Office Of Thrift Non-Supervision

In the deluge of financial news, one story that is emblematic of the colossal failure of the conservative approach to government has gotten too little attention: The Washington Post's in-depth look [1] Sunday at the Office of Thrift Supervision.

Like so many federal financial regulatory agencies under President Bush, it was viewed not as a guardian of the public interest but a Wall Street party-pooper that had to be reined in itself. So not only did the ideologues who took it over systematically starve it of funds, but they abashedly shifted its focus from being one of several vice cops on the beat to one of proprietors of the bordello. Regulated firms became "customers" that were ardently courted for the fees that they would pay to be regulated. (Yes, that's right; the agency is funded by fees paid by the financial institutions, not by general tax revenues.)

The Post reports:

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 destructive excesses despite clear evidence of mounting problems, according to banking officials and a review of financial documents.

Instead, OTS adopted an aggressively deregulatory stance toward the mortgage lenders it regulated. It allowed the reserves the banks held as a buffer against losses to dwindle to a historic low. When the housing market turned downward, the thrifts were left vulnerable. As borrowers defaulted on loans, the companies were unable to replace the money they had expected to collect.

... The agency championed the thrift industry's growth during the housing boom and called programs that extended mortgages to previously unqualified borrowers as "innovations." In 2004, the year that risky loans called option adjustable-rate mortgages took off, then-OTS director James Gilleran lauded the banks for their role in providing home loans. "Our goal is to allow thrifts to operate with a wide breadth of freedom from regulatory intrusion," he said in a speech.

... Gilleran was an impassioned advocate of deregulation. He cut a quarter of the agency's 1,200 employees between 2001 and 2004, even though the value of loans and other assets of the firms regulated by OTS increased by half over the same period. The result was a mismatch between a short-handed agency and a burgeoning thrift industry.

...He also reduced consumer protections. The other agencies that regulate banks review corporate health and compliance with consumer laws separately, which consumer advocates say helps ensure that each gets proper scrutiny from specialists. Gilleran merged the consumer exam into the financial exam. ... At the time he headed the agency, he defended the consolidation of the exams, saying thrifts would be required to conduct "self-evaluations of their compliance with consumer laws."

One of the firms that the Office of Thrift Supervision courted was Countrywide Financial—a mutually beneficial catch, because the OTS could pull in huge fees from Countrywide (fees from Countrywide would cover 5 percent of the agency's budget) and Countrywide would end up answering to an agency that would be more compliant to its wishes than the Comprtoller of the Currency, which had been overseeing Countrywide's operations before 2006.

Scott Polakoff, deputy director at the Office of Thrift Supervision, said that Countrywide was told that it shouldn't expect that the agency would go easier on them. But, according to The Post,

Critics in government and industry said Countrywide's shift from OCC oversight to that of OTS was evidence of a 'competition in laxity' among regulators eager to attract business. "Institutions should not be able to find a safe haven in one regulator from the reasonable concerns of another regulator," said Karen Shaw Petrou of Federal Financial Analytics, referring to the Countrywide episode.

We're now paying dearly for an ideology that says businesses should be treated as "customers" of a regulatory agency that are owed deference for every financial "innovation" they come up with, no matter how detrimental to the long-term health of the economy they happen to be. And while it may make sense for financial institutions to pay for the costs of having their operations monitored, those fees do not mean they own the agencies getting those fees. We the people do, and the leadership of those agencies have to be committed to work for the public interest, not as servants of Wall Street.

Ultimately, the financial regulatory structure needs to be reworked in accordance with today's marketplace, just as today's financial marketplace needs to be reshaped so that institutions like Countrywide and Washington Mutual can't engage in practices that ultimately hold the American taxpayers hostage in fear of financial collapse. But while we wait for that reshaping, we can at least demand appointees within the existing structure who will not have contempt for the regulatory mission of the agencies they are chosen to lead.