All the Devils Are Here [134]
When the regulators finally issued the guidance in the fall of 2006, it required lenders to include “consideration of a borrower’s repayment capacity.” But the guidance applied only to the category of mortgages that allowed borrowers to defer the payment of principal or interest. And, most important, it was just guidance. It didn’t carry the force of law. Subprime companies could ignore it.
To see what that meant in practice, you needn’t look any further than the Office of Thrift Supervision, which supervised Washington Mutual. After a meeting with the OTS in the fall of 2006, a WaMu executive wrote an e-mail in which he summarized the regulator’s position: “Their initial response was that they view the guidance as flexible. They specifically pointed out that the language in the guidance say [sic] ‘should’ vs. ‘must’ in most cases and they are looking to WaMu to establish our position on how the guidance impacts our business practices.”
A Senate investigation later concluded that during the drafting of the guidance, the OTS had argued for less stringent standards. It was very much in keeping with the turn the agency had taken. Under James Gilleran, the agency’s director from late 2001 to the spring of 2005, the OTS had shrunk disastrously: Gilleran chopped 20 percent of its staff in 2002. The OTS’s new goal, it said, was to “place emphasis on institutions, not the regulator, to ensure compliance with all existing laws, including consumer protection statutes.”
What’s more, the OTS was funded from fees paid by the thrifts themselves, based on their size. When Gilleran had taken the job, the OTS had been, as he later put it, “in a deficit financial position.” WaMu’s rapid growth, thanks to its exploding subprime business, meant that it was becoming an ever more important source of funds for its regulator. Between 2003 and 2008, for instance, WaMu’s fees represented 12 to 15 percent of the agency’s revenue, according to the Senate Permanent Subcommittee on Investigations. Perhaps that explains why John Reich, Gilleran’s replacement at OTS, once described Kerry Killinger, WaMu’s CEO, as “my largest constituent asset-wise.”
When Washington Mutual executives analyzed the consequences of implementing the regulators’ guidance, they concluded that it would reduce volume by 33 percent. So they didn’t do it. As late as June 2008, an FDIC examiner found that WaMu was “not in compliance with Interagency Guidance on Nontraditional Mortgages.”
That it took regulators until so late in the subprime madness to announce the guidance can’t be blamed only on the OTS. There was another culprit: the Federal Reserve. The Fed’s mind-set was on display in a late 2004 piece, published by the New York Fed, entitled, “Are Home Prices the Next ‘Bubble’?” The answer: “As for the likelihood of a severe drop in home prices, our examination of historical national home prices finds no basis for concerns.” Even after Ben Bernanke had replaced Greenspan as chairman in February 2006, it remained, in spirit, Greenspan’s Fed. The market still knew best. The market knew better than career bureaucrats how to properly price risk. Market discipline would prevent truly bad things from happening. The most important task of the banking regulators was to get out of the market’s way.
The president of the New York Fed by then was one of Rubin’s protégés from the Clinton Treasury: Tim Geithner, who had risen to be undersecretary for international affairs while still in his thirties. When he was named to head the New York Federal Reserve in 2003, he was all of forty-two. Having