDIC oversight of the bank, including restricting its physical access to office space at the bank, its participation in bank examinations, and its access to loan files. In addition, as the FDIC began to express greater concern about the bank's viability, recommend ratings downgrades, and urge enforcement action, OTS officials displayed increasing resistance to its advice. In the end, OTS not only undermined years of cooperative oversight efforts, but at times actively impeded FDIC oversight of one of the largest insured banks in the country.

Resisting FDIC Advice. During the period 2004-2008, internal FDIC evaluations of Washington Mutual were consistently more negative than those of OTS, at times creating friction between the two agencies. OTS also resisted the FDIC's advice to subject WaMu to stronger enforcement actions, downgrade its CAMELS rating, and solicit buyers for the bank.

As early as 2005, the FDIC examination team expressed concerns about WaMu's high risk lending strategy, even though the bank's management expressed confidence that the risks were manageable. In an internal memorandum, for example, the FDIC team identified multiple negative impacts on WaMu's loan portfolio if housing prices were to stop climbing. The memorandum stated in part:

    "Washington Mutual Bank's (WMB) single-family residential (SRF) loan portfolio has embedded risk factors that increase exposure to a widespread decline in housing prices. The overall level of risk is moderate, but increasing. … A general decline in housing prices would adversely impact: a) The SRF loan portfolio; b) The home equity loan portfolio; and c) Mortgage banking revenue. … In January 2005, management developed a higher-risk lending (HRL) strategy and defined company-wide higher-risk loans as … sub prime loans … SFR loans with FICO scores below 620, … consumer loans with FICO scores below 660, and … [the] Long Beach … portfolio. Management intends to expand the HRL definition and layer additional risk characteristics in the future. … 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 WMB 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." |752|

In mid-2005, an internal FDIC memorandum discussed the increased risk associated with the new types of higher risk mortgage loans being issued in the U.S. housing market:

    "Despite the favorable history, we believe recent lending practices and buyer behavior have elevated the risk of residential lending. Concerns are compounded by significantly increased investor activity and new loan products that allow less creditworthy borrowers to obtain mortgages. The new loan products of most concern include Option Adjustment Rate Mortgage (ARM) Loans, Interest Only (IO) Loans, and Piggyback Home Equity Loans." |753|

WaMu offered all three types of loans, in addition to subprime loans through Long Beach.

In 2007, an FDIC memorandum again identified WaMu's high risk home loans as its "primary risk," singling out both its subprime and Option ARM loans:

    "SFR [Single Family Residential loan] credit risk remains the primary risk. The bank has geographic concentrations, moderate exposure to subprime assets, and significant exposure to mortgage products with potential for payment shock. … The bank's credit culture emphasized home price appreciation and the ability to perpetually refinance. … In the past, the bank relied on quarterly sales of delinquent residential loans to manage its non performing assets. The bank's underwriting standards were lax as management originated loans under an originate to sell model. When the originate to sell model collapsed in July 2007 for private and subprime loans, management was no longer able to sell non performing assets. Consequently, non performing assets are now mounting, and the bank's credit risk mitigation strategy is no longer effective." |754|

From 2004 to 2008, the FDIC assigned LIDI ratings to WaMu that indicated a higher degree of risk at the bank than portrayed by the bank's CAMELS ratings. LIDI ratings are intended to convey the degree of risk that a bank might cause loss to the Deposit Insurance Fund, with A being the best rating and E the worst. |755| The FDIC IG explained the difference between LIDI and CAMELS ratings as follows: "LIDI ratings consider future risks at an institution, where CAMELS rating, in practice, are more point-in-time measures of performance." |756| As early as 2004, the FDIC viewed WaMu as having higher levels of risk than indicated by its CAMELS ratings. This chart shows the comparable ratings over time:

WaMu CAMELS and LIDI Ratings, 2004-2008 |757|

Assessment Period

CAMELS Composite Rating

LIDI Rating

January 2004



July 2004



January 2005



July 2005



January 2006



July 2006



March 2007



June 2007



September 2007



December 2007



March 2008



June 2008



September 2008



FDIC IG Rymer explained that the B/C rating meant that the FDIC viewed WaMu as posing a "somewhat more than ordinary risk" to the Deposit Insurance Fund, the C rating meant it "posed more than an ordinary risk," D meant the FDIC had "a high level of concern," and E meant that the FDIC had "serious concerns" that WaMu would cause a loss to the Fund. |758|

Despite assigning lower LIDI ratings to the bank, indicating the increasing risk it posed to the Deposit Insurance Fund, the FDIC – like OTS – continued to support a 2 CAMELS rating throughout 2007. The result of both regulators delaying a downgrade in WaMu's rating had a direct impact on FDIC operations. According to the FDIC Inspector General, WaMu's CAMELS rating of 2 prevented the FDIC from charging higher premiums for the Deposit Insurance Fund until February 2008, when its rating was dropped to a 3. |759| Higher premiums are one of the tools used by the FDIC to signal to financial institutions that they should better control their risk. Unfortunately, in this case, that tool was not available in 2005, 2006, or 2007.

OTS downgraded the bank to a 3 CAMELS rating in February 2008, after WaMu incurred substantial losses. OTS also required WaMu to issue a nonpublic Board Resolution making general commitments to strengthen its operations. The FDIC undertook a special insurance examination of the bank, analyzed its capital, and concluded that the bank should raise additional capital. |760| The FDIC staff attempted to engage OTS staff in discussions about increasing the bank's capital and downgrading its CAMELS ratings, but OTS was not persuaded. |761|

In July 2008, tensions between the FDIC and OTS flared after the FDIC sent a letter to OTS urging it to take additional enforcement action: "As we discussed, we believe that [WaMu's] financial condition will continue to deteriorate unless prompt and effective supervisory action is taken." |762| The letter urged OTS to impose a "corrective program" that included requiring the bank to raise $5 billion in additional capital and provide quarterly reports on its financial condition. OTS not only rejected that advice, but also expressed the hope that the FDIC would refrain from future "unexpected letter exchanges." |763| In a separate email, Scott Polakoff, a senior OTS official called the FDIC letter "inappropriate and disingenuous":

    "I have read the attached letter from the FDIC regarding supervision of Wamu and am once again disappointed that the FDIC has confused its role as insurer with the role of the Primary Federal Regulator. Its letter is both inappropriate and disingenuous. I would like to see our response to the FDIC, which I assume will remind it that we, as the PFR, will continue to effectively supervise the entity and will continue to consider the FDIC's views." |764|

Two weeks later, on July 31, both OTS and the FDIC met with the WaMu Board of Directors to discuss the bank's problems. At that meeting, the FDIC Dedicated Examiner suggested that the bank look for a "strategic partner" who could buy or invest in the bank. The OTS director, John Reich, later expressed anger at the FDIC for failing to clear that suggestion first with OTS as the bank's primary regulator. An FDIC examiner wrote to his colleagues:

    "Major ill will at WAMU meeting yesterday caused by FDIC suggestion in front of WAMU management that they find a strategic partner. [OTS Director] Reich reportedly indicated that was totally inappropriate and that type of conversation should have occurred amongst regulatory agencies before it was openly discussed with management." |765|

The next day, on August 1, 2008, due to WaMu's increasing financial and deposit losses, the FDIC Chairman, Sheila Bair, suggested that the bank's condition merited a downgrade in its CAMELS rating to a 4, signaling a troubled bank. |766| The head of OTS sent an email to the head of the FDIC responding that "rating WaMu a 4 would be a big error":

    "In my view rating WaMu a 4 would be a big error in judging the facts in this situation. It would appear to be a rating resulting from fear and not a rating based on the condition of the institution. WaMu has both the capital and the liquidity to justify a 3 rating. It seems based on email exchanges which have taken place that FDIC supervisory staff in San Francisco is under pressure by the fear in Washington to downgrade this institution. … [P]rior to such action I would request a[n FDIC] Board meeting to consider the proper rating on this institution." |767|

The FDIC Chairman responded: "We will follow the appropriate procedures if the staff cannot agree." |768|

A few days later, Ms. Bair sent an email to Mr. Reich requesting a discussion of "contingency planning" for WaMu, including making "discrete inquiries" to determine whether any institution would be willing to buy the bank. The OTS Director responded with a lengthy email criticizing the request and stating in part:

    "I do not under any circumstances want to discuss this on Friday's conference call …. 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 …. You personally, and the FDIC as an agency, would likely create added instability if you pursue what I strongly believe would be a precipitous and unprecedented action. … It seems as though the FDIC is behaving as some sort of super-regulator – which you and it are not." |769|

In September 2008, Ms. Bair informed WaMu that there was a likely ratings disagreement between the FDIC and OTS, and that the FDIC intended to lower the bank's rating to a 4. After the FDIC Chairman informed the OTS Director by email of her conversation with WaMu, Mr. Reich forwarded the exchange to his OTS Deputy Director, upset that she had not come to him first with that information: "I cannot believe the continuing audacity of this woman." |770| Two weeks later, the bank failed.

Restricting Office Space and Information. Throughout the period examined by the Subcommittee, OTS not only rebuffed the FDIC's analysis and advice, it began to actively impede FDIC oversight efforts at WaMu. OTS even went so far as to limit the FDIC's physical access to office space, as well as to needed information, at WaMu's new headquarters. Prior to 2006, OTS had always provided the FDIC examiners with space in its on-site offices at the bank, making it easy for FDIC examiners to participate in OTS examinations. In the summer of 2006, however, following WaMu's move to a new headquarters in Seattle, OTS did not provide any of its desks for the FDIC examiners. OTS also restricted the FDIC's access to an important database that all examiners used to review WaMu documents, referred to as the "examiner's library." From July until November 2006, a period of about four months, the FDIC examiners were denied access to both office space on the bank's premises and the examiner's library. The FDIC had to make multiple requests, taking the issue up through the OTS hierarchy in Washington, D.C. headquarters, to regain the access it had enjoyed for years at WaMu.

In an October 2006 email to the FDIC Assistant Regional Director, George Doerr, the FDIC Dedicated Examiner at WaMu, described in exasperation how he had been promised permanent space at the bank, but still did not have it. Demonstrating how poisoned the relationship was at that point, the FDIC examiner blamed the lack of cooperation on "stalling tactics and misrepresentations:"

    "Our issue is with OTS management (Finn and Dochow) and how they have apparently mislead RD [Regional Director] Carter, DRD [Deputy Regional Director] Villalba, you, and me. This regards space for the dedicated examiner and access to information …. I met with OTS examiners yesterday and they have not made arrangements for permanent space for me at the new location and protocols for information sharing have not been developed …. In July RD Carter [from FDIC] talked with Finn [from OTS] and he agreed to space and access. On 8/17 you and DRD Villalba had a telephone conversation with Dochow and he agreed it was not necessary to fix what was not broken and he promised access to space and information. On 9/15 I met with Dochow and he agreed to space and information sharing …. I am prepared for more of Dochow's stalling tactics and misrepresentations." |771|

Mr. Doerr forwarded the "info about OTS denying us space and access to information" to other FDIC officials stating: "The situation has gone from bad to worse." |772|

At the Subcommittee hearing, when asked why OTS took four months to restore FDIC access to office space and WaMu documents, Mr. Doerr of the FDIC responded:

    Mr. Doerr: I can't explain what the reason was. I personally think they didn't want us there. I mean, we were denied physical access and the access to this examiner library … of electronic materials that WaMu puts together for the regulators …. [Y]ou shouldn't have to go 4 months without having to have that. …

    Senator Levin: And it was essential that Mr. Funaro [the FDIC Dedicated Examiner] have access to that library in order to get information about the Washington Mutual?

    Mr. Doerr: Absolutely. |773|

By November 2006, when OTS relented and provided desk space and database access to the FDIC Dedicated Examiner, it did little to ameliorate the situation. Its actions contributed to a worsening relationship between the two agencies, impeded FDIC oversight efforts, and weakened oversight of WaMu's activities. |774|

Restricting FDIC Examinations. At the same time OTS was withholding office space and database access from the FDIC examination team, it also, for the first time, refused an FDIC request to participate in an OTS examination of WaMu.

Although the FDIC has a broad statutory right to participate in examinations of insured depository institutions, |775| it had agreed to spell out how it would exercise that statutory authority in a 2002 Interagency Agreement with the Federal Reserve, OCC, and OTS. |776| The Interagency Agreement authorized the FDIC to conduct "special examinations" of insured institutions that "represent a heightened risk" to the Deposit Insurance Fund, defined as institutions with a 3, 4, or 5 rating on the CAMELS scale or which were "undercapitalized as defined under Prompt Corrective Action" standards. |777| Other FDIC bank examinations had to be authorized by the primary regulator. Prior to 2006, OTS had routinely authorized joint OTS-FDIC examinations without regard to the CAMELS ratings, but in January 2006, OTS suddenly changed its policy. The change was signaled in an email sent by a senior OTS official to his colleagues:

    "The message was crystal clear today. Absolutely no FDIC participation on any OTS 1 and 2 rated exams. . . . We should also deny FDIC requests to participate on HC [holding company] or affiliate exams.

    Permission for FDIC to join us on WaMu … will stand for now, but they should not be [in] direct contact with thrift management or be requesting info directly from the thrift." |778|

This email signaled the beginning of a much more restrictive policy toward the FDIC participation in OTS examinations, even though in January 2006, OTS indicated it would allow an exception for the FDIC examiners to continue participating in its scheduled examination of WaMu. The reasons for this change in policy were never made clear, but in several interviews, OTS and FDIC officials attributed it to certain senior OTS officials who were reluctant to share thrift oversight responsibilities with the FDIC.

In August 2006, the FDIC made what it viewed as a routine request to join in the next OTS examination of WaMu, which was designed to focus, in part, on WaMu's subprime lending. To the surprise and consternation of the FDIC, the OTS Regional Director Michael Finn sent a letter denying the request and stating that OTS would instead "share our exam findings with the FDIC, as we have in the past." |779| Mr. Finn wrote that because WaMu's CAMELS rating was a 2 and FDIC had not shown "any concerns regarding our past or planned examination activities, and our continued commitment to share all appropriate information, the FDIC has not shown the regulatory need to participate in the upcoming Washington Mutual examination."

After discussing the Finn letter in an internal email, the FDIC Assistant Regional Director, George Doerr, wrote to his colleagues:

    "Obviously, we have a major problem here. OTS is taking the approach we need to establish a ‘regulatory need to participate' on an exam, and that the basis would have to be disagreement on exam findings. Mr. Finn is totally missing the point on our need for timely accurate information to properly categorize WAMU for deposit insurance premium purposes, more so now than ever in the past." |780|

In October 2006, John Carter with the FDIC sent Michael Finn of OTS a letter repeating the FDIC's request to participate in the WaMu examination:

    "I have received your response to our August 14 2006 letter in which we request permission to participate in aspects of the upcoming examination of Washington Mutual Bank. Regarding your reasoning for rejecting our participation in these target reviews, you are correct that our request is not predicated on any current disagreement related to examination findings or concerns regarding supervisory activities at Washington Mutual. Such criteria are not prerequisite for requesting – or for the OTS granting – FDIC staff participation in target examination activities.

    As you are aware, the FDIC and the OTS have a long, cooperative, and productive working relationship with respect to the examination of Washington Mutual Bank, which we hope to continue. Past experience has proven that our participation in targeted reviews is beneficial to our respective Agencies, as well as to the Bank. … The 2002 Agreement clearly allows for FDIC staff participation in examination activities to evaluate the risk of a particular banking activity to the deposit insurance fund.

    Washington Mutual Bank is very large insured financial institution, and in our view participation on the upcoming targeted reviews is necessary to fulfill our responsibilities to protect the deposit insurance fund." |781|

On November 10, 2006, Mr. Finn responded with a letter that, again, refused to allow the FDIC to participate in the WaMu examination:

    "OTS does not seek to have FDIC staff actively participate in our examination activities and conclusions at Washington Mutual. We do understand your need for access to examination information and your need to meet with OTS staff to discuss our supervisory activities at Washington Mutual. To facilitate this information sharing and discussions, we have agreed to allow your Dedicated Examiner … to conduct his FDIC risk assessment activities on site at Washington Mutual when our examination team is on site. All FDIC requests for information should continue to be funneled through our examinerin- charge." |782|

The OTS letter also restricted the ability of the FDIC to place more than one examiner on site at WaMu, even though the bank, with $300 billion in assets, was one of the largest insured institutions in the country and was engaged in a high risk lending strategy:

    "We also understand that the FDIC may occasionally request OTS permission to have FDIC examination staff assist [its Dedicated Examiner] on site at Washington Mutual in his risk assessment activities. We will consider these limited requests to send additional FDIC staff to Washington Mutual on a case-by-case basis." |783|

Despite the negative tone of the OTS letter, the FDIC persisted in its request, and OTS eventually allowed the FDIC examiners to participate in some WaMu examinations in 2006 and 2007, though it continued to press the FDIC to limit its requests and personnel. |784|

During the Subcommittee hearing, the FDIC staff described their surprise at the new OTS policy and frustration at its seemingly circular reasoning – that the FDIC needed to specify a "basis" and "disagreement" with OTS to justify joining an OTS examination, but the FDIC was also barred from participating in the very examinations that could develop that basis and disagreement. |785|

Restricting Access to Loan Files. Even after OTS reluctantly allowed the FDIC to participate in some OTS examinations, it held firm in its refusal to allow the FDIC to directly 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| 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.

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 sheer size of WaMu, was, to me, enough reason for FDIC to ask for back-up authority." |791|

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 stressed that the key point he was trying to convey was that OTS was WaMu's primary federal regulator:

    Mr. Reich: I think basically and fundamentally it was who was the primary Federal regulator.

    Senator Levin: It was turf, in a word.

    Mr. Reich: I think OTS had the responsibility as the primary Federal regulator.

    Senator Levin: Turf.

    Mr. Reich: We had the statutory responsibility.

    Senator Levin: Instead of going at this as partners –

    Mr. Reich: I have more than most – an understanding of the role of the FDIC and their need to participate. I have been there." |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 in the kind of dangerous practices that the bank engaged in, dangerous to their solvency, dangerous to their investors, dangerous to their depositors, dangerous to this economy." |795|

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.


608. See 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001482, Hearing Exhibit 4/16-94 [Sealed Exhibit]. See also, e.g., 12/17/2004 email exchange among WaMu executives, "Risks/Costs to Moving GSE Share to FH," JPM_WM05501400, Hearing Exhibit 4/16-88 (noting that Fannie Mae "is well aware of our data integrity issues (miscoding which results in misdeliveries, expensive and time consuming data reconciliations), and has been exceedingly patient."). [Back]

609. See 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001509, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

610. 6/30/2004 OTS Memo to Lawrence Carter from Zalka Ancely, OTSWME04-0000005357 at 61 ("Joint Memo #9 - Subprime Lending Strategy"); 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001483 [Sealed Exhibit]. See also 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302978, Hearing Exhibit 4/13-2a ("As we implement our Strategic Plan, we need to address OTS/FDIC 2004 Safety and Soundness Exam Joint Memos 8 & 9 . . . Joint Memo 9: Develop and present a SubPrime/Higher Risk Lending Strategy to the Board."). [Back]

611. 1/2005 "Higher Risk Lending Strategy Presentation," submitted to Washington Mutual Board of Directors, at JPM_WM00302978, Hearing Exhibit 4/13-2a; see also "WaMu Product Originations and Purchases by Percentage – 2003-2007," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1i. [Back]

612. 4/18/2006 Washington Mutual Home Loans Discussion Board of Directors Meeting, at JPM_WM00690894, Hearing Exhibit 4/13-3 (see chart showing gain on sale for government loans was 13 basis points (bps); for 30-year, fixed rate loans was 19 bps; for Option ARMs was 109 bps; for home equity loans was 113 bps; and for subprime loans was 150 bps.) [Back]

613. The Home Loans presentation to the Board acknowledged that risks of the High Risk Lending Strategy included managing credit risk, implementing lending technology and enacting organizational changes. 4/18/2006 Washington Mutual Home Loans Discussion Board of Directors Meeting, at JPM_WM00690899, Hearing Exhibit 4/13-3. [Back]

614. 1/18/2005 Washington Mutual Inc. Washington Mutual Bank FA Finance Committee Minutes, JPM_WM06293964-68 at 67; see also 1/2005 Washington Mutual, Higher Risk Lending Strategy Presentation, at JPM_WM00302987, Hearing Exhibit 4/13-2a (chart showing peak loss rates in 2007). [Back]

615. See 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001509, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

616. "WaMu Product Originations and Purchases by Percentage – 2003-2007," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1i. [Back]

617. "Securitizations of Washington Mutual and Long Beach Subprime Home Loans," chart prepared by the Subcommittee, Hearing Exhibit 4/13-1c. [Back]

618. 4/2010 "Evaluation of Federal Regulatory Oversight of Washington Mutual Bank," report prepared by the Offices of Inspector General at the Department of the Treasury and Federal Deposit Insurance Corporation (hereinafter "Treasury and FDIC IG Report"), at 9, Hearing Exhibit 4/16-82. [Back]

619. Id. An August 2006 WaMu internal presentation indicated that over 95% of its Option ARM borrowers were making minimum payments. See 8/2006 chart, "Borrower-Selected Payment Behavior," in WaMu internal presentation entitled, "Option ARM Credit Risk," JPM_WM00212646, Hearing Exhibit 4/13-37. [Back]

620. See Treasury and FDIC IG Report, at 9, Hearing Exhibit 4/16-82. [Back]

621. Id. at 10. [Back]

622. Id. [Back]

623. Id. at 11. [Back]

624. See Thorson prepared statement, at 5, April 16, 2010 Subcommittee Hearing at 105. [Back]

625. WaMu's Chief Credit Officer informed the Board of Directors that WaMu was "heavily concentrated" in residential mortgages and high risk products as well as in "highly stressed" geographic markets, which negatively affected WaMu's portfolio performance. See 2/25/2008 Credit Risk Overview Report to the Board of Directors, prepared by John McMurray, WaMu Chief Credit Officer, JPM_WM02548447, at 28-29. He reported that WaMu's mortgages were 1366% of its common tangible equity, the highest percentage of any of the top 20 banks. He also informed the Board that the bank's residential mortgages "performed very poorly" and WaMu had "generally retained higher risk products (e.g., Option ARMS, 2nd Liens, Subprime, Low Doc)." [Back]

626. OTS Fact Sheet 12, "Securitizations," Dochow_Darrel-00001364_001. [Back]

627. Id. [Back]

628. 3/17/2008 letter from Kerry Killinger to Darrel Dochow with enclosed Board Resolution, OTSWMS08-015 0001216. See also Treasury and FDIC IG Report at 31. [Back]

629. Subcommittee interviews of WaMu Chief Financial Officer Tom Casey (2/20/2010); WaMu Controller Melissa Ballenger (2/14/2010); and OTS Western Region Office Director Darrel Dochow (3/3/2010); 4/2010 "Washington Mutual Regulators Timeline," prepared by the Subcommittee, Hearing Exhibit 4/16-1j. [Back]

630. See 7/21/2008 letter from FDIC to OTS, FDIC_WAMU_000001730, Hearing Exhibit 4/16-59. [Back]

631. For more information on IndyMac Bank, see section E(2), below. [Back]

632. See undated charts prepared by FDIC on "Daily Retail Deposit Change," FDIC-PSI-01-000009. [Back]

633. See, e.g., 12/1/2008 "WaMu Bank Supervisory Timeline," prepared by OTS Examiner-in-Charge Benjamin Franklin, at Franklin_Benjamin-00035756_001, at 032 (7/22/2008 entry: "Although they have $60 billion in borrowing capacity, the FHLB is not in a position to fund more than about $4 to $5 billion a week"). See also FDIC LIDI Report for the Second Quarter of 2008, at FDIC_WAMU_000014991 [Sealed Exhibit]. [Back]

634. 7/3/2008 email from John Reich to Kerry Killinger, "MOU vs. Board Resolution," Hearing Exhibit 4/16-44. [Back]

635. 7/21/2008 letter from FDIC to OTS, FDIC_WAMU_000001730, Hearing Exhibit 4/16-59. [Back]

636. 7/22/2008 letter from OTS to FDIC, OTSWMS08-015 0001312, Hearing Exhibit 4/16-60. [Back]

637. See 8/1/2008 email exchange among FDIC colleagues, FDIC-EM_00246958, Hearing Exhibit 4/16-64. [Back]

638. 8/1/2008 email exchange among OTS officials, Hearing Exhibit 4/16-62. The FDIC had performed a capital analysis earlier in the summer and had been pushing for a downgrade for weeks. See 7/21/2008 letter from FDIC to OTS, FDIC_WAMU_000001730, Hearing Exhibit 4/16-59. [Back]

639. 8/1/2008 email from OTS Director John Reich to FDIC Chairman Sheila Bair, Hearing Exhibit 416-63. [Back]

640. See 8/6/2008 email from John Reich, OTS Director, to Sheila Bair, FDIC Chairman, "Re: W," FDICEM_ 00110089, Hearing Exhibit 4/16-66. [Back]

641. 9/11/2008 OTS document, "WaMu Ratings," Hearing Exhibit 4/16-48. [Back]

642. 7/28/2008 email from OTS Deputy Director Scott Polakoff to Timothy Ward, "Re: WAMU MOU," Polakoff_Scott-00060660_001, Hearing Exhibit 4/16-45. [Back]

643. Subcommittee interview of Tim Ward, OTS Deputy Director of Examinations, Supervision and Consumer Protection (2/12/2010). [Back]

644. 9/10/2008 email from OTS Director John Reich to OTS Deputy Director Scott Polakoff, Polakoff_Scott- 00065461_001, Hearing Exhibit 4/16-68. [Back]

645. See undated charts prepared by FDIC on "Daily Retail Deposit Change," FDIC-PSI-01-000009. [Back]

646. See IG Report at 13. [Back]

647. See IG Report at 28. [Back]

648. 5/12/2004 OTS Memo 5, "SFR Loan Origination Quality," OTSWME04-0000004883. [Back]

649. 5/20/2004 FDIC-DFI Memo 3, "Single Family Residential Review," OTSWME04-0000004889. [Back]

650. 9/13/2004 OTS Report of Examination, at OTSWMS04-0000001498, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

651. 9/13/2004 OTS Report of Examination, at OTSWMS04-0000001492, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

652. 9/13/2004 OTS Report of Examination, at OTSWMS04-0000001497, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

653. 10/18/2004 OTS Field Visit Report of Examination, at OTSWMEF-0000047576-78, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

654. 2/7/2005 OTS Letter to Washington Mutual Board of Directors on Matters Requiring Board Attention, OTSWMEF-0000047591 [Sealed Exhibit]. [Back]

655. 6/3/2005 OTS Findings Memorandum, "Single Family Residential Home Loan Review," OTSWME05-004 0000392, Hearing Exhibit 4/16-26. [Back]

656. Id. at OTSWME05-004 0000392. [Back]

657. 8/29/2005 OTS Report of Examination, at OTSWMS05-004 0001794, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

658. 3/14/2006 OTS Report of Examination, at 19, OTSWMEF-0000047030, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

659. 5/23/2006 OTS Findings Memorandum, "Home Loan Underwriting," OTSWMS06-008 0001299, Hearing Exhibit 4/16-33. [Back]

660. Id. [Back]

661. 5/25/2006 OTS Findings Memorandum, "Loan Underwriting Review - Long Beach Mortgage," OTSWMS06- 008 0001243, Hearing Exhibit 4/16-35. [Back]

662. 8/26/2006 OTS Report of Examination, at OTSWMS06-008 0001680, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

663. 9/18/2007 OTS Report of Examination, at OTSWMEF-0000046679, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

664. 9/18/2007 OTS Report of Examination, at OTSWMEF-0000047146, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

665. 7/15/2008 OTS Presentation to WaMu Board of Directors based on Comprehensive Examinations, Polakoff_Scott-00061303_007, 012, 027, Hearing Exhibit 4/16-12b. [Back]

666. Subcommittee interviews of Ronald Cathcart (2/23/2010), David Schneider (2/17/2010), and Cheryl Feltgen (2/6/2010). [Back]

667. 9/13/2004 OTS Report of Examination, at OTSWMS04-0000001504, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

668. Id. at OTSWMS04-000001488. [Back]

669. 4/5/2004 OTS Report of Examination, at OTSWMEF-0000047477, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

670. 3/15/2004 OTS Report of Examination, at OTSWMS04-0000001509, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

671. Id. [Back]

672. 6/1/2005 OTS Findings Memorandum, "Corporate Risk Oversight," OTSWMS05-005 0002046, Hearing Exhibit 4/16-23. [Back]

673. 8/29/2005 OTS Report of Examination, at OTSWMS05-003 0001783, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

674. Id. at OTSWMS05-004 0001792. [Back]

675. 10/3/2005 OTS Field Visit Report of Examination, at OTSWMEF-0000047602, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

676. 8/29/2006 OTS Report of Examination, at OTSWMS06-008 0001671, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

677. Id. at OTSWMS06-008 0001687, 91. [Back]

678. 6/7/2007 OTS Asset Quality Memo 11, "Broker Credit Administration," Hedger_Ann-00027930_001, Hearing Exhibit 4/16-10. [Back]

679. Prepared statement of Treasury IG Thorson, April 16, 2010 Subcommittee Hearing, at 5. [Back]

680. 6/7/2007 OTS Asset Quality Memo 11, "Broker Credit Administration," Hedger_Ann-00027930_001, Hearing Exhibit 4/16-10. [Back]

681. Id. at 011. [Back]

682. 9/18/2007 OTS Report of Examination, at OTSWMEF-0000046681, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

683. Id. at OTSWMEF-0000046690. [Back]

684. Id. at OTSWMEF-0000046691. [Back]

685. 5/31/2007 Draft OTS Findings Memorandum, "Compliance Management Program," Franklin_Benjamin- 00020408_001, Hearing Exhibit 4/16-9. [Back]

686. 3/11/2008 WaMu presentation, "Summary of Management's Action to Address OTS Concerns," JPM_WM01022322; 3/17/2008 letter from Kerry Killinger to Darrel Dochow with enclosed Board Resolution, OTSWMS08-015 0001216 (committing to initiatives outlined by management). [Back]

687. 6/19/2008 OTS Asset Quality Memo 22, Bisset_John-00046124_002, Hearing Exhibit 4/16-12a. [Back]

688. 7/15/2008 OTS presentation to WaMu Board of Directors based on Comprehensive Examinations, Polakoff_Scott-00061303-028, Hearing Exhibit 4/16-12b. [Back]

689. See April 16, 2010 Subcommittee Hearing at 25. [Back]

690. See, e.g., 10/3/2005 OTS Report of Examination, at OTSWMEF-0000047601, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

691. 5/20/2005 OTS Memo 4, "Safety and Soundness Examination," at OTSWME06-039 0000214. [Back]

692. Id. [Back]

693. 3/14/2005 OTS Report of Examination, at OTSWMEN-000001794, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

694. 5/23/2006 OTS Memo 2, "Safety and Soundness Examination," at OTSWME06-039 0000205. [Back]

695. Undated OTS internal memo, OTSWMSP-00000001936-51 at 39 [Sealed Exhibit]. [Back]

696. Undated OTS internal memo, OTSWMEN-0000015926-31 at 28 [Sealed Exhibit]. [Back]

697. Undated OTS internal memo, OTSWMSP-00000001936-51 at 39 [Sealed Exhibit]. [Back]

698. Subcommittee Interview of Bruce Thorvig (2/24/2010). [Back]

699. Id. [Back]

700. 5/22/2006 WaMu internal email, OTSWMEN-0000020983. [Back]

701. Subcommittee Interview of Bruce Thorvig (2/24/2010). [Back]

702. IG Report, at 11, Hearing Exhibit 4/16-82. [Back]

703. 2/21/2007 draft internal WaMu report, "Residential Appraisal Department Review," OTSWMEN-0000000274 (drafted by Mark Swift). [Back]

704. 4/5/2007 OTS Asset Quality Memo 2, OTSWME07-067 0001082. [Back]

705. Id. [Back]

706. 11/1/2007 New York Attorney General press release, http://www.ag.ny.gov/media_center/2007/nov/nov1a_07.html. Both companies appraised property in New York, which provided jurisdiction for the complaint. [Back]

707. New York v. First American Corporation, et al., (N.Y. Sup.), Complaint (November 1, 2007), at 3. [Back]

708. 11/7/2007 email from Darrel Dochow to Benjamin Franklin, Randy Thomas, others, OTSWMS07-011 0001294. [Back]

709. See undated OTS internal memo to John Bowman, OTSWMSP-0000001936 [Sealed Exhibit]. [Back]

710. 11/16/2007 email from OTS Director John Reich to OTS Operations Director Scott Polakoff, Reich_John- 00040045_001. [Back]

711. 7/28/2008 Draft Memo to Hugo Zia from Bruce Thorvig, OTSWMEN-0000015851 [Sealed Exhibit]. [Back]

712. See 12 CFR Part 564. [Back]

713. Undated OTS internal memo, OTSWMSP-00000001936-51 at 47 [Sealed Exhibit]. [Back]

714. Id. at 37 [Sealed Exhibit]. The Subcommittee found no evidence that anyone in OTS senior management disputed the conclusions of the investigation. [Back]

715. Id. [Back]

716. OTS internal document, OTS Enforcement Status of Formal Investigations, Quigley_Lori-00231631_001. [Back]

717. 12/21/2005 OTS internal memorandum by OTS examiners to OTS Deputy Regional Director, OTSWMS06-007 0001010, Hearing Exhibit 4/16-31. [Back]

718. Id. [Back]

719. 1/13/2004 FDIC-Washington State joint visitation report, FDIC-EM_00102515-20, Hearing Exhibit 4/13-8b. OTS held a copy of this report in its files, OTSWME04-0000029592. [Back]

720. 4/14/2005 OTS internal email, OTSWME05-012 0000806, Hearing Exhibit 4/16-19. [Back]

721. 10/3/2005 OTS Holding Company Field Visit Report of Examination, at OTSWMS06-010 00002532, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

722. See 12/21/2005 OTS internal memorandum by OTS examiners to OTS Deputy Regional Director, at OTSWMS06-007 0001011, Hearing Exhibit 4/16-31. [Back]

723. 6/3/2005 OTS memorandum from Rich Kuczek to Darrel Dochow, "Long Beach Mortgage Corporation (LBMC) Review," OTSWMS06-007 0002683, Hearing Exhibit 4/16-28. [Back]

724. Id. See also 5/19/2005 OTS email, "LBMC Fair Lending," OTSWMS05-005 0002002, Hearing Exhibit 4/16-20 ("I would not … feel comfortable with their moving [Long Beach] under the thrift without some conditions"). [Back]

725. See 12/21/2005 OTS internal memorandum by OTS examiners to OTS Deputy Regional Director Darrel Dochow, OTSWMS06-007 0001009-16, Hearing Exhibit 4/16-31. [Back]

726. Id. at OTSWMS06-007 0001011. [Back]

727. See 12/21/2005 OTS internal memorandum by OTS examiners to OTS Deputy Regional Director Darrel Dochow, OTSWMS06-007 0001009-16, Hearing Exhibit 4/16-31. [Back]

728. Id. at OTSWMS06-007 0001015-16. [Back]

729. See 10/3/2005 OTS Report of Examination, OTSWMS06-010 0002530, Hearing Exhibit 4/16-94 [Sealed Exhibit] (noting that, after a field visit to Long Beach that concluded in December 2005, OTS learned that loan repurchases had surged: "Subsequent to our on-site field visit, management informed us that loan repurchases had increased considerably. … Management indicated that approximately $0.6 billion in loans were repurchased during the fourth quarter of 2005 out of approximately $13.2 billion in total whole loan sales. The gross financial impact at December 31, 2005, was $72.3 million."); 1/20/2006 email from Darrel Dochow to Michael Finn and others, with chart, OTSWMS06-007 0001020 to 1021 (describing Long Beach repurchases). [Back]

730. See 4/17/2006 memorandum by WaMu General Auditor to Board of Directors' Audit Committees of Washington Mutual Inc. and Washington Mutual Bank, "Long Beach Repurchase Reserve Root Cause Analysis," JPM_WM02533760, Hearing Exhibit 4/13-10 (Long Beach "experienced a dramatic increase in EPD's [early payment defaults], during the third quarter of 2005 [which] … led to a large volume of required loan repurchases. The unpaid principal balance repurchased as a result of the EPD provision for the year ended December 31, 2005 was $837.3 million. The net loss from these repurchases was approximately $107 million."). [Back]

731. Subcommittee interview of Benjamin Franklin (2/18/2010). [Back]

732. See "Washington Mutual Regulators Timeline," chart prepared by the Subcommittee, Hearing Exhibit 4/16-1j. [Back]

733. 5/25/2006 OTS Findings Memorandum, "Loan Underwriting Review - Long Beach Mortgage," OTSWMS06- 008 0001243, Hearing Exhibit 4/16-35. See also 1/20/2006 email from Darrel Dochow to Michael Finn, et al., "LBMC EDP Impact," OTSWMS06-007 0001020 (emphasis added). [Back]

734. 6/9/2006 email from Darrel Dochow to Richard Kuczek, Lawrence Carter, and Benjamin Franklin, "Findings Memos," OTSWMS06-008 0001253, Hearing Exhibit 4/16-36. [Back]

735. 8/29/2006 OTS Report of Examination, at OTSWMS06-008 0001680, Hearing Exhibit 4/16-94 [Sealed Exhibit]; 9/18/2007 OTS Report of Examination, OTSWMEF-0000047146, Hearing Exhibit 4/16-94 ("Based on our review of 75 subprime loans originated by LBMC, we concluded that subprime underwriting practices remain less than satisfactory . . . . Given that this is a repeat concern and MRBA, we informed management that underwriting must be promptly corrected, or heightened supervisory action would be taken, including limiting the Bank's ability to continue SFR subprime underwriting.") [Sealed Exhibit]. [Back]

736. April 13, 2010 Subcommittee Hearing at 22. [Back]

737. Id. at 20. See also IG Report at 28. [Back]

738. April 16, 2010 Subcommittee Hearing at 17. [Back]

739. Id. at 18. [Back]

740. See FDIC Complaint Against WaMu Executives at ¶ 79. [Back]

741. Id. [Back]

742. Id. [Back]

743. Id. at ¶ 81. [Back]

744. Id. [Back]

745. Id. [Back]

746. Id. at ¶ 82. [Back]

747. IG Report at 8. [Back]

748. April 16, 2010 Subcommittee Hearing at 76. John Corston was the Acting Deputy Director of the FDIC's Division of Supervision and Consumer Protection, Complex Financial Institution Branch. [Back]

749. Id. [Back]

750. Subcommittee interview of Sheila Bair (4/5/2010). [Back]

751. See, e.g., April 16, 2010 Subcommittee Hearing at 61 (testimony of OTS Director Reich: "[F]irst of all, the primary regulator is the primary Federal regulator, and when another regulator enters the premises, when the FDIC enters the premises, confusion develops about who is the primary regulator, who really is calling the shots, and who do we report to, which agency.") [Back]

752. 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). In an interview, when shown the draft memorandum, FDIC Assistant Regional Director George Doerr, who was a member of the WaMu examination team, told the Subcommittee that this type of analysis was prepared for a select group of mortgage lenders, including WaMu, to understand where the mortgage market was headed and how it would affect those insured thrifts. He did not have a copy of the final version of the memorandum, but said the FDIC's analysis was discussed with OTS. Subcommittee interview of George Doerr (3/30/2010). [Back]

753. 7/5/2005 memorandum from FDIC Associate Director John H. Corston to FDIC Associate Director Michael Zamorski, "Insured Institutions' Exposures to a Housing Slowdown," FDIC_WAMU_000015114, Hearing Exhibit 4/16-51b. [Back]

754. FDIC Washington Mutual Bank LIDI Report, Q307, FDIC_WAMU_000014851, Hearing Exhibit 4/16-94 [Sealed Exhibit]. [Back]

755. An A rating indicates a "low risk" of concern that an institution will cause a loss to the Deposit Insurance Fund, a B rating indicates an "ordinary level of concern," a C rating indicates a "more than an ordinary level of concern," a D rating conveys a "high level of concern," and an E rating conveys "serious concerns." See prepared statement of FDIC IG Rymer at 5 (chart showing FDIC LIDI ratings descriptions), April 16, 2010 Subcommittee Hearing, at 124 (showing FDIC LIDI ratings description). [Back]

756. Id. [Back]

757. See prepared statement of FDIC IG Rymer at 6 (chart showing WaMu ratings and insurance assessments), April 16, 2010 Subcommittee Hearing at 125. [Back]

758. Id. [Back]

759. Prepared statement of FDIC IG Rymer at 6-7, April 16, 2010 Subcommittee Hearing, at 125-26. See also IG Report at 40-42. [Back]

760. See 7/21/2008 letter from FDIC to OTS, FDIC_WAMU_000001730, Hearing Exhibit 4/16-59. [Back]

761. Subcommittee interview of Steve Funaro (3/18/2010). [Back]

762. 7/21/2008 letter from the FDIC to OTS, FDIC_WAMU_000001730, Hearing Exhibit 4/16-59. [Back]

763. 7/22/2008 letter from OTS to the FDIC, OTSWMS08-015 0001312, Hearing Exhibit 4/16-60. [Back]

764. 7/22/2008 email from OTS Deputy Director Scott Polakoff to OTS colleagues, Hearing Exhibit 4/16-59. [Back]

765. 8/1/2008 email from David Promani to FDIC colleagues, FDIC-EM_00246958, Hearing Exhibit 4/16-64. [Back]

766. See 8/1/2008, email from Darrell Dochow to OTS senior officials, Hearing Exhibit 4/16-62. [Back]

767. 8/1/2008 email from OTS Director John Reich to FDIC Chairman Sheila Bair, Hearing Exhibit 416-63. [Back]

768. Id. [Back]

769. 8/6/2008 email from OTS Director John Reich to FDIC Chairman Sheila Bair, "Re: W," FDIC-EM_00110089, Hearing Exhibit 4/16-66. [Back]

770. 9/10/2008 email from OTS Director John Reich to OTS Deputy Director Scott Polakoff, Polakoff_Scott- 00065461_001, Hearing Exhibit 4/16-68. [Back]

771. 10/13/2006 email chain from Vanessa Villalba to J. George Doerr, John F. Carter, and John H. Corston, "Re: wamu quarterly," FDIC_WAMU_000014449, Hearing Exhibit 4/16-53. See also 9/6/2006 FDIC internal email chain, "OTS re: WAMU," FDIC-EM_00252239, Hearing Exhibit 4/16-51c ("He absolutely agreed you'd have access to the Examiner Library. And he hasn't arranged that."). [Back]

772. Id. [Back]

773. April 16, 2010 Subcommittee Hearing at 72-73. [Back]

774. See also IG Report at 42-45 ("It appears that 2006 was a turning point in the relationship between FDIC and OTS in terms of information sharing that carried through to 2008."). [Back]

775. See 12 U.S.C. § 1820(b)(3). [Back]

776. See "Coordination of Expanded Supervisory Information Sharing and Special Examinations," PSI-FDIC-10- 0001. [Back]

777. Id. [Back]

778. 1/24/2006 email from OTS senior official Michael Finn to Edwin Chow and Darrel Dochow, OTSWM06-006 0000129, Hearing Exhibit 4/16-49. [Back]

779. 9/6/2006 FDIC internal email chain, "OTS re: WAMU," FDIC-EM_00252239-40, Hearing Exhibit 4/16-51c. [Back]

780. Id. at FDIC-EM_00252240. [Back]

781. 10/6/2006 letter from FDIC senior official John Carter to OTS senior official Michael Finn, FDIC_WAMU_000014445-46, Hearing Exhibit 4/16-52a. [Back]

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. [Back]

783. Id. [Back]

784. See, e.g., 1/22/2007 letter from Michael Finn to John Carter, Hearing Exhibit 4/16-52d. [Back]

785. See, e.g., April 16, 2010 Subcommittee Hearing at 73-74. [Back]

786. 9/7/2006 email from FDIC senior official John Carter to George Doerr, FDIC-EM_00252239, Hearing Exhibit 4/16-51c. [Back]

787. 2/6/2007 email from Stephen Funaro to George Doerr, Hearing Exhibit 4/16-55. [Back]

788. 2/6/2007 email from George Doerr to John Carter and others, Hearing Exhibit 4/16-55. [Back]

789. 4/30/2007 email from George Doerr to David Collins, FDIC_WAMU 000014457, Hearing Exhibit 4/16-57. [Back]

790. April 16, 2010 Subcommittee Hearing at 80-81 (testimony of Sheila Bair). [Back]

791. April 16, 2010 Subcommittee Hearing at 34. [Back]

792. Id. at 35. [Back]

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."). [Back]

794. April 16, 2010 Subcommittee Hearing at 64. [Back]

795. Id. at 66. [Back]

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B. Background D. Regulatory Failures

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