For years, the Federal Reserve received ground-level warnings about the breadth and depth of the nation’s impending subprime mortgage crisis but failed to take decisive action, according to an investigation published in the Washington Post Monday. Beginning in 1999, a cavalcade of Chicago activists regularly visited Fed regulators to warn them about predatory and unsound practices by subprime lending arms of the nation’s biggest banks in minority neighborhoods. But even as other consumer advocates and government officials joined the chorus, the Fed declined to take action against the mounting subprime bubble, the Post said. Although empowered to regulate bank lending, the Fed as a rule didn’t hold affiliate lending businesses to the same standard. As a result, bank affiliates wrote more than a million subprime loans — 13 percent of the national total — in the three years leading up to the burst. Thousands would default, deepening the economy’s crisis. “In the prime market, where we need supervision less, we have lots of it. In the subprime market, where we badly need supervision, a majority of loans are made with very little supervision,” former Fed Governor and critic Edward M. Gramlich wrote at the start of the subprime downturn. “It is like a city with a murder law, but no cops on the beat.” Now regulators are scrutinizing the Fed’s record, as Congress deliberates whether to broaden the central bank’s oversight powers or strip them all together. The White House and key legislators have made it clear they’d prefer a single new governing body, the Consumer Financial Protection Agency, to assume the banking-oversight responsibilities that are now divided between the Fed and other regulating bodies.

As a result, the Fed has been playing defense for most of this summer, with Chairman Ben Bernanke testifying to Congress that the central bank has ramped up its consumer protections. Yet many are still asking whether its past kinship with the financial industry and its free-market bias render it toothless as a regulator of non-bank subsidiaries. The controversy has its roots in a January 1998 policy decision in which the Fed’s Board of Governors unanimously agreed “to not conduct consumer compliance examinations of, nor to investigate consumer complaints regarding, nonbank subsidiaries of bank holding companies.” Even though the Fed regulated lending by the bank holding companies, they began passing complaints about non-bank subsidiaries to the Federal Trade Commission, where they foundered. That decision was part “a long period when things were going very well and regulation was viewed as something that got in the way,” said Alice Rivlin, the Fed’s vice chairman from 1996 to 1999. The result: Within five years, the banking industry had largely absorbed the consumer finance industry, and banks’ subsidiary financial arms were responsible for at least 12 percent of the nation’s high-interest mortgages, the Post said. Abuses quickly racked up, particularly as the sketchy lending arms of some banks — Wells Fargo Bank and Citigroup among them — began engaging in discriminatory lending practices to write more subprime loans. Wells Fargo, for example, “charged high interest rates on only 9 percent of its loans between 2004 and 2007,” the Post said. “Wells Fargo Financial, which used the same stagecoach logo and the same red-and-yellow color scheme, charged high rates on 80 percent of its loans during the same period. The disparities were similar at Citigroup and HSBC.” That raised alarm bells with some regulators — but not with the Fed, the one agency in a position to make an immediate difference.“The significant amount of subprime lending among holding company subsidiaries, combined with recent large settlements in cases involving allegations against such subsidiaries, suggests a need for additional scrutiny and monitoring of these entities,” the GAO said. Yet until the bubble burst, the Fed denied that all those numbers added up to a systemic problem. “I stood up at a Fed meeting in 2005 and said, ‘How may anecdotes makes it real?’” Margot Saunders of the Washington-based National Consumer Law Center told the Post. “How many tens or thousands of anecdotes will it take to convince you that this is a trend?”