WASHINGTON — When Countrywide Financial felt pressured by federal agencies charged with overseeing it, executives at the giant mortgage lender simply switched regulators in the spring of 2007.
The benefits were clear: Countrywide's new regulator, the Office of Thrift Supervision, promised more flexible oversight of issues related to the bank's mortgage lending. For OTS, which depends on fees paid by banks it regulates and competes with other regulators to land the largest financial firms, Countrywide was a lucrative catch.
But OTS was not an effective regulator. This year, the government has seized three of the largest institutions regulated by OTS, including IndyMac Bancorp, Washington Mutual — the largest bank in U.S. history to go bust — and, on Friday evening, Downey Savings and Loan Association. Three others, including Countrywide, had to sell to avoid failure.
In the parade of regulators that missed signals or made decisions they came to regret on the road to the current financial crisis, the Office of Thrift Supervision stands out.
OTS is responsible for regulating thrifts, also known as savings and loans, which focus on mortgage lending. As the banks under OTS supervision expanded high-risk lending, the agency failed to rein in their excesses despite clear evidence of mounting problems, according to banking officials and a review of financial documents.
Deregulatory stanceOTS instead adopted an aggressively deregulatory stance toward the mortgage lenders it regulated. It let the reserves the banks held as a buffer against losses dwindle to a historic low. When the housing market turned downward, the thrifts were left vulnerable. As borrowers defaulted, the companies were unable to replace the money they had expected to collect.
The decline of the thrifts further rattled the economy, making it harder and costlier for people to get mortgages and disrupting businesses that relied on the banks for loans. Investors lost money, employees lost jobs and the public lost faith in financial institutions.
As Congress and the incoming Barack Obama administration prepare to revamp federal financial oversight, the collapse of the thrift industry offers a lesson in how regulation can fail. It happened over several years, a product of the regulator's overly close identification with its banks, and of the agency managers' appetite for deregulation, new lending products and expanded homeownership, sometimes at the expense of traditional oversight. Tough measures, like tighter lending standards, were not employed until after borrowers began defaulting in large numbers.
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