IndyMac Regulators Ignored Warning Signs

According to “government watchdog” report regulators recognized warning signs at IndyMac but did nothing to put a halt to the bank’s risky business practices:

From the WSJ:

WASHINGTON - Federal regulators failed to catch warning signs that presaged the collapse of mega-thrift IndyMac Bank last July, a U.S. government watchdog said Thursday.

The Treasury Department’s inspector general said in a report that the Pasadena, Calif., savings and loan pursued an overly aggressive growth strategy that included failing to verify borrowers’ income and relying on expensive deposits to fund its operations.

The Office of Thrift Supervision, IndyMac’s regulator, recognized the red flags but did nothing to stop them, the Treasury inspector general said.

“We found that OTS identified numerous problems and risks, including the quantity and poor quality of nontraditional mortgage products,” the report said. “However, OTS did not take aggressive action to stop those practices from continuing to proliferate.”

The report suggests OTS examiners put faith in IndyMac’s management because the firm was turning profits and growing. Auditors found that OTS examiners didn’t always report all the problems identified by its examiners, and “did not ensure that the thrift took the necessary corrective actions” when it did bring problems to IndyMac’s attention.

“The thrift’s high-risk business strategy warranted more careful and much earlier attention,” the report said.

OTS officials didn’t dispute the findings, instead promising “aggressive action” to address shortcomings cited by auditors. OTS Director John Reich said the agency is establishing a “large bank” unit to improve oversight of thrifts with assets exceeding $10 billion.

The lesson here for the regulators is that they need to evaluate business practices and potential risks agnostically, and assess them in terms of the future problems they could cause for the bank. So as to avoid situations where they either purposely or inadvertently let present day success serve as a validation of potentially dangerous business practices. If regulators are going to fulfill their mission as a early warning system that helps to mitigate and/or prevent future problems, they need to be forward thinking in terms of how they identify and address risks.

It doesn’t take a mathematical genius from MIT to figure out that originating loans without verify income, and using expensive funding sources would eventually become a problem.

Finally this sort of thinking isn’t just a problem within regulatory bodies. Corporate managers often ignore all sorts of bad business practices when the company is profitable, using the old saw of “but we’re making money” to legitimize things that could get them in trouble later on. Hence the reason why it’s always good to turn a harsh eye inward and evaluate potential problems agnostically, lest you let present day strength blind you to future weaknesses.

Each and every formerly great company that has either collapsed or is currently facing dire straits, has a laundry list of problems they could’ve fixed in the past yet ignored because the company was doing well at the time.

You can read more here.

Source:

The WSJ: “Regulators Missed Woes at IndyMac” — Michael R. Crittenden, February 27, 2009

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn’t be viewed as financial or investment advice.

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