Post-Mortems Reveal Obvious Risk at Banks

The coroner’s report left no doubt as to the cause of death: toxic loans.

That was the conclusion of a financial autopsy that federal officials performed on Haven Trust Bank, a small bank in Duluth, Ga., that collapsed last December.

In what sounds like an episode of “CSI: Wall Street,” dozens of government investigators — the coroners of the financial crisis — are conducting post-mortems on failed lenders across the nation. Their findings paint a striking portrait of management missteps and regulatory lapses.

At bank after bank, the examiners are discovering that state and federal regulators knew lenders were engaging in hazardous business practices but failed to act until it was too late. At Haven Trust, for instance, regulators raised alarms about lax lending standards, poor risk controls and a buildup of potentially dangerous loans to the boom-and-bust building industry. Despite the warnings — made as far back as 2002 — neither the bank’s management nor the regulators took action. Similar stories played out at small and midsize lenders from Maryland to California.

What went wrong? In many instances, the financial overseers failed to act quickly and forcefully to rein in runaway banks, according to reports compiled by the inspectors general of the four major federal banking regulators. Together, they have completed 41 inquests and have 75 more in the works.

Current and former banking regulators acknowledge that they should have been more vigilant.

“We all could have done a better job,” said Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation.

The reports, known as material loss reviews, delve into the past, but their significance lies in how they might shape the future. As another wave of bank failures looms, policy makers are considering a variety of measures that would generally strengthen banks’ finances and limit their ability to lend money aggressively in risky areas like construction. Bankers contend that such steps would not only hurt their businesses but also the broader economy, because they would throttle the flow of credit just as growth is resuming.

But while the worst seems to be over for the banking industry as a whole, many lenders are still in danger. The havoc caused by the collapse of the housing market is now being exacerbated by the deepening problems in commercial real estate, which many analysts see as the next flashpoint for the industry.

Given the past lapses, some wonder whether examiners will spot new troubles in time. Of the nation’s 8,100 banks, about 2,200 — ranging from community lenders in the Rust Belt to midsize regional players — far exceed the risk thresholds that would ordinarily call for greater scrutiny from management and regulators, according to Foresight Analytics, a banking research firm.

About 600 small banks are in danger of collapsing because of troubled real estate loans if they do not shore up their finances soon, according to the firm. About 150 lenders have failed since the crisis erupted in mid-2007.

Many bank examiners acknowledge they were lulled into believing the good times for banks would last. They also concede that they were sometimes reluctant to act when troubles surfaced, for fear of unsettling the housing market and the economy.

Then as now, banking lobbyists vigorously opposed attempts to rein in the banks, like the 2006 guidelines that discouraged banks from holding big commercial real estate positions.

“Hindsight is a wonderful thing,” said Timothy W. Long, the chief bank examiner for the Office of the Comptroller of the Currency. “At the height of the economic boom, to take an aggressive supervisory approach and tell people to stop lending is hard to do.”

Haven Trust, founded in 2000, enjoyed a light touch from its regulators, according to its autopsy, which was completed in August.

Almost from the start, examiners with the F.D.I.C and the state of Georgia raised red flags. In 2002, F.D.I.C. officials found problems with the bank’s underwriting practices. Over the next few years, Haven’s portfolio of risky commercial real estate loans grew so quickly — by an astounding 40 percent annually — that the regulators raised questions about the dangers.

But not until August 2008 did examiners step up their scrutiny by telling Haven to raise its capital cushion. A month later, the regulators issued a memorandum of understanding, known as an M.O.U., ordering the bank to limit its concentration of risky loans.

Haven’s examiners “did not always follow up on the red flags,” says the report, which runs 29 pages. “By the time the M.O.U. was issued in September 2008, Haven’s failure was all but inevitable,” it concluded.