FDIC saw risks at IndyMac in 2002 but failed to act

The Federal Deposit Insurance Corp.’s Inspector General released a report today on the regulator’s handling of failed IndyMac Bank, which specialized in stated-income loans to folks with decent credit scores.

The FDIC noted issues at IndyMac as early as 2002, but did not stop the bank’s risk taking, the report says.

“It was not until August 2007 that the FDIC began to understand the implications that the historic collapse of the credit market and housing slowdown could have on IMB and took additional actions to evaluate IMB’s viability,” the report says.

IndyMac’s failure is expected to cost the FDIC’s insurance fund $10.7 billion.

Critics of regulators have long said their failure to recognize and deal with the housing bubble and related loose lending is a key reason why the entire financial system nearly collapsed.

According to the Inspector General’s report, from 2001 to 2003, the FDIC worked with IndyMac’s main regulator, the Office of Thrift Supervision, and became concerned about IndyMac’s business model and its exposure to a potential housing bubble (they still weren’t sure if a bubble actually existed).

FDIC employees spent 8,096 hours in a “back-up capacity” at Indymac, the report says. Yet the FDIC failed to do much about their concerns, accept give the bank a higher risk ranking than OTS wanted.

In January 2002, examiners noted that “non-recession-tested lending programs such as subprime lending and (high loan-to-value) lending may pose the biggest threat to consumer loan portfolio credit quality in a slowing economy.”

The report says FDIC examiners also noted:

“consumers’ ever-increasing debt load, the expansion of adjustable rate mortgages, and a potential housing bubble;

“pricing and modeling charge-off risk with respect to the originate-to-sell model of the mortgage business.”

Despite these risks, the FDIC switched to relying on examinations from the OTS from 2004 to mid 2007, a period in which Indymac “continued to rely heavily on volatile funding sources such as brokered deposits and (Federal Home Loan Bank) advances to fund its growth.”

During that period, FDIC had a turnover problem, with five different case managers handling IndyMac.

As has been previously reported, the Office of Thrift Supervision allowed IndyMac to backdate a capital infusion to the first quarter of 2008, even though it was made in the second quarter. Here’s more from the report (bold added):

Further, although there was a noticeable deterioration in IMB in the fourth quarter of 2007 and into 2008, the FDIC did not suggest that OTS take, or itself take, any enforcement action against IMB. Notably, the FDIC’s analysis and conclusions of IMB’s first quarter 2008 financial data were affected by a capital contribution adjustment that was permitted by OTS. Had the capital contribution not been reflected in the first quarter data:

(1) IMB would have been required to request a waiver from the FDIC to continue to receive brokered deposits and

(2) the value of assets pledged as collateral to secure FHLB advances would have been reduced, thereby limiting the amount of FHLB advances and possibly the cost of IMB’s failure.

The report paints FDIC officials as aware of risks but not doing enough about them. That’s a $10 billion mistake.

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