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updated 4/18/2010 3:35:17 PM ET 2010-04-18T19:35:17

Federal Deposit Insurance Corp. chairman Sheila Bair is denying that the FDIC could have done more to prevent the largest bank failure in U.S. history.

Bair says the FDIC could not invoke its power as backup regulator of Washington Mutual Inc. because other regulators found the bank to be stable. WaMu's main regulator refused to downgrade WaMu's rating in 2008 over the FDIC's objections.

The FDIC's inspector general said earlier Friday that the FDIC could have done more given its concerns about WaMu and the bank's size.

Bair is testifying before a hearing of the Senate Permanent Subcommittee on Investigations.

Sen. Carl Levin, the chairman of the panel, on Friday blasted federal bank regulators, saying they ignored mounting risk at Washington Mutual and then fought among themselves as the bank collapsed.

The Michigan Democrat said that regulators "saw the shoddy lending practices, saw the high-risk lending, saw the shoddy securitizations, understood the risk, but let the bank do it anyway."

Friday's hearing focuses on regulatory failures that contributed to WaMu's failure. It follows an 18-month investigation by the subcommittee.

Levin aimed his harshest criticism at the Office of Thrift Supervision, WaMu's main regulator, which he said "was more of a spectator on the sidelines, a watchdog with no bite, nothing problems and making recommendations, but not trying to correct the flaws and failures it saw."

"OTS wrung its hand as the bank sank into deeper and deeper waters," he said.

A Treasury Department watchdog told the panel that regulators trusted the executives of Washington Mutual to correct risks at the bank but did little to force a change — leading to the biggest U.S. bank failure.

Treasury Inspector General Eric Thorson said that OTS officials "accepted assurances from WaMu management and its board of directors that problems would be resolved."

Thorson said "OTS did not ensure that WaMu corrected those weaknesses."

WaMu engaged in increasingly risky lending starting in 2002. The bank originated some of the highest-risk mortgages — those that allow borrowers to pay so little their debt level actually increases over time.

It also bought loans from outside mortgage brokers, often without ensuring the loan applications were complete and accurate, the Senate panel charges.

The mortgages had high rates of default but WaMu nevertheless packaged them into investments and resold them through the financial system.

"Together, WaMu and (its mortgage lender) Long Beach dumped hundreds of billions of dollars of toxic mortgages into the financial system like polluters dumping poison in a river," Levin said.

Decrying the cozy relationship between regulators and bankers, Levin pointed to an e-mail in which then-OTS chief John Reich called WaMu CEO Kerry Killenger "my largest constituent assetwise."

OTS was funded with fees from WaMu and other regulated banks. WaMu's fees made up 12 to 15 percent of the agency's budget — more than any other bank's.

The hearing is part of a series of probes into the causes of the financial crisis. The panel sparred with WaMu executives Tuesday.

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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