Where were regulators when banks were failing?

When ANB Bank of Arkansas failed last year, it was easy to blame executives whose pursuit of high-adrenaline growth led to the bank's demise. But now other key culprits have emerged in ANB's collapse: the government officials who were supposed to be policing the bank.

The inspectors general at the U.S. Treasury and the Federal Deposit Insurance Corp. (FDIC) have both issued reports saying that bank failures surged because regulators in some cases didn't step in and prevent hazardous behavior, and in others actively helped banks hide their growing problems.

As early as Wednesday, the Obama administration is set to release details of a new regulatory framework for the vast and complex financial system of commercial and investment banks and brokers that has evolved in the last few years. However, the recent reports from the inspectors general highlight that bank regulators failed to do their job properly even when supervising far simpler banking institutions, showcasing the difficulty the administration faces in ensuring the new supervisory system will work effectively.

Banks are closing at a faster clip than has been seen in 15 years. Already in 2009, 37 banks have failed, after 25 failures in 2008. Expectations are for a fourfold jump for the rest of the year. That has come at a high cost. The FDIC, which today insures deposits at banks for up to $250,000, has paid out $28.5 billion in just the last two years. Some of the failures might have been prevented.

At ANB, for instance, management suddenly started writing high-risk loans in a bid to grow. Half of the bank's loan portfolio in 2005 was concentrated in risky construction and land-development loans — a 300% increase from 2004. That same year, the bank had the highest loan losses in its history, and earnings plunged as its loan delinquency rate hit twice the national average. But rather than flagging those missteps, the bank's top cop, the Office of the Comptroller of the Currency (OCC), condoned ANB's behavior by awarding it the top overall safety rating.

"You can get into a comfort zone by looking at the rating from our primary regulator that says everything's OK," says Debra Jackson, who was chief operating officer of ANB and worked at the bank from its inception in 1994 until it failed. Conditions got worse after 2005, but it wasn't until the end of 2007 that the OCC conducted an on-site examination of the bank.

Months later, in May 2008, the FDIC seized ANB. "If OCC had acted more aggressively and sooner," the inspector general's report said, "ANB might have acted earlier or differently to address its problems."

That type of regulatory failure was repeated at several institutions that the FDIC has had to seize. In at least six banks examined by the Treasury's inspector general and at seven more scrutinized by the FDIC's inspector general, regulators were incompetent or indifferent — willing to look the other way as bank executives took their banks down destructive paths. The Federal Reserve's inspector general is conducting its own reviews on at least three institutions that failed under its supervision.

Perhaps the most extreme examples were two banks where the Treasury found "inappropriate" backdating of capital, which contributed to "misleading financial reporting."

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