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• Fears for other building societies after Dunfermline's collapse
• 'Cynical, rapacious' bankers targeted building society execs
• Plunging house prices and rising unemployment accelerating mortgage defaults
A former Financial Services Authority supervisor has accused the City watchdog of "turning a blind eye" in its regulation of building societies, allowing them to be "eaten alive" by investment bankers.
Vince Cable, Treasury spokesman for the Liberal Democrats, has written to Lord Turner, the FSA chairman, asking him to investigate the claims which he described as a "scathing indictment" of FSA regulatory practice, according to a report in today's Financial Times. "What may surprise you is the extent to which the problems continue and pose a threat to other societies," Cable wrote.
On Wednesday, credit ratings agency Moody's delivered a shock warning to the sector when it downgraded nine building societies to near junk-bond status. Dunfermline building society recently collapsed under its unsustainable debts after the government refused to bail it out.
The whistleblower, who is reported to have been a supervisor at the FSA's retail firms division but now works in the City, contacted Cable just days before the Moody's downgrade.
The former FSA employee said: "I witnessed trusting and naive provincial building society executives and non-executives, who had no real understanding of securitisation or structured finance or any other aspect of the workings of global capital markets, being eaten alive by cynical, rapacious and short-termist investment bankers."
Other experts have also warned that building societies across the country could follow in the steps of Dunfermline. Plunging house prices and rising unemployment are accelerating the rate of loan defaults, challenging smaller building societies which, unlike banks, cannot access investors in the equity markets to shore up their books.
During the credit boom, lenders such as Dunfermline aggressively expanded into new areas such as commercial real estate, self-certified borrowers or buy-to-let mortgages. Deal fees soared – until the downturn, when borrowers could not pay their bills.
The whistleblower said "building societies have only ever been able to do one thing well: provide residential mortgages to prime borrowers". He criticised the failure of the FSA to prevent them venturing outside their areas of expertise into specialised lending during the boom.
In particular, in 2005 and 2006 big mortgage books were sold by wholesale lenders to building societies. The loans in those books were categorised as "full status" - but did not contain any proof of borrowers' incomes.
"We had unearthed incontrovertible proof that societies had been paying big prices for what were ostensibly the safest residential mortgages but were in fact risky self-certification loans," the former FA supervisor said. "FSA management turned a blind eye."
He added: "A culture of apathy and complacency marked the FSA in the period of its nadir, with anyone standing up against light-touch official policy criticised for rocking the boat and branded a troublemaker."
Even though building societies are still generally considered to be safe and sound, he warned that they had become "highly vulnerable" in recent years due to lowered asset quality, increased reliance on funding from the wholesale markets and undercapitalisation.
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