Ed Morrison · Insights into the collapse of National City

December 21st, 2009

From today’s Washington Post:

The Fed watched as National City made billions of dollars in subprime loans that were never repaid… The Fed’s failure to see the rot inside National City resulted from the central bank’s reliance on others to identify problems.

In part this was a matter of policy. The Fed regulated National City, but the company’s major subsidiary, a bank also called National City, was regulated by another federal agency, the Office of the Comptroller of the Currency. In 1999, Congress passed a law instructing the Fed to rely on the OCC “to the fullest extent possible.”

The law clearly authorized the Fed to conduct its own reviews where necessary, but the Fed lacked an effective system for determining when it should look more closely, said Orice Williams, director of financial markets and community investment at the GAO.

“If you aren’t looking, how would you know there is a problem?” Williams said.

…By 2006, National City had become primarily a subprime mortgage lender, federal data show. Even as the Fed continued to regard National City as healthy, the company’s executives were increasingly divided, with some warning that National City needed to pull back. The following year, the bank sold its subprime lending operation to Merrill Lynch, but by then it was too late to get rid of the loans. As defaults rose, so did losses, and the bank could no longer persuade investors to lend it the money it needed to survive.

…In January 2005, National City’s chief economist had delivered a prescient warning to the Fed’s board of governors: An increasingly overvalued housing market posed a threat to the broader economy, not to mention his own bank and others deeply involved in writing mortgages.

The message wasn’t well received. One board member expressed particular skepticism — Ben Bernanke.

Fed’s approach to regulation left banks exposed to crisis

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