The Office of Thrift Supervision: A case of Regulatory Capture
Created with fan fare and removed with disdain, the Office of Thrift Supervision ceased to exist after 22 years of existence. President George Bush Sr. signed the law which created the OTS in the wake of the Savings and Loan disaster of the 80s and the failure of their previous regulator, the Federal Home Loan Bank Board (FHLB). In typical congressional action, the OTS staff have been absorbed into the FDIC, OCC, Federal Reserve Board and FHFA. Like OTS, FHLB didn’t actually go away until it was merged with the Office of Federal Housing Enterprise Oversight (OFHEO) to create Federal Housing Finance Agency (FHFA). The OTS represents how legislative good intentions and economic incentives led a regulator to become a slave to the industry.
The Savings and Loan business model was to fund on the short end of the curve (through CDs) and buy assets on the long end. As long as the curve doesn’t invert, they made great money. As long as members kept buying CDs and their long dated commercial loans kept paying, money grew on trees. Even the politicians were involved to make sure the business continued without government interference. Let’s not forget the Keating 5 (which included Deer-in-the-Headlights Senator John McCain). As students of financial history know, the curve inverted, commercial loans stopped paying and short end funding costs soared.
President Bush Sr said “never again will America allow any insured institution operate without enough money” when signed the law which created the OTS. (I guess Jr missed that speech.) Since the GOP doesn’t believe in requiring taxpayers to be taxed for anything (except military based activities), the OTS was funded by a tax on the very institutions they regulated based on the size of company’s assets. Hence, OTS could hire more examiners, have nicer office furniture, and increased regulatory prestige if they could grow their portfolio of regulatees. Initially, the first real leader of the OTS, T. Timothy Ryan (now running the Wall Street lobbying group SIFMA), shut down thrifts and OTS suffered as they lost “clients”.
In the mid 1990s, OTS management, especially OTS Director James Gilleran, made a concerted effort to market themselves as the easier softer regulator. He even brought a chainsaw to a Thrift industry event. Just imagine what their marketing must have been like:
“Capital requirements got you down? We will beat any other regulator’s requirements by 50 bps!”
“No interest rate or credit risk model capabilities? No problem! At the OTS you can use ours!
“Our regulators await your call! Free up capital for those BBB CDOs you want to buy NOW!”
Countrywide and others headed their call. In 2005, Countrywide switched their charter and became a Thrift. At the same time both EMC (a Bear Stearns mortgage originating sub) and Lehman Brothers’s mortgage unit also became Thrifts. OTS staff nearly doubled by the time the economic crisis hit. When Countrywide spun off IndyMac, guess which regulator they chose? OTS of course! Ka-Ching!
As early as 2003, mid level OTS examiners starting finding major issues with thrifts like IndyMac, Countrywide, EMC, AIG and WashingtonMutual and raised them to senior management. These earnest folk actually wanted to reign in these thrifts to protect them. These examiners were no match for the Thrift lobbyists and incompetence of senior management. Even the FDIC couldn’t get past OTS management to protect “their” thrifts.
At the end of the day, OTS was doomed from the start due to its mission and economic incentives. It’s a model for how not to set up a financial regulator. OTS’s failures are well known and thousands of pages of text have been written about it. Regulators are supposed to be the last line of defense when financial institution management goes off the deep end and OTS just furthered their insanity. OTS had lost its way.
In the same vein, assuming the Consumer Finance Protection Board ever gets off the ground (and in a twist of irony are moving into OTS’s old offices) they too will be captured by the industry (and the lobbyists) they are supposed to regulate if incentives are misaligned and independence isn’t protected. (Which may not be a bad thing if you a member of the Banking Lobby).
Further Reading on this topic:
Senate Financial Crisis Report (161-242)