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Report: Lax oversight allowed Downey Savings' loan binge

June 17, 2009 |  4:17 pm

Federal regulators responded inadequately from 2005 on as billions of dollars in high-risk mortgages piled up at weakly managed Downey Savings and Loan, the U.S. Treasury Department inspector general said in a report on last year’s failure of the Newport Beach thrift.

The Office of Thrift Supervision, the Treasury arm that regulates S&Ls, began warning Downey management in 2002 about its heavy issuance of pay-option adjustable-rate mortgages but failed to rein in the practice, the report said.

These option ARMs, often written without verifying borrowers’ income and assets, allowed homeowners to pay so little that their loan balances went up. The loans have emerged as a major contributor to the nation’s foreclosure crisis.

Downey Yet despite the warnings, "OTS examiners did not require Downey to limit concentrations in higher-risk loan products," said the 71-page inspector general report, posted Tuesday on the Treasury Department’s website.

"We believe that in light of the OTS’s repeated expressions of concern and management’s unresponsiveness to those concerns, OTS should have been more forceful, at least by 2005, to limit such concentrations," the report said.

Even after Downey, operated by parent Downey Financial Corp., was downgraded in regulators' confidential ratings from a strong 2 to a so-so 3 in 2006, the OTS took only an informal enforcement action against the thrift. The agency’s guidelines required a formal enforcement action, the Treasury's inspector general said.

An OTS spokesman did not immediately respond to a request for comment today.

U.S. Bancorp acquired Downey on Nov. 23 along with PFF Bank & Trust of Pomona, a savings and loan hammered by bad loans to Inland Empire developers and home builders. The Federal Deposit Insurance Corp. said Downey’s collapse would cost the deposit insurance fund about $1.4 billion and PFF’s failure an additional $729 million.

A series of large OTS-supervised thrifts, including Washington Mutual Inc., IndyMac Bancorp and Downey, failed last year after suffering large losses on option ARMs and other risky loans.

As part of its overhaul of the nation’s financial regulation, the Obama administration is recommending that Congress abolish the OTS and force S&Ls to switch to commercial bank charters.

-- E. Scott Reckard

Photo credit: Lori Shepler / Los Angeles Times