MELISSA BLOCK, host:
From NPR News, this is ALL THINGS CONSIDERED. I'm Melissa Block.
ROBERT SIEGEL, host:
And I'm Robert Siegel.
The Obama administration is working on a proposal to transform how banking is regulated. Reforming regulations means understanding what went wrong in the first place - how regulators missed all the financial shenanigans that helped to sink the economy.
BLOCK: Chana Joffe-Walt is part of our Planet Money team, and she's been taking a special look at AIG - that's the global insurance company whose risky bets placed it at the heart of the financial meltdown. The government has committed to provide AIG with more than $170 billion in rescue money.
Chana's question was this: AIG was supposedly watched over by 400 regulators in 150 countries and all 50 states, so what went wrong?
CHANA JOFFE-WALT: There was a gap in regulation. Sure, there were hundreds of regulators, but there was this gap and no one caught it because no one was watching over the whole company. That was the story of what went wrong with AIG.
From Congress, Fed Chairman Ben Bernanke was telling it and we were all repeating it. For months that story stuck. Until one day, Donald Cohen with the Federal Reserve, he's telling that story at a congressional hearing, no one charged, a senator is dutifully asking follow ups, and then they get interrupted. A hunched man peeking over his glasses says, um, we were. We were in charge, we screwed up.
Mr. SCOTT POLAKOFF (Interim Director, Office of Thrift Supervision): Senator, may I make a comment?
Unidentified Man: Yeah.
Mr. POLAKOFF: There may be a slight difference of opinion. And it's time for OTS to raise their hand and say we have some responsibility and accountability here. We were deemed an acceptable regulator for both U.S., domestic and international operations.
JOFFE-WALT: It wasn't a huge apology, but there it was. Scott Polakoff, interim director of the Office of Thrift Supervision, OTS, saying, blame us. The OTS regulates thrifts and holding companies that own thrifts. Thrifts are the same thing as savings and loans.
And this moment, you can tell, watching the hearing, that the congressmen, they're kind of taken aback. A few actually seem sort of incredulous. Senator Mel Martinez leans in.
Senator MEL MARTINEZ (Republican, Florida): Mr. Polakoff, I wanted a direct response, I wanted to ask you, I was struck by your acknowledgment that perhaps you are the regulator that we've been looking for. I think that we had assumed that there wasn't one. If you could please enlighten us and deepen a little bit on that comment.
Mr. POLAKOFF: Yes, sir, Senator, I'll give it a shot.
Sen. MARTINEZ: Rare moment, by the way, to say, me, I'm the one.
(Soundbite of laughter)
Mr. POLAKOFF: I'm the one, sir.
JOFFE-WALT: I'm going to go ahead and guess you've never heard of the Office of Thrift Supervision. A lot of regulation experts didn't know much about this agency until recently, like Patricia McCoy. She's a law professor at the University of Connecticut, someone who, in her free time, sits down with a pen and paper and does bank autopsies. She'll, like, research failed institutions, look at what went wrong. You know, for fun. So, one day, McCoy, she's making this graph of major bank failures from '07 and '08.
Professor PATRICIA MCCOY (University of Connecticut School of Law): It was late at night, I tend to work late at night. I had filled in the asset sizes and then I had to do a little research to see who the regulators were. And when I started typing in OTS, OTS, OTS, I went, what happened at this agency? It's been flying under the radar and we didn't notice.
JOFFE-WALT: Which institutions were you seeing and naming and writing OTS in next to them?
Prof. MCCOY: IndyMac, Washington Mutual, Downey Savings and Loan, NetBank.
JOFFE-WALT: You might recognize some of those names. For instance, IndyMac, the most expensive bank failure of this crisis: regulated by the OTS. Second most expensive, BankUnited: regulated by the OTS. The largest bank ever to fail, Washington Mutual: OTS. Other OTS claims to fame: Countrywide and AIG.
I did call the Office of Thrift Supervision several times. They wouldn't talk to me about AIG. William Black used to work there back in the early '90s. He's a professor at the University of Missouri, Kansas City now. And he says the idea that the OTS could ever go up against AIG, the world's largest insurance company, well…
Professor WILLIAM BLACK (University of Missouri): No contest. It's like the super heavyweight of the world going up against the 65 pound, 13-year-old class weakling - the one that keeps tripping over his feet walking down the hall.
JOFFE-WALT: That was the OTS.
Prof. BLACK: That was the OTS.
JOFFE-WALT: So, how did the heavyweight end up with the puny 13-year-old? Two things - two crazy truths about our system of regulation - number one: banks choose their regulators. If you're a national bank, you have four regulator choices, you go regulator shopping. Number two: if you're a regulator, you want to get picked, because you get paid by the banks - the institutions you're supposed to regulate. The more banks you regulate, the more money you have.
And the Office of Thrift Supervision, it was born at exactly the wrong time when it comes to these two things. So 1989, the savings and loan crisis, thrifts were dropping dead by the hundreds, but the OTS was the thrift regulator, it needed thrifts to pay for its budget.
Prof. BLACK: The OTS was losing revenue and losing revenue. And it was shrinking its staff, but it was losing revenue even faster than it was shrinking staff. So the staff feared that they would lose their jobs. And, of course, the bosses feared, why did they need an agency if there are fewer and fewer institutions?
JOFFE-WALT: The OTS couldn't hold a press conference and say, hello, we're having a going out of business sale. We'll be the laxest regulator in town. Come on down and sign up. No, instead they went to industry meetings. They talked about the services they offered. They showed up at press conferences to make their presence known. Like, this one time in June 2003, bunch of federal regulators are getting together to announce a campaign to ease regulation, you know, cut through red tape, and James Gilleran, the head of the Office of Thrift Supervision, he shows up for the photo op and here's what happened. Professors Patricia McCoy and William Black paint the picture.
Prof. MCCOY: They were essentially standing in a horseshoe. Behind them is a banner that announces the new regulatory relief campaign.
Prof. BLACK: And they're all grinning broadly and poised over a stack of the federal regulations, to demonstrate their intention to cut through all the federal regulations.
Prof. MCCOY: The other federal regulators showed up at the press conference with garden shears, and each of them is holding up their instrument ready to clip - very picturesque. Gilleran showed up with a chainsaw.
JOFFE-WALT: The OTS guy is holding a chainsaw.
Prof. MCCOY: Yes. And he's standing in front.
JOFFE-WALT: Companies got the message. You needed a thrift to be regulated by the OTS. General Motors got one. Next couple of years, so did GE, H&R Block and a large insurance conglomerate called AIG. So, the OTS was the chosen regulator and the OTS messed up.
Mr. MIKE ROSTER (Regulation Attorney): I don't care who was the regulator, I don't think they would've caught this.
JOFFE-WALT: This is Mike Roster. He's a veteran regulation lawyer. And he says, sure, you can dump on the OTS if you want, many would like to see the agency abolished. But Roster says there are bigger fish, like Congress. Congress passed a law in 2000 that made it nearly impossible to regulate the derivatives that got AIG in so much trouble. Be angry at them, Roster says. Rating agencies gave AIG endless stamps of approval. Be angry at them. OTS, he says, that's just a footnote.
Mr. ROSTER: And I hope we don't get diverted to that sideshow. It's getting diverted to sideshows that unfortunately doesn't solve things.
JOFFE-WALT: Last fall, Treasury Secretary Henry Paulson recommended getting rid of the OTS. President Obama is likely to recommend the same thing in the next couple weeks.
So if that's a sideshow, I think we're likely to get diverted. And that's what we do - a crisis, that's our favorite time to throw another layer of regulation on to our already super complicated system. We had the panic of 1907 that gave us the Federal Reserve. Then we had the Great Depression. The Great Depression gave us the FDIC. Then we had the S and L crisis. The S and L crisis gave us the Office of Thrift Supervision and now, here we are.
Chana Jaffe-Walt, NPR News.
SIEGEL: And you can hear more from Chana on AIG and the regulators this weekend on Chicago Public Radio's This American Life.