March 19, 2009 / 2:42 AM / 10 years ago

U.S. regulators ignored red flags on risk: GAO

WASHINGTON (Reuters) - The U.S. government’s hodgepodge of financial regulatory agencies failed to take a big-picture view of risk and ignored red flags in the current economic crisis, a government report said on Wednesday.

The House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises swears in (L-R) Scott Polakoff, Acting Director of the U.S. Office of Thrift Supervision, Joel Ario, Insurance Commissioner for the State of Pennsylvania, testifying on behalf of the National Association of Insurance Commissioners, Orice M. Williams, Director of Financial Markets and Community Investment at the U.S. Government Accountability Office and Rodney Clark, Managing Director of Insurance Ratings for Standard & Poor's to testify on "American International Group's Impact on the Global Economy: Before, During, and After Federal Intervention" before hearing testimony from AIG CEO Edward Liddy on Capitol Hill in Washington, March 18, 2009. REUTERS/Jason Reed

“Regulators did not effectively address the weaknesses or in some cases fully appreciate their magnitude, until the institutions were stressed,” Orice Williams, director of financial markets and community development at the Government Accountability Office, told a Senate panel.

“No regulator systematically looks across institutions to identify factors that could affect the overall financial system,” the report said.

Policymakers are considering giving increased authority to one regulator, possibly the Fed or FDIC, to be a systemic risk regulator that would have broad authority to monitor and manage risk across firms and products.

The ranking Republican Senator on the panel blasted the regulators.

“Welcome back from the vacations you’ve been taking for the past five years,” said Jim Bunning of Kentucky. “The regulators should have stopped the risk takers taking undue risk with taxpayers’ money or with equity that has been invested.”

The GAO studied a sample of financial institution reviews by regulators between December of 2008 and March 2009. It did not identify the banks.

A slew of regulators with differing responsibilities, including the Federal Reserve, the Securities and Exchange Commission, the Federal Deposit Insurance Corp and several others, in some cases did identify risk but did not act on it, the report said.

In some cases, regulators conceded that they relied on corporate management’s descriptions of risk, including in the subprime mortgage area, according to the report.

Sen. Jack Reed of Rhode Island, the panel’s chairman, asked if the regulators agreed with the report’s assessment that they relied too much on management’s representation of risk.

“There is an element of truth to that,” said Scott Polakoff, acting director of the Office of Thrift Supervision. He also said all financial services should be regulated in the same manner.

Orice Williams, Director of Financial Markets and Community Investment in the U.S. Government Accountability Office testifies before the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises on "American International Group's Impact on the Global Economy: Before, During, and After Federal Intervention" ahead of testimony from AIG CEO Edward Liddy on Capitol Hill in Washington, March 18, 2009. REUTERS/Jason Reed

NO STRESS TESTS AT BIG BANKS

The report also cited a 2006 review by the Federal Reserve in which the central bank found that none of the huge financial organizations it regulates had done systemwide ‘stress tests’ in which they tested risk for different scenarios.

“In these instances, regulators told us that they did not fully appreciate the risks to the institutions under review or the implications” to the larger system, the report said.

Roger Cole, the Federal Reserve’s director of banking supervision and regulation, said that same example highlights the Fed’s oversight.

“We used that as a major tool in terms of pushing on those firms ... (we) said ‘look, you need to do more here,’” Cole said.

Representatives from the major regulators told the panel they had been improving their risk identification practices since the crisis began.

“From 2004 to 2007 I think we all saw the accumulation of risk,” said Timothy Long, a senior deputy controller at the Office of the Comptroller, noting the warnings and other actions it took.

But he conceded: “We did not rein in the excesses driven by the market.”

Reporting by Kim Dixon; Editing by Gary Hill, Andre Grenon

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