Failed Banks Showed Red Flags Early, Report Says
OTS Failed to Heed Warning Signs of Troubled Banks
According to the Center for Responsible Lending’s Second S&L Scandal: How OTS Allowed Reckless and Unfair Lending to Fleece Homeowners and Cripple the Nation’s Savings and Loan Industry, the federal government allowed banks to engage in high-risk lending practices, was slow to take aggressive action that could have reduced the economic fallout from bank failures and hid serious financial problems from investors and the public.
The report compared today’s problems with those of the savings and loan crisis of the late 1980s. In 2008, five thrifts with assets totaling $354 billion collapsed compared to 1989 when thrifts with assets totaling $135 billion failed, the report said.
“Even when inflation is taken into account, the dollar total for 2008’s failures still exceeds those for 1989.”
Four Banks Provide Test Cases
Center for Responsible Lending looked at public records surrounding four case studies, Superior Bank, FSB; NetBank, FSB; IndyMac, FSB; and Washington Mutual Savings Bank. In each case, OTS failed to heed early warning signs, the report noted.
For example, lawsuits against Washington Mutual Finance proved the company was harming borrowers. In 2003, the Texas attorney general opened an investigation of lost mortgage payments after receiving more than 200 consumer complaints.
Some of the other warning signs included:
- Three audits of the failed Superior Bank revealed OTS ignored growing risks in the bank’s business strategy since 1993.
- In 2006, investors forced NetBank to buy back $182 million in questionable loans, which had increased in 2005.
- IndyMac boosted loan volume by relying on risky, weakly underwritten mortgage products and ignoring borrowers’ ability to repay loans.
- IndyMac also failed to document financial income of its borrowers and recorded huge losses from quarter to quarter.
- Research companies ranking banks safety listed IndyMac at the bottom of their lists.
- Washington Mutual increased its volume of subprime lending from $20 billion in 2003 to $36 billion in 2005.
- By the end of 2007, Washington Mutual held $48 billion in payment option adjustable rate mortgages that resulted in negative amortization, meaning monthly payments weren’t enough to cover monthly interest charges.
Report Recommends Improvements
The Center for Responsible Lending recommended that the federal government should consolidate OTS into the Comptroller of the Currency Office. Federally chartered banks and thrifts would be overseen by the Comptroller of the Currency Office, bank holding companies would be overseen by the Federal Reserve Board and state-chartered thrifts would continue to operate under state regulators. The Comptroller of the Currency Office also should improve its consumer protection efforts and force lenders to follow state consumer laws and enforcement. In the report, the center also offered these standards.
- State-chartered banks should continue to operate.
- Federal officials should stop getting in the way of state laws designed to prevent predatory lending and protect consumers.
- Mortgage lending should be based on sound underwriting.
- Market incentives should be aligned to ensure no one can get out of its responsibility to make responsible lending.
Authors of the report said the lessons of the first S&L scandal were clear that weak regulation and reckless lending practices would lead to financial disaster. The country has an opportunity to put these lessons to work now to improve the financial situation, the report concluded.
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