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Regulators failed for years to properly supervise the giant
savings and loanWashington Mutual, even as the company wobbled under the weight
of risky subprime mortgages, a federal investigation has concluded.

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.

By then, it was too late. A week later, amid a wave of deposit
withdrawals, the government seized the bank and sold it to JPMorgan Chase for
$1.9 billion. It was by far the largest bank failure in American history.

The report, prepared by the inspectors general for the Treasury
Department and the Federal Deposit Insurance Corporation, is expected to be
released Friday. A draft was obtained by The New York Times. The release
coincides with hearings this week by the Senate subcommittee on investigations,
which is treating Washington Mutual as a case history of the financial crisis.

Based on research conducted from March to November 2009, the
report examines the conduct of the bank’s primary regulator, the Office of
Thrift Supervision, an independent arm of the Treasury that regulates savings
associations, and the F.D.I.C., which insured the institution’s deposits.

The thrift supervision office was supposed to ensure the
company’s safety and soundness, while the F.D.I.C. was tasked with assessing
risks to its deposit insurance fund.

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.

But the report also levelled unexpectedly sharp criticism at the
F.D.I.C., which by July 2008 concluded that the bank needed $5 billion in
capital to withstand future potential losses. The report said the F.D.I.C.,
which had questioned the Office of Thrift Supervision’s assessments of the
bank’s soundness, could have stepped in earlier and acted as the primary
regulator, but decided “it was easier to use moral suasion to attempt to
convince the O.T.S. to change its rating.” 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.

Problems with quality

Although regulators found problems with the quality of the
mortgages it had originated and with the wholesale loans it bought through
outside brokers and banks, the office consistently deemed WaMu “fundamentally
sound,” giving it a rating of 2, the second-highest on a five-point scale used
to assess a bank’s condition, from 2001-7. Moreover, the office relied on
WaMu’s own tracking system to follow up on regulators’ findings.

The office did not lower the rating to 3 (“exhibits some degree
of supervisory concern”) until February 2008, and to 4 (“unsafe and unsound”)
until September 2008, days before WaMu collapsed. “It is difficult to
understand how O.T.S. continued to assign WaMu a composite 2 rating year after
year,” the report found.

O.T.S. officials said the agency had accepted the findings; the
F.D.I.C. said it could not comment until the report was completed.

The report said it would be “speculative to conclude that
earlier and more forceful enforcement action would have prevented WaMu’s
failure,” but also said such actions, if taken in 2006 or 2007, might have
pushed managers to move aggressively to correct weaknesses and stem losses.

Stiff resistance

The report said the F.D.I.C. “met resistance” from the thrift
supervisor when it assigned additional examiners to look at WaMu from 2005-8
and when it challenged the 2 rating in 2008.

In the summer of 2008, as WaMu teetered on the brink of failure,
the two regulators still could not agree. “The O.T.S. as primary regulator
wanted to rehabilitate WaMu and keep it in business,” the report states. “The
F.D.I.C., on the other hand, as an insurer wanted to resolve the institution’s
problems as soon as possible to maintain the value of WaMu in order to reduce
the cost of any failure.” The inspectors general, Eric M. Thorson of the
Treasury and Jon T. Rymer of the F.D.I.C., concluded that the F.D.I.C. should
make its own risk assessments of institutions large enough to pose significant
risk to its insurance fund.

The chairman of the House panel holding this week’s hearings,
Senator Carl Levin, Democrat of Michigan, said in a statement that he hoped the
hearings would inform the debate over changes in financial rules, which the
Senate could take up as early as this week, after its return from a spring
recess. Two former WaMu executives, Kerry K. Killinger and Stephen J. Rotella,
are expected to testify Tuesday.

“The recent financial crisis was not a natural disaster; it was
a manmade economic assault,” Mr. Levin said. “It will happen again unless we
change the rules.” The WaMu report could also influence the work of the
Financial Crisis Inquiry Commission, created by Congress to investigate the
financial disaster.

© The New York Times