FDIC and SEC: Suing banks over offenses government ignored.

Commentary about business and finance.
March 29 2011 5:22 PM

Left Hand, Meet Right Hand

The government sues bankers over offenses government regulators once ignored.

Kerry Killinger. Click image to expand.
Kerry Killinger, former CEO of Washington Mutual

A couple of weeks ago, the government started signaling, at long last, that it was ready to get tough on the bankers who caused the 2008 financial crisis. On March 16 the Federal Deposit Insurance Corporation, or FDIC, sued three former top executives of Washington Mutual, or WaMu, for taking "extreme and historically unprecedented risks," thereby causing the bank to lose "billions of dollars." That same day, the New York Times reported that the Securities and Exchange Commission had sent so-called Wells notices—often a sign that civil charges are imminent—to a handful of former executives at mortgage-securitization giants Fannie Mae and Freddie Mac.

Bethany  McLean Bethany McLean

Bethany McLean is a contributing editor at Vanity Fair and the co-author of All the Devils Are Here: The Hidden History of the Financial Crisis.

Bethany McLean writes a weekly business column for Slate and is a contributing editor to Vanity Fair. She is the author (with Joe Nocera) of All the Devils Are Here: The Hidden History of the Financial Crisis and (with Peter Elkind) "The Smartest Guys In The Room."

The targets seem well-chosen. The collapse of WaMu, acquired by JPMorgan Chase at a fire-sale price in the fall of 2008 was, according to the FDIC, the biggest bank failure in U.S. history. The FDIC is seeking to recover $900 million from the three bankers. Fannie and Freddie were taken over by the government in the fall of 2008. So far, they have cost taxpayers about $130 billion.

Perhaps you're thinking: If only the government had known at the time what these scoundrels were up to, we could all have been spared a great deal of pain. The trouble with that line of reasoning is that, um, the government did know what was going on. The Office of Thrift Supervision, which regulated WaMu, and the Office of Housing Enterprise Oversight, which regulated Fannie and Freddie, were supervising the very behavior that their sister agencies are now suing over. The government's lawsuits call to mind a cynical boast by Burt Lancaster, playing tabloid power broker J.J. Hunsecker, in the 1957 noir classic Sweet Smell of Success:  "My right hand hasn't seen my left hand in 30 years."

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The FDIC's complaint against WaMu alleges that the three executives—former CEO Kerry Killinger, former Chief Operating Officer Stephen Rotella, and former President of Home Lending David Schneider—"focused on short term gains to increase their own compensation, with reckless disregard for WaMu's longer term safety and soundness."  Or as Killinger put it in a June 2004 memo, ""Above average creation of shareholder value requires significant risk taking." The FDIC complaint basically says that as experienced bankers, the three should have known better. Yet they repeatedly ignored warnings from risk managers, including one who said that WaMu was "putting borrowers into homes that they simply cannot afford."  According to the complaint, the three not only embraced risky loans, but "layered these already risky products with additional risk factors." Both Killinger and Rotella were "heard to deride risk managers as 'checkers, checkers, checkers.' " Both Killinger and Rotella have come out swinging in their own defense, insisting that they took what steps they could to save WaMu.  (Schneider has been silent.)

The FDIC has marshaled an impressive amount of evidence against Killinger, Rotella, and Schneider, but its complaint doesn't have much to say about WaMu's chief regulator, the Office of Thrift Supervision.  Not quite one year ago, when the Senate Permanent Subcommittee on Investigations looked into OTS's role in the 2008 meltdown, committee chairman Sen. Carl Levin, D.-Mich, observed, "[M]ost of those financial firms couldn't have done what they did unless their regulators let them." These regulators, Levin said, "saw the shoddy lending practices, saw the high risk lending, saw the substandard securitizations, understood the risk, but let the banks do it anyway." OTS's oversight of WaMu was Levin's chief example.

One reason the OTS didn't act, according to Levin, was that OTS was almost as fixated on short-term profits as WaMu was. These "precluded enforcement action to stop the bank's use of shoddy lending," the Senate committee concluded. One OTS employee wrote to another in September 2005:"It has been hard for us to justify doing much more than constantly nagging (okay, 'chastising') … since they [WaMu] have not been really adversely impacted in terms of losses." While WaMu executives layered risk upon risk in subprime loans, the regulators did nothing to stop them. Rather than issue regulations to prohibit banks' risky mortgage practices, the regulators issued a tepid "guidance" instead—and that "Interagency Guidance on Nontraditional Mortgage Products" wasn't  issued until the fall of 2006, by which time the horse was already pretty much out of the barn.  While WaMu's executives allegedly ignored their own risk managers telling them that borrowers couldn't pay back their loans, federal banking regulators ignored consumer advocates telling them exactly the same thing!

As the FDIC started to worry about WaMu's financial health—WaMu's deposits were insured by the FDIC—the OTS, Levin said, "acted like a WaMu guard dog, trying to keep the FDIC at bay."  It wasn't until September 2008 that the OTS took its first formal enforcement action against WaMu; the FDIC had been trying to persuade the OTS to get moving for more than a month. The FDIC, Rotella complained in his press statement, isn't blameless either; it "actively participated in the examination of WaMu, rating the bank Satisfactory or better until the middle of 2008, just months before it seized the bank." This calls to mind another pearl of cinematic cynicism, from 1978's Animal House: "You fucked up! You trusted us!" (Granted, the FDIC was not WaMu's primary regulator.)