WASHINGTON — Federal Deposit Insurance Corp. Chairman Sheila Bair testified Friday that the Office of Thrift Supervision "rejected" her agency's alarms on Washington Mutual's capital levels in 2008, portraying escalating discord between the two regulators prior to Wamu's seizure.

The Permanent Subcommittee on Investigations, a part of the Senate Homeland Security and Governmental Affairs Committee, is hearing testimony Friday from current and former OTS and FDIC personnel on the issue of Wamu's demise.

In February 2008, Wamu was pondering whether to raise more capital or accept a merger offer from another firm. It ended up raising $7 billion through an issuance of new stock, which resulted in the two federal regulators scrapping over whether the measure was adequate.

According to Bair's prepared testimony, the FDIC in May 2008 prepared an analysis that stated that, in a "stress scenario," Wamu would need an additional $5 billion to survive. Bair said that OTS "rejected the analysis," despite the FDIC's view that Wamu "did not recognize the problems facing it and was not taking the necessary corrective measures."

In July, Bair said that the two agencies again disagreed, this time over whether whether to downgrade Wamu's safety and soundness rating. When the disagreement was discussed in September 2008 by the FDIC board, Bair said the OTS "strongly disagreed" with the downgrade but that they relented and lowered Wamu's rating to the same level as the FDIC's assessment.

The FDIC's deputy regional director for the San Francisco region, George Doerr, testified Friday that FDIC officials found the OTS's change in heart "puzzling."

A week later, Lehman Brothers Holdings Inc. failed and Wamu experienced a run on its deposits, resulting in Wamu's seizure by the OTS.

Bair said that JPMorgan Chase & Co. had offered to buy Wamu for $7 billion in early 2008, but that Wamu management preferred a capital infusion that "preserved Wamu's independence but also limited future options from raising capital."

But even after the capital infusion, it appears that Bair was actively trying to spur a sale of Wamu. A March 26, 2008, email from John Reich, OTS director at the time, to his staff, released Friday by the Permanent Subcommittee on Investigations, states that Bair was encouraging the OTS "to make certain if they receive an acquisition offer, they should accept it."

Bair defended the decision to seize Wamu, saying that "the reality is that mortgage losses were mounting, downgrades were occurring, and efforts to raise capital had been exhausted."

By contrast, Reich argued in testimony Friday that Wamu was "too big to fail" — at least by what he described as "an inconsistent and moving public policy." Reich said the FDIC's Oct. 3, 2008, announcement of an increase in deposit insurance to $250,000 per depositor "would have mitigated the run on deposits which took place," but that the increase came too late for Wamu.

"Whether there would have been a later capital failure is pure conjecture," Reich said.

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