Sewell Chan writes an excellent article in today’s NYT: “U.S. Faults Regulators Over a Bank” which illustrates the regulatory disfunction and conflict of interest that lead to the financial meltdown.
In fact, in our firm’s experience as an appraiser doing work for Washington Mutual during their run-up, you’d have to be blind not to see the conflicts and the loss of a sense of risk. The appraisal departments were the last bastion of neutrality in the organization to protect appraisers from pressure by loan officers and they were eventually closed as “cost centers.” Nearly two years to the day that WAMU closed their in house appraisal departments and went with Appraisal Management Companies, they became insolvent.
The two agencies that oversaw Washington Mutual, the investigation found, feuded so much that they could not even agree to deem the company “unsafe and unsound” until Sept. 18, 2008.
And one had an operational incentive:
With more than $300 billion in assets, WaMu was the largest institution regulated by the Office of Thrift Supervision and accounted for as much as 15 percent of its total revenue from assessments, the report found.
In 2004, while property values were rising at double-digit rates, I remember thinking that my firm would be “out of business” in 3 years if we continued to keep our majority of client base with large retail banks because most were pursuing high risk lending strategies. This meant high-ball appraisal values and little concern about borrowers ability to pay – firms like ours simply didn’t fit in. Frustrated with the insanity of all this, I eventually started up blogging in 2005 – the timing in this article as outlined in the treasury report framed the WAMU debacle perfectly.
The report found that Washington Mutual had failed primarily “because of management’s pursuit of a high-risk lending strategy that included liberal underwriting standards and inadequate risk controls.” The strategy accelerated in 2005 and came to a crashing end in 2007 with the drop in the housing market.
Here are a few simple takeaways that should be considered in all forms of financial regulation.
- Regulators need clearly defined lines of authority – turf wars between all agencies were a distraction – politics not allowed.
- Regulators can not be specifically dependent on income derived from the institutions they regulate – an amazingly large conflict.
- Institutions can not select which agency they wish to be regulated by – wow, common sense.